2023 ASRJC H2 Econs Prelim Paper 2 Suggested Answers

1 © ASRJC Economics Department B Anderson Serangoon Junior College 2023 JC2 Preliminary Examination H2 Economics 9570/02 Suggested Answers and Marker’s Comments Section A 1. The cocoa buyers' deal, which sets a minimum price on cocoa beans at US$2,600 per ton, aims to reduce income gaps between farmers and traders. However, it may affect cocoa beans prices and export revenues. Consequently, chocolate producers specialising in mass- produced chocolate and those focusing on artisanal creations may be prompted to look for cocoa beans substitutes such as carob beans. (a) Explain two unintended consequences for the governm ent resulting from the implementation of a minimum price on cocoa. [ 10] (b) Discuss how the implementation of a minimum price o n cocoa beans may affect the revenue of chocolate and carob beans producers. [15] Suggested answer part a)  R1: Allocative inefficiency [Can consider resource s are overallocated to cocoa production]  R2: Worsening of other macro goals or government b udget The implementation of a minimum price policy is aim ed at supporting farmers' income and improving income equity. While this policy is designed with good intentions, it often leads to unintended consequences for the government, such as economic inefficiencies and a n egative impact on macroeconomic objectives. Introduction R1 : A price floor (P 1) is a government-imposed minimum price that is set above the equilibrium price (P0) in a market. It is typically implemented with the intention of ensuring that farmers receive a certain level of income. In a free and competitive market, supply and demand determine the equilibrium price (P 0) and quantity (Q 0) of a cocoa. When the quantity supplied equals the quantity demanded at equilibrium output Q 0, the sum of consumer and producer surplus is maximised and allo cative efficiency is achieved. No other output /price combination will r esult in as much benefit to the consumers and producers as a whole. R1 : Explain how the minimum price worsens efficiency C Quantity of cocoa Q0 Q2 Q1 Price 0 S0 D0 P0 E0 P1 A

2 © ASRJC Economics Department When a minimum price (P 1) is set above the equilibrium price (P 0), producers are willing to produce at Q 2. However, due to the higher price, consumers are only willing to consume at Q 1. The implementation of minimum price will result in surplus (Q 2Q1) as the quantity supplied (Q 2) exceeds the quantity demanded(Q 1), leading to deadweight loss (ACE 0). Deadweight loss reflects the value of transactions that do not occur due to the minimum price. These are the mutually beneficial transactions that that would have taken place in a free market at the equilibrium price but are now lost because the price is artificially high. At the same time, due to higher price, producers al located more resources into the production of cocoa beans. The quantity pr oduced increased from Q 0 to Q 2. This represents an overallocation of resources an d under allocation of resources to other sectors with poten tially higher economic returns. This misallocation distorts the economy's overall production structure and hinders its ability to maximise societal welfare. To address the surplus, the government may need to intervene by purchasing and storing excess cocoa. This incurs st orage costs, which represent an additional opportunity cost. Resources used for storage could have been utilised more productively elsewhere in the economy. Moreover, if the government decides to subsidise farmers to e nsure they receive the minimum price, it diverts financial resources that could have been directed toward public services like education, healthcare, or infrastructure. This diversion compromises the potential benefits that could have been achieved by allocating funds to alternative societal needs. R2 : Worsening of Other Macroeconomic Goals - Fall in Real National Income and worsening of trade balance. The implementation of minimum price on domestic coc oa is intended to benefit domestic cocoa producers by ensuring they receive a higher income per unit of cocoa. However, this policy can have unintended consequences. Assuming that the price of domestic cocoa is above the world price, it means that it is less price competitive in the global mar ket. Importers may start seeking out cheaper alternatives, such as cocoa fro m countries where prices are not artificially elevated by a minimum p rice policy. Assuming cocoa exports constitute a substantial portion of the country's total exports, the introduction of a minimum price policy will lik ely lead to a decrease in the quantity of cocoa exported. This decrease in cocoa exports will, in turn, result in a reduction in the country's net export r evenue (X-M), causing a decline in AD. When AD decreases, it triggers a mul tiplier effect, causing successive rounds of decreased in spending and re-s pending throughout the economy, leading to a multiplied fall in the country's real national income and fall in economic growth. The fall in export revenue, assuming no change to i mport expenditure, will also worsen the country’s balance of trade. R2 : Explain the negative impact on macro performance R2 : Worsening of budget balance resulting in negative impact on macroeconomic performance. The implementation of minimum price for domestic coca results in a surplus within the country. To address this surplus and to support local cocoa R2 : Explain negative impact on govt budget and

3 © ASRJC Economics Department producers, the government will intervene by purchas ing the excess cocoa Q1Q2 from farmers. While this intervention is aimed at stabilising cocoa prices and aiding the agricultural sector, it comes at a cost to the government. The purchase of surplus cocoa will lead to an increase in government expenditure (ABQ 1Q2). However, if there is no corresponding increase in government revenue, this situation lead s to a worsening of the budget balance, resulting in budget deficit. To address budget deficits, the government might re sort to increased borrowing. This, in turn, contributes to the accumulation of fiscal debt, which is the total amount of money the government owes to creditors. Increasing fiscal debt can undermine economic stability as the re would be concerns about the government’s ability to manage it finance. Furthermore, the accumulation of fiscal debt often results in a deterioration of the country's credit rating. A lower credit rati ng can erode investor confidence even further, potentially leading to dec reased Aggregate Demand (AD) in the economy. This reduction in AD can trigger a multiplied decrease in rounds of spending and repeated spendin g throughout the economy, leading to an overall decrease in the coun try's real national income (NY). consequent neg impact on macro performance Mark Scheme Level Knowledge, Application/Understanding and Analysis Mark L3 Detailed explanation with use of diagrams of the un intended consequences for the government resulting from the implementation of a minimum price on cocoa.  Students are required to explain how the implement ation of minimum price will result in allocative inefficiency.  Students are required to explain how there is wors ening of other macroeconomic goals/budget position. 8 – 10 L2 Cursory explanation of the unintended consequences. 5 – 7 L1 Shows some knowledge of the unintended consequences. 1 – 4

4 © ASRJC Economics Department b) Discuss how the implementation of a minimum price on cocoa beans may affect the revenue of chocolate and carob beans producers. [15]  R1: Revenue of chocolate producers [PED concept]  R2: Revenue of carob produ