Jurong Junior College 2012 J1 Economics 9732 (H2) : Tutorial 2: Demand, Supply & Price Determination (Answers)

Jurong Junior College 2012 J1 Economics 9732 (H2)
TUTORIAL 2: DEMAND, SUPPLY & PRICE DETERMINATION (ANSWERS)
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Jurong Junior College 2012 (H2)
Section A: 1.
Short Questions (For Self-Reflection)
Demand refers to the quantities of a good or service that consumers are willing and able to buy at various prices over a period of time, ceteris paribus. 2. A change in quantity demanded refers to the response of demand to changes in the price of the good itself, (ceteris paribus). As shown in below, a rise in the price from 0P0 to 0P1 causes a decrease in the quantity demanded from 0Q0 to 0Q1. This is seen as an upward movement along the same demand curve, but the demand doesnt change because the same demand curve applies. Price
P1 Po Q1 Qo Quantity
A change in the demand for a good is caused by changes in any of the factors other than the price of the good itself. Diagrammatically, this is represented by a shift of the entire demand curve either to the right or to the left of the original demand curve. As shown below, an increase in demand means that the whole demand curve shifts to the right from D0 to D1. It means that at each and every existing price, the quantity demanded increases. For example, at OP0, we look at the demand curve D0, where the quantity demanded is 0Q0. When the demand curve shifts to the right to D1, it means that at the same price OP0, the quantity demanded increases to OQ'0. Similarly when the price is at OP1, the quantity demanded increases from OQ1 to OQ1.
Price
Q1
Qo
D1 D0 Quantity Q1 Qo
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3.
Complete the table for each of the products indicated below Product Scenario Underlying factor? Movement along OR shift of the demand curve? Determinant: Price of the good itself Graphically: Downward Movement. Price of the good. Determinant: Composition of consumer/population Graphically: Rightward Shift. Composition of consumer/populatio n. Determinant: Income level of consumers Graphically: Leftward Shift. Income level of consumers. Determinant: Taste and preference Graphically: Rightward Shift. Taste and preference. Determinant: Taste and preference Graphically: Leftward Shift. Taste and preference. Leftward Shift Determinant: Future expectation of price Graphically: Leftward Shift. Determinant: Leftward Shift. Price of related goods (Substitutes) Graphically:
Chicken rice
Fall in the price of chicken rice.
Diapers
Increase in birth rate.
Outdated fashion
General rise in the level of income in the economy.
Coca Cola
Jennifer Lopez endorses Coca Cola.
Margarine
Researchers found that eating too much margarine will lead to cancer. Price of Apple iPhone is expected to fall by 50% in the next month. Fall in price of Samsung Galaxy Tab.
Apple iPhone
Apple iPad
Leftward Shift .
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4. What effect will the following have on the demand for air travel? a. The H1N1 epidemic (Changes in Consumer Tastes/Preferences) Fear of contracting the disease caused many tourists to shun away from the affected areas where the epidemic struck, hence resulting in a decrease in the demand for air travel, shifting the demand curve for air travel to the left. b. Global recession (A Fall in the Level of Income) A recession can be defined as two or more consecutive quarters of negative economic growth. During the global recession, world economies experienced negative economic growth, which is usually accompanied by rising unemployment. The consequent loss of income from rising unemployment causes a decrease in the purchasing power of consumers and a fall in their ability to spend, deterring people from travelling overseas. Hence, there will be a decrease in the demand for air travel, shifting its demand curve to the left. c. The emergence of low-cost budget flight operators into the Asian flight market (Price of the good itself) The lower costs of production can then be passed on to the consumers in terms of lower air ticket prices (the price of an airline ticket become more affordable for the same destination), leading to an increase in the quantity demanded for air travel. This is illustrated by a downward movement along the original demand curve. d. A fall in the price of domestic rail transport (Prices of related goods substitutes) A fall in the price of domestic rail transport will lead to a rise in the quantity demanded for domestic rail transport. Since rail and air transport are substitutes of one another, consumers may choose instead to consume the relatively cheaper mode of rail transport, hence leading to a fall in demand for domestic air travel. This is illustrated by a shift of the demand curve to the left.
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5. It is observed in the stock market that when share prices rise, people tend to buy especially in a bull market. Does this imply that the demand curve for shares is upward sloping and contradicts the law of demand? (Expectation of Future Price Changes) Prices in the stock market are determined by the demand and supply of shares. When share prices rise, people expect that the price will rise further, especially in a bull market, so they tend to buy more. It is the expectation of a further rise in share prices that results in an increase in demand for shares, leading to a rightwards shift in the demand curve. Thus the demand curve for shares is not upward sloping and it does not contradict the law of demand. 6. Explain the effects of the increase in demand for biofuels have on the demand for crops. Since crops such as wheat and corn are factor inputs used in the production of biofuels, the demand for crops is derived from the demand of biofuels. Hence, an increase in the demand for biofuels will lead to an increase in demand for crops. Supply 1. Supply refers to the quantities of a good or service that the producers or sellers are willing and able to offer for sale at various prices over a period of time, ceteris paribus. 2. A change in quantity supplied refers to the response of supply to changes in the price of the good itself, ceteris paribus. Price P1 S
P0 O0 Quantity
Q0
Q1
As shown in the figure, a rise in the price from OP0 to OP1 causes an increase in the quantity supplied from OQ0 to OQ1. This is seen as an upward movement along the same supply curve, but the supply doesnt change because the same supply curve applies.
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A change in the supply for a good is caused by changes in any of the factors other than the price of the good itself. Diagrammatically, this is represented by a shift of the entire supply curve either to the right or to the left of the original supply curve. S0 S1
D O0 0
Quantity
As shown in figure, an increase in supply means that the whole supply curve shifts to the right from S0 to S1. It means that at each and every existing price, the quantity supplied Price increases. For example, OP0, we look at the supply curve S0, where the quantity supplied is OQ0. When the supply curve shifts to the right to S1, it means that at the same price OP0, the quantity supplied increases to OQ0. Likewise at OP1, the quantity supplied from OQ1 to OQ1. 3. T I G E R S Technology Prices of Factor Inputs Government Policy (Taxes, Subsidies) Expectations of Future Price Changes Prices of Related Goods (Goods in Joint Supply, Goods in Competitive Supply) Number of Sellers
F O P
Firms Objective Other determinants of supply (like weather conditions, discovery of new sources of the good, supply shocks) Price of good itself
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4.Exceptional Supply (a) Vertical Supply Curve The supply curve may be vertical for two reasons: - There could be a fixed quantity of the good supplied because there is insufficient time to produce more of it. - There is a fixed quantity of the good because there is no possibility of ever producing more of it. Price S
Q0
Quantity
Since the quantity supplied is the same (OQ0) at any price, the supply curve is vertical as shown in the above figure. Therefore, the quantity supplied is independent of the price. (b) Horizontal Supply Curve It is also possible for the supply of a good to be infinite at a certain price. Since the price is fixed or controlled at a certain level, the supply of the good will be infinite at the fixed price OP0. Hence, there is a horizontal supply curve, as shown in the figure below. Price
O0
Quantity
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5. Corn and wheat are goods in competitive supply as both the production of corn and wheat requires the same resources such as land and labour. An increase in the price of wheat encourages the profit maximizing producers to switch to producing the more profitable product, resulting in an increase in the quantity supplied of wheat. Since the limited resources are now reallocated to the production of the wheat, producers will consequently have to reduce the supply of corn. Price Swheat S2 P1 P0 P2 Price S3 S2
Q0 Figure (a)
Q1
Quantity of wheat
Q3
Q2 Figure (b)
Quantity of Quantity Corn
Figure (a) shows that if the price of wheat rises from P0 to P1, a farmer may switch from corn production to wheat production, hence causing an increase in the quantity supplied of wheat from OQ0 to OQ1, resulting in an upward movement along the supply curve of corn. Since the land was previously used to grow corn is now used to grow wheat, there will be a consequent fall in the supply of corn because corn is in competitive supply with wheat. This results in a leftward shift of the supply curve of corn from S2 to S3, as shown in figure (b). 6. A fall in demand of ostrich meat results in lower prices. This will lead to a fall in the quantity supplied of ostrich meat. As fewer ostriches are slaughtered for their meat, less ostrich skin is available since ostrich meat and ostrich skins are goods in joint supply. As the supply of ostrich skin falls, the price of ostrich skin increases. Since ostrich skin is a factor input for ostrich skin handbags, costs of production increases and consequently profit of suppliers falls. Thus, the profit maximizing suppliers would have less incentive to supply ostrich skin handbags. Therefore, the supply of ostrich skin handbags falls.
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The decrease in price of ostrich meat from P1 to P2 results in decrease in quantity supplied of ostrich meat from Q1 to Q2. This causes a downward movement along the supply curve of ostrich meat as shown in figure (a). The supply of ostrich skin handbags decreases as well. The decrease in the supply of ostrich skin handbags is shown by a leftward shift of the supply curve from S1 to S2, as shown in the figure (b).
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7.
Product
Circumstance
(i) Identify the underlying factor. (ii) Movement along OR shift of the supply curve?
a)
Beef noodle in (i) An increase in the Change in the price of the good Singapore price of beef noodle itself An increase in the price of beef noodle would increase the profits to producers, ceteris paribus. This provides incentive to sellers to incur higher production cost so as to produce more beef noodle. This leads to an upward movement along the supply curve for beef noodles. (ii) An outbreak of mad- Goods of Joint Supply cow disease in the US An outbreak of mad-cow disease in the US would reduce the supply of beef. A shortage of beef, ceteris paribus, would cause prices of beef to rise. Sellers of beef noodles in Singapore would have to pay a higher price for beef imported from the US. With a higher cost of production, sellers would cut down on production as profit has fallen. This causes a leftward shift of the supply curve for beef noodle in Singapore.
b)
Solar energy
c)
Canned food
Advancement in solar Change in technology technology With the advancement in solar technology, producers can use the factors of production more efficiently and thus the cost of production falls. Profit margin increases and now the producers have more incentive to produce more. This increases the supply of solar energy. This causes a rightward shift of the supply curve for solar energy. The National Change in government policy Environment Agency To meet the more stringent imposes stringent requirements on personal and requirement to maintain food hygiene, canned food excellent personal and establishments would have to food hygiene incur a higher cost of production. Measures such as rubber hand 11
gloves and clean uniforms would have to be implemented to maintain a high standard of cleanliness, housekeeping and hygiene. Profit margin decreases and now the producers have lesser incentive to produce. Supply of canned food will fall. The additional cost would cause the supply curve of canned food to shift to the left. d) Cigarettes Government impose a Change in government policy higher tax on cigarettes Imposition of higher tax on cigarettes would increase the cost of production and thus the profit margin will fall and now the producers have lesser incentive to produce. Supply of cigarettes decreases and the supply curve will shifts leftward. Appreciation Singapore dollar of Change in the price of the good itself Appreciation of Singapore dollar will increase the demand for US pharmaceutical products by Singaporeans. This leads to increase in price and hence the increase in quantity supplied of US pharmaceutical product. This causes an upward movement along the supply curve for US pharmaceutical products.
e)
US Pharmaceutical Products
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Price Determination 1. Define market equilibrium Equilibrium means to be at rest, with no tendency to change. Market equilibrium can only exist if the amount that producers are willing and able to sell is equal to the amount consumers are willing and able to buy and hence there is no tendency for either party to change their decisions. Hence, market equilibrium occurs when the demand curve intersects the supply curve, where quantity demanded is equal to quantity supplied. The price that prevails in market equilibrium is the equilibrium price, 0Pe, and the quantity is the equilibrium quantity, 0Qe. 2. Explain the meaning of disequilibrium: excess demand (shortage) and excess supply (surplus) and how the market adjusts for both cases to reach equilibrium. The market is in disequilibrium when quantity demanded is not equal to quantity supplied, resulting in either a shortage or a surplus. The market will need to readjust itself till it is back in equilibrium again. A shortage (or a situation of excess demand) is defined as a situation where the quantity demanded exceeds the quantity supplied at the current price. A surplus (or a situation of excess supply) is defined as a situation where the quantity supplied exceeds the quantity demanded at the current price. [For market adjustment process back to equilibrium, please refer to Sections 3 & 4 of Topic 5: Price Determination lecture notes.]
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3.
The Agri-Food and Veterinary Authority has destroyed 11 consignments of salted duck eggs shipped to Singapore. The eggs, most of which had come from China, were found to contain the banned dye "Sudan Red". Since the ban was imposed, the price of a salted egg has gone up by around 50%, from about 22 to 35. Importers are now trying to source more eggs from Malaysia and Vietnam. With the help of a diagram, account for the change in the price of salted eggs. - Step 1: Demand factor tastes/preferences: Once news of the food scare becomes public, consumers are also likely to become fearful of consuming salted duck eggs, whether they are from China or other places, for fear of poisoning from the contaminated food products. This will cause a decrease in the demand for salted eggs, causes a leftward shift of the demand curve from D to D' as shown. This will result in a downward pressure on prices and quantity. - Step 2: Supply factor government policy: The destruction of stocks of salted duck eggs and the ban on the imports of salted duck eggs from China would have resulted in a leftward shift of the supply curve of salted eggs from S to S' as shown in Fig 1 below. This would have put an upward pressure on prices of salted eggs. - Step 3: Which effect dominates? [Backward induction] From the context, the price of salted eggs is seen to have risen, which shows that the fall in supply outweighs the fall in demand. - Justify why: When a primary source of supply of salted eggs from China was stopped due to the government ban, and importers required time to source for new suppliers from Malaysia and Vietnam, there will be a very significant fall in the supply, which outweighs the fall in demand. Step 4: Draw & describe diagram S Price S P1 P0
D Quantity of salted eggs
Q1
Q0
The fall in supply outweighs the fall in demand, shifting the supply curve to the left from S to S more than the demand curve shifts to the left from D to D. This results in a rise in prices from P0 to P1 and a fall in quantity from Q0 to Q1. 14
4.
"In China, cars are a luxury few can afford - though that does not stop them from dreaming among Chinas increasing millionaires, there is a growing willingness to show off their wealth. Luxury car makers like Italy's Ferrari expect the number of cars it sells in China to jump sharply. Sweden's Volvo has set up a network of maintenance and sales outlets in China. With the easing of governmental regulations, more premium cars such as BMW will be produced locally in 2005." Adapted from BBC News, 27th April 2005 With the aid of a diagram, explain one demand factor and one supply factor that have caused the rapid expansion of the luxury car market in China in recent years. [6]
Two factors: Step 1: Demand factor Level of Income: Due to the rapid growth of the Chinese economy in recent years (by an average of 8-10% annually), household disposable income has risen sharply, as can be seen by the increased number of millionaires in the country. This has resulted in higher purchasing power and greater ability to afford of the Chinese and people have begun to spend more on luxury goods such as houses and cars. OR Step 1: Demand factor Tastes/Preferences: (Another common answer will be the changing tastes and preferences of the Chinese for luxury cars as status symbols and appreciation of good quality brand names.) Step 2: Supply factor Government Policy: Due to the easing of government regulations, there is a rise in the number of foreign and local luxury car manufacturers (such as for Ferrari and Volvo) as well as an expansion of their operations in China would have resulted in an increase in supply of luxury cars. Step 3: Which effect dominates? [It doesnt matter because BOTH an increase in demand and an increase in supply will result in an increase in quantity.] The increase in demand outweighs the increase in supply.
- Justify why: With the continued economic growth in China, the combined greater ability and willingness to consume luxury cars results in a significant increase in the demand, which outweighs the increase in supply. - However, coupled with the demand rise, there is a rise in the quantity, resulting in a rapid expansion of the luxury car market, as seen in the quantity rising from Q0 to Q1.
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Step 4: Draw & describe diagram (Figure 1) Price S S P1 P0 D D 0 Q0 Q1 Quantity of luxury cars
- As shown in Fig 1, an increase in the demand for luxury cars will cause a rightward shift of the demand curve from D to D'. This will result in an upward pressure on prices and a rise in the quantity. An increase in the supply of luxury cars will result in a rightward shift of the supply curve of luxury cars in China from S to S'. This would have put a downward pressure on prices. - Nonetheless, the combined increase in both demand and supply will lead to a significant rise in quantity from Q0 to Q2, resulting in a rapid expansion of the luxury car market.
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Section B: Case Study Skills Trend Reading Exercise (Answers) Question 1 Describe the trend in coffee prices from 1977 to 1992. [2] Answer: From 1977 to 1992, coffee prices have a general downward trend with some variations. [1] There was a sharp increase in 1985. [1] OR However, there was an upward trend from 1981 to 1986. [1] Question 2(SAJC H2 Prelims) Describe the trend of Singapore governments expenditure on education from 2002 to 2007. [2] Answer: Singapore governments expenditure exhibited an increasing trend over the period, rising from S$6.4b in 2002 to S$7.2b in 2007. [1] However, there was a significant dip in 2005, where governments expenditure hit a low of S$5.97b. [1] Question 3 (HCI H2 P1) Describe the trend in car traffic volume in UK from 1950 to 2008. [2] Answer: The car traffic volume shows an increasing trend. [1] It is increasing at a decreasing rate. [1] Question 4 (RJC H2) Describe the trend of Japans wine imports between 1997 and 2006. [2] Answer: Japans wine imports have been experiencing an overall increasing trend between 1997 and 2006. [1] The largest source of imports is coming from Italy. [1] Question 5 Compare the change in average monthly earnings for all industries with the change in average monthly earnings of those employed in Financial Services from 2001 to 2003. [2] Answer: Monthly earnings are rising for both all industries and financial services. [1] The increase in all industries is 4.8% while the increase in financial services is 17%. Hence, the increase in financial services is higher than that for all industries. [1]
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Question 6a Describe what happened to total world steel production between mid-1998 and mid-1999. [2] Answer: Between mid-1998 and mid-1999, total world steel production fell throughout the period. This is observed from negative percentage change over this period. [1] The total world steel production was decreasing at an increasing rate from mid-1998 to early 1999. However, the total world steel production was decreasing at a decreasing rate from early 1999-mid-1999. [1] Question 6b What happened to world GDP between 1996 and 1997? [2] Answer: GDP increases between 1996 and 1997 [1] at a constant rate. [1] Question 7a Are general prices higher in 1989 compared to 1988? [2] Answer: Yes. [1] Although the initial absolute prices are not known, it can be deducted from the rising index number that within the same item, prices are rising over the years. [1] Question 7b Are prices higher for alcohol and tobacco in 1989 compared durables? [2] Answer: Data is insufficient to make a conclusion since we do not know the starting absolute price for each different item. [1] Index numbers cannot be used for comparison over different items. [1] Question 7c Are the numbers in dollars? [1] Answer: No. These are index numbers and they are not in dollars. [1] Question 8 (A-level 2007) Compare the change in retail sales in Singapore by type of outlet between 2000 and 2004. [2] Answer: The sales had risen in all types of outlets over the period. [1] Sales have increased the most in supermarkets. [1] OR Sales have increased the least in departmental stores. [1] (Note: Figures in table refer to retail sales but they are in index numbers and not in money terms. One cannot say that sales in supermarkets are higher than that in departmental stores.) 18
Section C: Mini Case Study Extract 1: Comfort raises basic cab fares Determinants of Demand 1. Population size The increase in population in the recent years and huge increase in the tourists visiting Singapore leads to an increase in demand for taxi services in Singapore. 2. Expectations of future income change Due to an uncertain economy consumers are becoming pessimistic. Since they are insecure about their future incomes, the consumers are more likely to save their money for the other necessities rather than spend on luxury items like taxis. This causes demand for luxury goods like taxi services to fall. Determinants of Supply 1. Price of factor inputs As mentioned in the extract, the cost of production has risen for the taxi drivers. Since taxi companies are typical profit-maximizing firms, when the cost of production rises, profits fall and hence they will produce less to reduce their losses. When the price of factor inputs, like petrol rises there will be a consequent fall in the supply of taxi services (ceteris paribus). Extract 2: Bak Kwa sales stay strong despite high prices Determinants of Demand 1. Taste and Preferences of Consumers Buying Bak Kwa during the Chinese New Year is a tradition which the Singaporeans follow. Consumers taste changes in favor of this good during this festival and thus will cause the demand for Bak Kwa to increase. 2. Changes in the level of income A stronger economy means an increase in the level of income. This results in increasing the purchasing power of consumers which in turn increases the ability to afford Bak Kwa. As Bak Kwa is a normal good, the consumers will increase their demand for Bak Kwa as their income rises. Determinants of Supply 1. Change in weather The pork which is used to prepare Bak Kwa is mainly transported from other countries (like Malaysia and Philippines). Due to unfavourable weather conditions in these countries, the supply of the pork is disrupted. Consequently, there is a decrease in the supply of Bak Kwa. 2. Price of factor inputs Pork is used to produce Bak Kwa. Since price of pork has gone up, the cost of producing Bak Kwa has risen and profits have fallen. Since Bak Kwa producers are profit-maximizers, producers now have less incentive to supply Bak Kwa. This would lead to a consequent fall in supply of Bak Kwa (ceteris paribus).
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Extract 3: Rice Prices Soar on Supply Shortages and Rock a Buoyant Economic Boat Determinants of Demand 1. Changes in the climate/ weather First, a series of typhoons in Philippines have destroyed crops in the country resulting in a surge in importation of rice from Philippines. Likewise, India who is also hit by the driest monsoon in four decades ever is turning from a net exporter of rice into a net importer for the first time in two decades. In addition, the large population size of developing countries China and India also added to the already increasing demand for rice. 2. Changes in the Level of Income Second, Asia is leading the world economy out of recession and we expect income levels to rise in tandem with the road to recovery. In particular, emerging markets like China, India and Indonesia who are populous in their respective regions are setting the pace for renewed growth in Northeast Asia, South Asia and Southeast Asia respectively. The rise in income leads to an increase in the purchasing power of the consumers. Thus, the consumers now have greater ability to afford more rice. Consequently the demand for rice, which is considered as a normal good (necessity) rises. Determinants of Supply 1. Government Policy Poor families spend 40% of their income on rice, which is a key determinant in reducing poverty. Rice is a necessity for the population and a shortage of rice is likely to trigger riots. Thus, governments of rice-importing countries have to ensure to hoard sufficient stocks of rice available so as to guarantee adequate social welfare and political stability amidst the recovery from economic crisis. The act of hoarding to ensure sufficient rice stocks will then decrease the supply of rice in the world market. 2. Weather/ Climate Monsoons in India, a series of typhoons in Philippines and droughts elsewhere like in Australia, coupled with poor harvests in parts of Asia have led to a fall in supply of rice. This is evident in that India has turned from a net-exporter of rice into a net importer of rice. However, Thailand and Vietnam have seen higher yields and these increase in supply were used to meet the surge in demand from Philippines and India who was previously a net exporter. In addition, Indonesias bumper harvests also only increased rice supply slightly. In sum, there is an increase in the supply of rice globally by Thailand, Vietnam and Indonesia but some of these are offset by the bad weather conditions that plagued Philippines and India. Thus, supply is likely to increase only slightly on the whole.
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Section D: Case Study Question: The Market for Tea and Coffee (a) (i) Calculate the percentage change in the price of coffee and the percentage change in the price of tea between 1995 and March 2004. [2] The price of coffee was 54.7% lower (or fell by) [1m M]. The price of tea was 16.8% higher (or rose by) [1m M]. (ii) Compare the trend in the price index of all beverages with that of tea between 1999 and 2004. [2] Both have an overall falling trend [1 mM] and the price of all beverages falls more rapidly than fall in price of tea [1m M] or Index of all beverages rises since 2002 while tea continues to fall [1m M] or Price of beverages started to rise in 2002 whereas price of tea rose in 2003 [1m M]. (iii) Explain whether the data shown in Table 2 is always consistent with the changes in the price of coffee shown in Table 1. [2] From 1998 to 2002, table 2 shows that world production always exceeds consumption. At the same time, price of coffee in Table 1 shows that prices are falling. This is consistent with the theory that surplus causes prices to fall. [1M] However, production exceeds consumption in years 2002/2003, suggesting downward pressure on prices but according to Table 1, price of coffee is rising [1 M].
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Extract 2: Indian tea: overflowing cup of woes Indias 13,000 tea gardens with a workforce of 2 million people have made Indian tea the pride of the world. Yet most of the legendary names in the tea industry are in trouble. The industry says that multinational beverage companies like Coca-Cola and Pepsi are drawing away Indian tea drinkers. Indian youth would rather grab a bottle of Coke than a cup of tea, said a tea planter adding that, suddenly tea drinking is not fashionable anymore. In addition, exporters from Sri Lanka, Kenya and other tea-producing countries are aggressively going after Indias traditional export markets, as Indias tea exporters remain complacent. Indeed nothing seems to be going well for the Indian tea industry, the worlds largest, with annual production exceeding 864 million kilograms. With years of increasing costs and declining revenues, the Indian tea industrys growers are pushed to the limit. World demand for tea is growing, but Indias exports are falling in the face of competition from newcomers like Indonesia and Vietnam, as well as old rivals like Sri Lanka and Kenya. All these factors are leading to sliding profit levels and a large accumulation of stocks for the industry. In fact sales of Indian tea in world markets have been declining at 1.5% a year for the past five years. In the domestic market too Indian tea is facing challenges from cheap imports from countries such as Nepal, Vietnam and Indonesia, encouraged by the removal of quantitative restrictions on imports in 2001. Last year at 22 million kilograms imported tea took up only 3% of the market, but this was a rise from just 1% three years ago. Some say that the tea industry stayed complacent even as colas and sodas took over the market and imported tea provided competition and even traditional drinks like coffee were promoted into fashionable drink status. The Indian tea plantation industry is suffering terribly, says Chandrakant Dhanuka, President of the Indian Tea Association. So much so that the future of the entire Indian tea industry has been called into question. Source: Asia Times, 20 November 2003
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(b) (i) Use demand and supply curves to explain the changes in the market for tea in India. [6] Demand Factors Para 1 Line 4 Indian youth would rather grab a bottle of Coke than a cup of tea, said a tea planter adding that, suddenly tea drinking is not fashionable anymore. Fall in DD for tea Step 1: Change in Demand? As mentioned in Extract 2, Indian youth are preferring soft drinks such as Coke and Pepsi compared to tea. This change in taste and preferences causes the demand to switch away from tea leading to a fall in the demand for tea. In addition in Extract 2, it was mentioned that other exporters from Sri Lanka and other tea-producing countries are promoting their tea aggressively and capturing a greater market share in Indias export market. This also leads to a fall in demand for tea in India.
Supply Factors Para 2 Line 1 With years of increasing costs and declining revenues, the Indian tea industrys growers are pushed to the limit. Fall in supply of tea in India Para1 Line 6 and Para 2 Line 6 In addition, exporters from Sri Lanka, Kenya and other tea-producing countries are aggressively going after Indias traditional export markets In the domestic market too Indian tea is facing challenges from cheap imports from countries such as Nepal, Vietnam and Indonesia, encouraged by the removal of quantitative restrictions on imports in 2001. Rise in Supply of tea in India Step 2: Change in Supply? The supply of tea increases due to the rise of tea imports as a result of the removal of quantitative restrictions in 2001 [2 M]. However it was also mentioned in Extract 2 that costs for tea producers in India has increased. This will lead to a fall in the supply for tea in India.
Para 3 Last year at 22 million kilograms imported tea took up only 3% of the market, but this was a rise from just 1% three years ago. 23
[Synthesis]: It is likely that the fall in supply in this case is the dominating supply factor as imports constitute a very lo w proportion of the total supply.
Step 3: Which effect dominates? With a fall in demand and a fall in supply, there are 3 possible outcomes on market price and quantity. However as the fall in demand is likely to be more than the fall in supply since the change in taste is likely to be prominent, this diagram is shown and explained below. Step 4: Draw & describe diagram. Price of tea P1 P2 D1 O D2 Q2 Q1 Quantity of tea Figure: Market for tea S2 S1
As shown in the diagram above, as the decrease in demand, shifting the demand curve leftwards from D1 to D2 is greater than the decrease in supply shifting the supply curve leftwards from S1 and S2. Thus, price will fall from P1 to P2 and equilibrium quantity will fall from Q1 to Q2. (ii) Discuss whether government action to fix a minimum price for tea sold in India would be an effective way to solve the problems experienced by Indian tea producers. [8] *4- Step Approach to tackling government policy question Step 1: Describe the problem Step 2: Explain how the suggested policy works to solve the problem Step 3: Evaluate the suggested policy Step 4: Suggest alternative policies Step 1: Explain the problem The Indian tea producers encountered the problems of increasing costs and declining revenues over many years. The imposition of a minimum price for tea sets the lowest permissible price the tea producers can legally charge. Step 2: Explain how the suggested policy works to solve the problem 24
Referring to the figure below, a minimum price of Pmin means that price of tea is allowed to rise above Pmin but is not allowed to fall below it. Price G Pmin Pe H S
D 0 Qd Qe Qs Quantity
At the minimum price of Pmin, quantity demanded is OQd and quantity supplied is OQs, resulting in a surplus of QdQs in the market. Step 3: Evaluate the suggested policy 1. Producers The minimum price may help the tea producers cover the rising costs. Tea producers who are able to sell at the minimum price are better off whereas those who are willing to sell their tea at a lower price but not able to do so are worse off. If the government does not intervene, price will falls to the original market equilibrium. 2. Government Due to the surplus problem, the government is required to buy the excess supply from the tea producers and incurs extra spending of GQd QsH. There are opportunity costs incurred as the money can be used for other purposes that might benefits society as a whole more rather than just the tea producers. For example, the money can be used to improve the facilities in school and provide children with a higher quality of education. 3. Long Run Effect Furthermore, tea producers will become complacent since they are already guaranteed a minimum high price for their goods. Problem of rising costs may worsen. Lastly, the minimum price policy does not help to address the problem of declining revenue. A black market may arise, and producers who cannot sell off their tea may sell illegally at a lower price in the black market to get rid of their tea. Since there will be consumers who will be willing to purchase tea at the lower price, other legally-abiding producers who cannot sell off their tea at the minimum price and choose not to get rid of their excess tea in the black market will be worse off even in the long run because they will still suffer from declining revenues. 25
Step 4: Suggest alternative solutions Instead, the government must find out the root cause of the problem which is (i) increasing cost and (ii) declining revenue. Rising Cost More R&D to find out more cost effective production methods or to increase the yield Encourage more competition so that the local tea industry stops being complacent. Declining Revenue Increase demand by improving the quality through more competition Increase demand by turning peoples taste or preferences towards Indian tea. For example, advertising tea drinking at a hip, cool and upmarket lifestyle. Increase quantity demanded by lowering prices Possible if the cost of production of tea can be successfully lowered. In conclusion, the minimum price legislation would not be the solution for the Indian government, as it does not solve the root cause of the problem. L3 Applies the effect of minimum price legislation to this case and discusses its effects, e.g. how government addresses excess supply problem and the lack of impact if the minimum price is set below equilibrium. Correctly analyses minimum price legislation when the price set is above the equilibrium price using diagram. Makes some relevant comment but without any appropriate analysis. 78
L2 L1
46 1-3
[20 marks]
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Section E: Essay Questions Price Determination Sales of adult fiction in hardback had fallen by over 10%, while cheaper paperback by only 6%. The price people are willing to pay is falling, while hard-cover prices are climbing. The Association of American Publishers announced that the explosive growth of e-books account for 13.6% of adult fiction market in America, with burgeoning e-books sales increasing by over 1000% in the last three years after the launch of the e-book reader. Adapted from: The Daily Telegraph August 2011 1a) Explain the likely reasons for the overwhelming increase in sales volume of e-books. [10] [2011 H2 NYJC Prelim EQ1] Outline Synopsis: To look into the different factors affecting the overwhelming increase in sales of e-books. The sales of e-books are represented by an increase in the equilibrium quantity of e-books. Backwards induction: Possible scenarios -increases in demand and supply of e-books. - Increase in demand > decrease in supply. Step 1: Explain the change in demand using demand determinants Fall in price of eBook readers ( Complements) eBook readers and eBooks are goods that are used in conjunction with one another. With the advancement in technology, there is an increase in efficiency in the production process, leading to lower cost of production. This is passed on to the consumers in terms of lower prices. Thus, eBook reader falls. When the price of eBook readers fall, the quantity demanded of eBook readers increases. Since eBook readers and ebooks are complements, although the price of eBooks remains unchanged, consumers who are buying eBook readers will need to consume eBooks as well. Therefore, the demand for eBooks increases. This is why sales of eBooks increases by over 1000%. With the robust economic growth, there is an increase in the level of income 27
Essay Introduction E-book prices are determined by the demand and supply forces. The equilibrium price is determined at the level at which the quantity demanded is equal to the quantity supplied The increase in sales of e-books can be attributed to changes in both demand and supply factors. An eBook is a book in electronic format. It is downloaded to a computer, PC, Mac, laptop, PDA or any other kind of computer, and is read on the screen. It can have numbered pages, table of contents, pictures and graphics, exactly like a printed book.
Increase in level of income
of the consumers. Consumers purchasing power and the ability to afford the eBooks increased. People may read eBook as a form of entertainment or leisure. As eBook is a normal good, the demand for eBook will increase as the income level increases. Due to the increase in use of technology, consumers own IT products such as laptops and iPads. Thus, there is a preference to download the e-book as it is easy to store, environmentally friendly and contain the feature of showing links for easy access to more information. Thus, demand for eBooks increases. The increase in price of traditional hard cover books makes them less attractive to consumers and hence, e-books can be consumed in place of hardcover books. Furthermore, with the convenience of books to allow consumers to read on the go, it will make EBooks a stronger substitute to hard cover books. When the price of a hard cover book increases, the quantity demanded for hard cover books falls. Consumers will find hard cover books relatively more expensive as compared to e books and hence switch to reading e-books, which are substitutes of hard cover books, instead. This will result in an increase in demand for eBooks. Overall, the demand for eBooks increases.
Change in taste and preferences
Increase in price of related goods Substitutes Hard covered books and eBooks
Synthesis Step 2: Explain the change in supply using the supply determinants Lower cost of producing eBooks due to improved technology Increasing number of firms creating ebooks due to high profits offered by eBooks Synthesis Step 3: Which effect dominates? Justify. # An increase in both demand and supply of eBooks will lead to an increase in quantity of eBooks. Thus, as long as the dominating effect is
With the advancement of technology of eBooks platform and e-distribution online, there is a lower cost in producing eBooks with the improved technology. Thus, profits increases and firms, having the objective to maximise profit will have a greater incentive to increase the supply of eBooks. Furthermore, due to the high profits earned by the sale of eBooks, it seems like eBooks are in an increasingly profitable sunrise industry. Being profit maximisers, thus may lead to an increase in number of e-publishers online. This will also increase the supply of e Books. Overall, the supply of eBooks increases. The most significant non price determinant will be the preferences of consumers that have changed in this digital age. Consumers demand and prefer eBooks to traditional books. This is probably due to the hectic lifestyle of people and thus purchasing a book online on the way to work brings about more convenience. This coupled with an increasing ability to afford such consumers tastes, help contribute to the increase in demand further. Therefore, the increase in demand will outweigh the increase in supply of e-books. #
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justified, It doesnt matter which effect dominates. Step 4: Diagram (Draw + Describe)
Conclusion
As shown in Figure1 below, the equilibrium price is OP1 and the equilibrium quantity is OQ1. The increase in demand of eBooks will shift the demand curve more significantly rightwards from D to D than the increase in supply shifts the supply curve rightwards from S to S. This will result in an increase in sales volume of eBooks from Q0 to Q1. In the future, perhaps advancement in technology will result in more innovative gadgets for eBooks. With an increase in accessibility to a greater variety of eBooks, the demand for eBooks may increase even further, resulting in higher sales volume of ebooks.
2) Are the demand or supply factors more critical in explaining rising housing prices in Singapore? [12] Outline Introduction Definition Essay The increase in housing prices can be attributed to changes in both demand and supply factors. The equilibrium price is determined at the level at which the quantity demanded is equal to the quantity supplied. Housing prices refer to both the public housing and private housing prices. The demand determinants that affect the housing prices are government policies, increase in level of income, population size. We will also examine the supply determinants, which are cost of factor inputs, government policies and level of technology to determine which factors are more critical in explaining rising housing prices. As the government has the objective of encouraging home ownership in Singapore, they have implemented some policies that are in line with the objectives. These policies are implemented to assist Singaporeans in their public housing purchase of HDB flat and private homes.
Summary of analysis
Step 1: Explain the change in demand using demand determinants
1) Government policy i) Interest Rate/Ease
Firstly, as home ownership involves a long-term commitment, the government changes it policy in 1968 to introduce the buying of public flats through CPF. This change offers flat buyers mortgage loans at concessionary interest rates pegged at 0.1% above the Central Provident Fund (CPF) Ordinary Account 29
of credit
interest rates. This rate is significantly below the market interest rates charged by private banks. With a lower interest rate, the cost of borrowing decreases. Thus, it is more affordable now to buy homes. With easier means to get loans, there is easier availability of credit available. Consumers can now afford these homes thus demand for homes increases. Secondly, the government also allows Singaporeans to finance private property with remaining leases of at least 30 years from the CPF savings in 1995. A flat or private property buyer has to use between 18% and 23% of his monthly income to service the monthly mortgage installments. As employees in Singapore have been required to save a percentage of their monthly income into their CPF, the flat or private property buyer, who is employed, is able to use CPF funds as the mortgage repayment mode. With the ease of payment modes available, the demand for housing increases. In the 2011 National Day Rally Speech, PM Lee announced the change in monthly income cap for public housing. There was a rise in the monthly income cap for public housing to be from the current S$8,000 to S$10,000 while for Executive Condominiums, the ceiling will be raised from the current S$10,000 to S$12,000. This government policy will allow more Singaporeans to be eligible to buy both the public and private housing, leading to an increase in demand for both private and public housing. Aside from government policies, the level of income has also increased. Singapore has been experiencing positive GDP growth. The average quarterly growth was 6.36% from 2007 to 2011. This implies that many Singaporeans are generally better off with rising income, which could come from rising wages or more bonuses. Thus, with an increase in purchasing power and ability to afford, Singaporeans have the ability to buy both private and public houses. Since demand for public housing is a normal good, demand for public housing will rise with an increase in level of income. In fact, since housing takes up a large proportion of income, it can be deemed as luxury goods especially private housing. Hence, when income increases, the demand for housing, especially private housing will increase more than proportionately. Private houses are luxury goods due to its luxurious living conditions. Private properties have a larger land area and recreation facilities. With an increase in level of income, private houses may be preferred as they are seen as status symbols. Thus, more Singaporeans and foreigners will be able to purchase private housing due to the increase in purchasing power. This will result in an increase in demand for private houses. Furthermore, Singapore government implemented policies to make Singapore more competitive globally and this has enticed many foreigners (expatriates) to come to Singapore to work and relocate. The non-residential foreigners in Singapore increase by 19% in 2008. Although the growth of non-residential foreigners has slow to 4.1 per cent in 2010, there is still an increase in size of population. With an influx of foreigners coming into Singapore, population size increases. Foreigners will demand more of private and public housing in Singapore, leading to an increase in demand for housing. Overall, the demand for housing increases in Singapore. 30
ii) Raising the income ceiling for housing eligibility
2) Rising income (Level of income)
3) Population size
Synthesis Step 2: Explain the change in supply using supply Determinants. Government Policy Increase in number of sellers
There are also supply factors that cause the rise in housing prices. First, the introduction of Land Acquisition Act in 1966 has played a significant role in increasing the supply of housing. Even though Singapore has a small land area, the government ensures that there is sufficient land to build new flats. The government will acquire land through the Land Acquisition Act for new public housing. Thus, as the government ensure the availability of land for housing, the supply of housing increases. With the government policy to increase the supply of housing in Singapore, more contracts will be awarded to construction firms. The construction industry may seem to be an increasingly profitable industry. Producers, which aim to maximize profits, will have a greater incentive to set up new firms to supply housing in Singapore. This will lead to an increase in number of construction firms to build and design both private and public housing. With low-skilled migrant workers from South East Asia to form the labor force in building houses, the cost of production decreases with lower labor cost. Assuming that producers are profit maximizers, the decrease in cost of production will result in an increase in profits. This will give the producers higher incentive to construct more public and private houses. As such, the supply of housing will increase. Furthermore, with an improvement in technology, there is an increase in efficiency in the construction process. For example, the Pinnacle HDB at Duxton uses prefabrication method to decrease the cost of production. It has also won the 2010 Best Tall Building Asia & Australasia award for the being the worlds tallest housing building as it has seven blocks that is of 50 storeys each. This had result in more public housing being constructed with the same or fewer resources. This will lead to a decrease in cost of production and increase in profits which give the profit maximising producers higher incentive to construct more houses more flats can be build in the same plot of land. Thus, supply of housing increases. Overall, the supply of housing increases.
Cost of factor inputs
Improvements in Technology
Synthesis Step 3: SR: Which effect dominates? Justify In the short run, the supply of both public and private housing is fixed as it takes time to build the houses. This shows that supply for housing is perfectly inelastic in the short run. Furthermore, there is a scarcity of land in Singapore. It is not possible to expand the land area to meet the rapid influx of foreigners in Singapore in the short run. Therefore, the demand factors are more critical in explaining rising housing prices. 31 S
Step 4: Diagram (Draw and Describe)
Q0
Quantity of housing
Figure 1: Market for housing in Singapore in Short Run As seen in Figure 1, the equilibrium price is OPo and the equilibrium quantity is OQo. The increase in demand of housing will shift more significantly rightwards from Do to D1 while the supply curve remains unchanged at S. This will result in an increase in the price of housing from 0P0 to 0P1. However in the long run, the supply for both public and private housing increase to the right from S0 to S1 as the government policy of releasing land will take effect. With the above government policies that make more Singaporeans willing and able to buy houses and the rapid increase in population due to the influx of foreigners, the increase in demand will dominate the increase in supply, making demand factors more critical in explaining the rise in housing prices. As Singapore faces the problem of land scarcity, there is a limit to how much the Singapore government can do to increase the supply, hence increase in supply is limited and insufficient to outweigh the increase in demand. Nevertheless, since Singapore faced the problem of land scarcity, the government may then have to moderate the rise in demand with it being a more critical factor in affecting the housing prices. This is seen in Figure 2.
Step 3: LR: Which effect dominates? Justify
Step 4: Diagram (Draw and Describe)
Quantity of housing
Figure 2: Market for houses in Singapore in the Long Run 32

Conclusion
In Figure 2, the initial equilibrium price is OP0 and the initial equilibrium quantity is at 0Qo. The increase in demand for housing will shift the demand curve more significantly rightwards from Do to D1 than the rightwards shift in the supply curve for housing from S0 to S1. This will result in an increase in price of houses from OP0 to OP1, hence explaining the rising housing prices. In both the short run and long run, the demand for housing is more critical in determining the prices rather than the supply. In the short run, given an inelastic supply, a rising demand will cause a more significant increase in the price of housing. However in the long run, the rising prices of housing can be dampened by increasing the supply of housing.
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3 Rising food prices are beginning to lead to political instability, with governments being forced to step in to control the price of bread, maize, rice and dairy products. (a) Using economic analysis, explain the rise in food prices in many countries in the recent years. [12] (b) Discuss whether fixing a maximum price is the best way of addressing the problem of rising food prices. [13] Keywords: Explain Provide details about how something happens; give clear reasons for; account for. Rise in food prices Can only be caused by a change in demand and/or supply Intro: Rise in prices could be due to: increase in the demand decrease in the supply Must apply to the context of the food (bread, maize, rice and dairy products) industry and able to suggest relevant demand and supply factors that led to the rise in food prices The food prices are determined by the interaction of the demand and supply forces. The equilibrium price is determined at the level at which the quantity demanded is equal to the quantity supplied. The rise in food prices in many countries in the recent years can be attributed to changes in both demand and supply of food.
Body: Step 1: Increase in the demand due to factors such as: Size of Population - The rapid growth of human population has contributed towards the rise in food prices. The rate of population growth is highest in Africa and is relatively high in countries like China and India. The increase in population means more mouths to be fed and will consume more food. Level of Income - In the recent years, rapid growth in emerging economies increases the income and purchasing power of consumers. As food is a normal good, the increase in the ability to spend will cause the demand for food to rise. Due to rising incomes, consumption of food per capita increases. Thus, food prices are driven by growing demand from huge emerging economies like China, India, Russia and Brazil, which is unlikely to slacken. Derived Demand - As maize is used as an input for producing bio-fuel, the demand for maize is derived from the demand for bio-fuels. Hence, when high oil prices increase the demand for bio-fuels which are substitutes to petrol and diesel, the demand for maize increases. In 2008, a surge in the demand for maize to make ethanol pushed world stocks to record lows and prices to record highs. Expectations of Future Price Increases - In view of food shortages, there is possibility of speculative trading of food commodities. Commodity traders may bid up the price in the hope of selling later when food prices rise further. The expected future price increase causes more traders to purchase food 34
commodities now, pushing food prices to a high level. Therefore, market speculation and panic buying increase the demand for food and keep food prices high even if stocks are adequate. Consumer Tastes/Preferences (& Derived Demand) - There are also changes in diets towards a higher proportion of meat. The greater demand for meat from emerging economies will in turn fuel competition for cereals that are used as livestock feed and reduce cereals available for human consumption (derived demand for cereals). [Select 2 demand factors from above to elaborate on.] Step 2: Decrease in the Supply due to factors such as: Competitive Supply - On the other hand, farmers growing maize tend to sell the crop to bio-fuel producers as it can fetch a better price. This will reduce the supply of maize for people to buy as food. In addition, since maize and other food crops are in competitive supply, farmers tend to use limited land for producing maize as input for bio-fuel production instead of growing other food crops. Hence, supply of food crops falls, shifting the supply curve of food crops to the left. Adverse Supply Shocks - Supply shocks are exacerbating the price hikes. Bad weather has cut grain supplies from Russia, Argentina and Australia, among others. Thailand and Vietnam, the worlds two largest rice exporters, faced severe drought conditions in 2010 that threatened to undermine harvest and global supply of rice significantly. On the other hand, harsh temperatures and droughts reduced the supply of wheat sharply in the Russian Federation. As bread is made from wheat, the price of bread increases when wheat price, the price of a factor input and hence costs of production, rise. Government Policy - As soaring food prices may lead to social unrest and political instability, governments of some Asian countries hoarded stocks of rice and imposed export restrictions on rice in 2008. A ban was also imposed on wheat flour exports by the Russian Federation in 2010. These government policies reduced the global supply of food and increased food prices. [Select 2 supply factors from above to elaborate on.]
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Step 3: Which effect dominates? Increase in demand >< Decrease in Supply? (Backward induction thinking process: It doesnt matter which effect dominates in this case because BOTH an increase in demand and a decrease in supply cause price to increase.) The increase in demand exceeds the decrease in supply. Justify why Increase in demand > Decrease in Supply Weighing the relative importance of determinants In recent years, the relatively more important demand factors for food are population growth and speculative trading. Despite the bad weather conditions due to climate change and the production of bio-fuel contributing towards the fall in supply of food, the rapid population growth of the emerging economies and hence their rapidly increasing demand for a necessity like food would suggest that there is a significant increase in the demand for food, that far outweighs the decrease in supply.
Step 4: Draw & describe D-S diagram. Price P2 P1 D1 O Q1 Q2 Figure 1 As shown in Figure 1, the initial equilibrium price and equilibrium quantity are OP1 and OQ1 respectively. An increase in demand for food will shift the demand curve to the right from D1 to D2 whereas a fall in supply of food will shift the supply curve to the left from S1 to S2. The increase in demand and fall in supply of food will then increase equilibrium price from OP1 to OP2. D2 Quantity of food S2 S1
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Discuss whether fixing a maximum price is the best way of addressing the problem of rising food prices. [13] Keywords: Discuss whether: weigh the evidence for and against something (to decide whether the policy is the best way of addressing the problem) *4- Step Approach to tackling government policy question Step 1: Describe the problem Step 2: Explain how the suggested policy works to solve the problem Step 3: Evaluate the suggested policy Step 4: Suggest alternative policies Intro: Step 1: Describe the problem Market price for food is too high and a maximum price (price ceiling) is needed to protect the consumers, especially the low-income households since food is a basic necessity. The rise in food prices will hurt the low-income households the most as their purchasing power will be reduced significantly. If governments fail to intervene to control the rising food prices, protests and riots may occur and that will disrupt social and political stability. Body: Step 2: Explain how the suggested policy works to solve the problem 1. What is a maximum price (price ceiling)? A price ceiling is a legal maximum on the price at which a good can be sold. By fixing a maximum price or price ceiling on food, a government can stipulate the highest permissible price that food producers can legally charge. This means that food prices are not allowed to rise above the level set but is allowed to fall below it. In order for a price ceiling to be effective, it must be set below the equilibrium price. Price S P1 Pmax D O Q0 Q1 Q2 Figure 2 37
Price Ceiling
Quantity of food
Step 3: Evaluate the suggested policy Figure 3 illustrates the effects of a maximum price on food to address the problem of rising food prices. Without government intervention, equilibrium quantity is OQ1 and the equilibrium price OP1 is too high. With the maximum price OPmax, food producers produce at a lower quantity OQ0 while consumers are willing and able to purchase a larger quantity of OQ2. In other words, at the maximum price OPmax, quantity demanded exceeds quantity supplied, resulting in a shortage of Q0Q2. Consumers The maximum price helps consumers to purchase food to certain extent. Consumers who are able to buy food at the lower price of OPmax are better off. However, not all consumers are able to buy food at the price ceiling due to the shortage of food. Consumers who are unable to buy food at price OPmax but willing and able to pay the higher price of OP1 are worse off. Producers On the other hand, since quantity supplied is OQ0 at price OPmax, food producers sell less food and at a lower price than before the implementation of a maximum price. Therefore, food producers are worse off as total revenue earned is lower. Government The problem of food shortage at the price OPmax tends to cause panic buying of food by consumers. This will increase demand and worsen the food shortage problem further at the maximum price. Thus, the government either accepts long queues or has to introduce a system of food rationing, probably based on the size of households. Long Run Effect The implementation of a maximum price on food is likely to result in a black market. Some consumers who are unable to buy food such as rice or sugar at price OPmax will be prepared to break the law and pay a price considerably above OPmax to get hold of them. Step 4: Suggest alternative policies Besides fixing a maximum price on food, the government can consider alternative measures to (i) reduce the demand for food and (ii) increase the supply of food. Alternative Policies to (i) reduce the demand for food (Select 1 demand policy): a. Explain how policy works to solve the problem: Policies targeting at controlling population growth such as the one-child policy in China will help to mitigate an exponential growth of population and the consequent soaring food prices. Evaluate the effectiveness of the policy: However, this draconian family planning has caused a disdain for female infants, while abortion, even infanticide, of female infants have resulted in the rise in the 38
ratio of males to females among babies born in China. In addition, the administrative costs of enforcement may be high. a. Explain how policy works to solve the problem: If firms and households are able to switch to fuelefficient appliances, this will reduce the demand for fuel, including bio-fuel, and thus reducing the demand for food used for bio-fuel production. Evaluate the effectiveness of the policy: It may take time for tastes and preferences to change. a. Explain how policy works to solve the problem: To discourage speculative activities that raise food prices, there should be more transparency in the market and government should implement measures to deter traders from profiteering through such transactions. b. Evaluate the effectiveness of the policy: This requires appropriate regulations and close monitoring of market activities by the authorities. Alternative Policies to (ii) increase the supply of food (Select 1 supply policy): a. Explain how policy works to solve the problem: On the other hand, to increase the supply of food, the government can provide subsidies for farmers to grow more crops for consumption purposes instead of growing crops for bio-fuel production. Subsidies given will lower costs of production, increase profits and hence create the incentive for profit-maximising farmers to increase the supply of crops for consumption purposes. b. Evaluate the effectiveness of the policy: The amount of subsidies given would affect the effectiveness of the policy too little subsidies may not be effective in convincing farmers to switch from growing crops for bio-fuel production to crops for consumption purposes; too much subsidies may make farmers complacent in the long run and they may lose the incentive to be efficient at producing crops for consumption purposes, hence limiting the increase in the supply of crops. a. Explain how policy works to solve the problem: In addition, the government can provide funding for research and development (R&D) in the agricultural sector to improve fertilisers and irrigation system. This will help to increase the yield of food crops. To improve productivity, capital-intensive farming that uses high inputs of capital and technology will also help to increase food yield. Furthermore, new crop varieties that are more resistant to drought, salinity and temperature changes will help to meet future demand for food. b. Evaluate the effectiveness of the policy: Genetically modified crops can increase yields and lower prices but debate continues over its safety. Furthermore, in order to provide subsidies to farmers, support R&D and improve productivity, the government must have sufficient funds and a certain level of technology and expertise are required. a. Explain how policy works to solve the problem: The government can also provide better roads, rail links and cold-storage facilities. The improved infrastructure will help raise supply of food and keep prices down by reducing spoilage of farm produce. b. Evaluate the effectiveness of the policy: Time is required for the infrastructure to be in place. Conclusion 39
In conclusion, fixing a maximum price on food is not the best way of addressing the problem of rising food prices as it does not tackle the root causes of the problem. Hence, long-term measures that include investing in the agricultural sector and improving productivity of the sector so as to increase the supply of food are required and are also better ways of addressing the problem. Population control to reduce demand for food also takes time to achieve results. A combination of measures that target at increasing supply and reducing demand is required to address the problem of rising food prices.
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Jurong Junior College 2012 J1 Economics 9732 (H2) : Tutorial 2: Demand, Supply & Price Determination (Answers)

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Jurong Junior College 2012 J1 Economics 9732 (H2) : Tutorial 2: Demand, Supply & Price Determination (Answers)

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Jurong Junior College 2012 J1 Economics 9732 (H2)

TUTORIAL 2: DEMAND, SUPPLY & PRICE DETERMINATION (ANSWERS)

Short Questions (For Self-Reflection)

Fall in the price of chicken rice.

Increase in birth rate.

General rise in the level of income in the economy.

Jennifer Lopez endorses Coca Cola.

Quantity of Quantity Corn

D Quantity of salted eggs

Increase in level of income

Change in taste and preferences

Step 1: Explain the change in demand using demand determinants

1) Government policy i) Interest Rate/Ease

ii) Raising the income ceiling for housing eligibility

2) Rising income (Level of income)

Cost of factor inputs

Step 4: Diagram (Draw and Describe)

Step 3: LR: Which effect dominates? Justify

Step 4: Diagram (Draw and Describe)

Figure 2: Market for houses in Singapore in the Long Run 32

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