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ECON1048 Price Theory

Industry Analysis

1   Introduction

Decision-makers in government rely on the advice of experts when formulating policy or discharging their statutory responsibilities. In this assignment you will take the role of an expert economist, employed by a government department. An expert economist’s role in the government decision-making process is two-fold:

● Analysis: Economists use their specialist knowledge and skills to analyse the likely outcomes of policy alternatives. They then evaluate these outcomes against the government’s objectives and statutory obligations.

● Communication: Economists communicate their findings to ministers and senior public servants, who, in many instances, do not share their specialised knowledge.

This assignment will assess your aptitudes in both of these domains. You are to conduct an industry analysis based on the scenario detailed in section 2. Then use your analysis as the basis for a brief (a short report) summarising your recommendations and the associated rationale.

1.1   Formatting requirements

Your assignment must be typed using Microsoft Word, or a similar word processor. Both parts of the assignment should be included in the same document with the brief placed before the industry analysis. The document should have a professional appearance, appro-priate to a government workplace. Format your assignment as follows:

● Use A4 sized paper with all margins at least 2.5cm.

● Body text to be 12pt and black. (There is no minimum line spacing.)

● All pages to be numbered.

● DO NOT include a cover sheet or table of contents.

● Optional: Save your assignment as a PDF to ensure that your document and equa-tions appear as you intend.

1.2  Grading

There are a total of 100 marks available in this assignment (50 marks for the industry analysis and 50 marks for the brief), and the assignment contributes 40% of your grade for Price Theory. The marks allocated to each step of the industry analysis are detailed in section 3. The marking criteria for the brief can be found in the rubric.

2   Scenario

The government is about to undertake a large program of public works, repairing and upgrading bridges around the city. The Department of Economic Development, Jobs, Transport and Resources has decided that the public works will be funded, in part, by a new tax on taxi companies. The government’s rationale for the new tax is that taxi operators benefit from well maintained roads and bridges, and therefore should contribute to their upkeep.

        The Department has developed two alternative proposals for the new taxi industry tax:

1. The first proposal is to levy a tax of $2.40 per taxi trip. (Note: This tax would increase each company’s marginal cost by $2.40.)

2. The second proposal is to levy a lump-sum tax of $50,000 per day, on each taxi company, regardless of the number of taxi trips it provides to consumers. (Note: This tax would increase each company’s fixed cost by $50,000.)

Taxi companies oppose both proposals. In a submission to the Department, the companies claim that a new tax will not have the intended effect. The companies state that they will have no choice but to pass the cost of a new tax on to consumers, in the form of higher prices, and that consequently the burden of the tax will fall on their customers, not the companies themselves.

2.1 Your task

The Minister for Public Transport has instructed you to evaluate the two proposals and recommend which of the two proposals (if any) the ministry should pursue. In your recom-mendation you should consider the revenue raised by each proposal, as well as the impact that each proposal will have on both consumers and the taxi industry. In particular, you are to assess the taxi companies’ claim that it is consumers who will ultimately bear the cost of any new tax. (The minister is concerned that the public will not support the new taxes if they result in significant price rises.)

2.2   Industry structure

Two taxi companies compete in the taxi industry: Gold Top Taxis and Dark Grey Cabs. Every morning the two taxi companies each decide how many taxis to put on the road. These decisions effectively determine the total number of taxi trips that are supplied into the market on that day. Consumers have no apparent preference over taxi companies.

        Inverse demand in the market has been estimated to be,

where P represents the price of a taxi trip in dollars, and Q is the total number of taxi trips supplied into the market on a given day.

        Gold Top Taxis faces a marginal cost of MC G = $12.50 per trip. Dark Grey Cabs marginal cost is MC D = $14.00 per trip. Both companies incur fixed costs of FC G = FC D = $100,000 per day (regardless of the number of trips supplied).

3   Industry analysis

For your Industry Analysis you must complete each of the steps detailed below. The required analysis draws on content covered in lectures 6–10 (primarily lecture 9). When completing the steps you must:

● Type all equations using the ‘Insert Equation’ function (or equivalent).

● Show all of your working.

● Include sufficient written description for the reader to follow your process.

● Use appropriate notation and economic terminology.

Your audience for the industry analysis is other expert economists who may be required to review your work. There is no page limit for the Industry Analysis.

3.1   Required steps

When completing the industry analysis you should assume that firms are engaged in Cournot Competition. Use the subscript G to denote variables belonging to Gold Top Taxis, and the subscript D to denote variables belonging to Dark Grey Cabs.

Step 1: Derive the two firms’ total cost functions for the case in which there is no tax imposed on the taxi industry. (3 marks)

Step 2: Derive the two firms’ profit functions for the case in which there is no tax imposed on the taxi industry. (4 marks)

Step 3: Derive the two firms’ best response functions for the case in which there is no tax imposed on the taxi industry. (6 marks)

Step 4: Derive the long-run equilibrium firm quantities, market price, firm profits, and consumer surplus, for the case in which there is no tax imposed on the taxi industry. (8 marks)

Step 5: Repeat steps 1 to 4 for the case in which a $2.40 tax per trip is imposed on the taxi industry. (20 marks)

Step 6: Derive the long-run equilibrium firm quantities, market price, firm profits, and consumer surplus, for the case in which a $50,000 per day tax is imposed on the taxi industry. (9 marks)

4   The brief

The purpose of the brief is to communicate your recommendations to the decision-maker who commissioned your analysis. You need to provide enough information for the decision-maker to understand your recommendations, and to reach a decision on the matter at hand. However, senior government officials are extremely busy, so you must be brief.

● The maximum length for your brief is 2 pages.

● Any content in excess of 2 pages will not be read or graded.

When writing the brief remember that it is for a non-expert audience. You must avoid using specialised economic terminology and state everything in ‘plain English’. For example:

● Terms such as consumer surplus, producer surplus, and deadweight loss, have lit-tle meaning outside of economics and should be avoided. (Note: This is not a comprehensive list.)

● On the other hand, the significance of terms such as price, revenue, and profit, are generally well understood outside of economics.

The brief should not include any equations or diagrams. Tables and dollar amounts may be included as appropriate.

4.1   Template

You must compose your brief according to the template detailed on the following pages. Instructions for each required element of the brief are included within this template. These instructions are reflected in the requirements of the rubric for the task. Ensure that your brief includes each of the elements detailed in the template, and that you do not reorder, rename, or omit any of these elements.

Briefing for the (insert decision-maker’s title here)

Subject: Include a brief but descriptive subject line. Maximum length 1 line.

Hint: The subject is, in effect, the title of your brief. Compose the subject as you would the title of a report.

Prepared by: Your name here.

Core Message

Write an executive summary of the brief. Your core message should consist of three sentences: The first sentence providing a summary of the scenario. The second sen-tence summarising the key rationale for your recommendation. And the third sentence summarising your recommendation(s). Maximum length 5 lines.

        Hint: The statements in the core message should stand on their own. Provide specific information and avoid generalities. The reader should be able to understand the core message without referring to the scenario or the rest of the brief.

Recommendation

Concisely state the principal recommendation that arises from your analysis.

        Hint: Your recommendation should be stated as a clear course of action for the gov-ernment to pursue. Be precise. Avoid generalities and ambiguous statements. DO NOT explain or seek to justify your recommendation in this section. DO NOT describe the consequences of your recommendation. DO NOT state conditions or caveats for your recommendation.

Key Information

Begin your key information section with a short (1–2 paragraph) outline of the context for the brief (as detailed in the scenario), the problem under consideration, and any additional issues raised.

        Hint: These 1–2 paragraphs should set the scene for the reader. They should provide the reader with sufficient background information to understand the purpose of the brief. DO NOT use these paragraphs to foreshadow, explain, or justify your recommendation(s).

        Use the remainder of the key information section to present the rationale behind your recommendation(s). You should highlight any trade-offs involved in your recommenda-tion(s), and address any additional issues raised in the scenario. Your rationale should be presented as follows:

● Use subheadings to concisely state the key findings of your industry analysis. The maximum length for a subheading is 2 lines (1 line is preferable).

● Write a short paragraph following each subheading to briefly explain the finding.

Taken together, the findings stated in the subheadings should form a logical argument supporting your recommendation(s).

        Hint: Incorporate all information required to support your recommendation(s) in this section, regardless of whether or not the same information has been included elsewhere in the brief. Each subheading should be written as a statement of fact. DO NOT include an explanation within a subheading, leave that for the following paragraph. DO NOT assert facts that are unsupported by either the scenario or your industry analysis.

Financial Implications

Briefly summarise the direct financial implications of your recommendation(s) (if any) for the Government. Include the precise dollar amounts that come out of your analysis.

        Hint: The financial implications section should provide the reader with easy access to the financial cost and/or benefit of your recommendations to the government. This section is not a substitute for stating the financial implications elsewhere in the brief. Specifically, if the financial implications form a part of the rationale for your recommendation(s), they will need to be included in both the key information section AND the financial implications section. DO NOT use this section to summarise other market outcomes (eg. profit and price). DO NOT use this section to present arguments in support of your recommenda-tion(s). This section must be included even if there are no direct financial implications from your recommendation(s).

Begin your industry analysis on a new page following the brief.

        Hint: Use the ‘Insert Page Break’ function in Microsoft Word to ensure the page break displays correctly.