MI 2023 PU3 H2 Econs EOY P2 Suggested Ans

1 Section A 1 Global wholesale gas and electricity prices were al ready rising in 2021 due to higher demand as economies reopened from Covid-19 l ockdowns, and as competition for supplies between regions intensified. Russia’s invasion of Ukraine led to sharp cuts in gas supplies to Europe, sending European natural gas prices to a record high, thus triggering a rise in electri city prices, since natural gas is required to produce electricity. To deal with the high prices, UK is imposing a price cap on energy prices. Source: CNBC, 22 Aug 22 (a) Explain how the above events may have led to the su rge in electricity prices. [10] (b) Discuss the policies that might be used by a government to mitigate the significant surge in electricity prices. [15] Question Analysis for (a): Command word = ‘explain’  explain the factors that lead to surge in electricity prices Content  Demand, Supply, PED, PES Context  Electricity market in UK Requirement 1: Rise in demand with inelastic supply will lead to surge in price of electricity Requirement 2: Fall in supply with inelastic demand will lead to surge in price of electricity Requirement Suggested answer Intro: As economies reopen and recover, there will be high er demand for electricity. Russia’s invasion of Ukraine will lead to a fall in supply of electricity as the input – natural gas has fallen. All these factors coupled with the inelastic demand and supply will lead to a surge in price of electricity. Requirement 1: Rise in demand with inelastic supply will lead to surge in price of electricity As the economies reopen, the economies will recover . This will lead to an increase in income for many households. The inc rease in income results in an increase in purchasing power and incr ease in ability and willingness to consume normal goods. Normal goods a re goods where a rise in income would lead to a rise in its demand . Electric appliances is an example of Normal goods. Electrical appliances and electricity are complement goods, as use of electricity is essentia l to ensure their

2 proper functioning of the electrical appliances. He nce the increase in income will lead to an increase in the demand for e lectricity by households. The increase in demand will lead to a shortage of electricity in the market and upward pressure on equilibrium price and increase in quantity. Firms will also tend to increase production of goods and sometimes the production of goods require the use of electricity as a factor of production. The rise in demand for electricity from D0 to D1 wi ll lead to a shortage of electricity Q0Q3 at the original price, P0. This will lead to upward pressure on the market price. As price increases, q uantity demanded falls and quantity supplied rise. This continues until equilibrium price and quantity is reached. Supply of electricity is likely to be price inelast ic due to the length and