EJC H2 Economics Examiners' Report 2024

EJC 2024 H2 Examiners’ report 1 Question 1: Towards sustainable fashion (a) With reference to Table 1, what can be concluded about the change in world price of cotton in 2022. [2] Production increase indicating an increase in supply while consumption fell indicating a decrease in demand resulting in a surplus [1]. Hence overall price of cotton in 2022 fell [1]. Or In 2022, there is a surplus as production is more than consumption [1]. A surplus result in a downward pressure on price hence overall price of cotton in 2022 fell [1]. (b) With reference to Figure 1 and Extract 1, explain one demand and one supply factor that could impact world cotton prices. [4] DD factor: “Shoppers have increasingly opted for alternative fabric” (Extract 1). Polyester, which is a substitute for cotton, is “ cheaper and quicker to produce”, hence the lower cost of production increases supply of polyester resulting in a decrease in price of polyester [1]. Since polyester and cotton are substitutes, the lower price of polyester (increases quantity demand of polyester and decreases the demand for cotton leading to a decrease in world cotton prices [1]. SS factor: As mentioned in Extract 1, “low prices for corn have pushed farmers in Brazil to plant cotton instead, resulting in a sharp rise in cotton production.” This has increased the number of sellers producing cotton since cotton and corn are in competitive supply as they use the same resources for production. This increases the world supply of cotton leading to a decrease in world cotton prices [1]. (c) Some governments thus implement programs such as minimum support price to support farmers (Extract 2). Explain how the above price control supports farmers and one possib le unintended consequence of the policy. [4] A price floor is a legally established minimum price. F armers affected are permitted to sell the goods at prices at or above the minimum price. A price floor is only effective if it is set above the equilibrium price (or shown on diagram) [1]. A price floor that is set below the market equilibrium price has no effect at all because the market equilibrium price is still attainable. With the implementation of price floor, price of cotton increase from P to Pf. Quantity demand fell from Q to Q1 and quantity supplied increases from Q to Q2. There is a surplus of Q1Q2. Initially the farmers income is 0PEQ. Assuming the government buys back the surplus Q1Q2, the income of farmers increases to 0PfBQ2 [1].

EJC 2024 H2 Examiners’ report 2 Or Assuming that demand of cotton is price inelastic as with agricultural goods, The increase in price, because of the price floor, decreases quantity demanded less than proportionately. Overall income of farmers will increase to 0PfAQ1 [1]. Unintended consequence (2m) • Allocative inefficiency - deadweight loss of area CE due to changes in consumer and producer surplus • A price floor might cause firms to be even more inefficient. This is because the high prices might not motivate firms to find a more efficient method of production and to reduce their cost of production, if their profits are being protected by price floors. The high price might discourage firms from producing alternative goods which they could produce more efficiently, or which are in higher demand, because these alternative goods have a lower equilibrium price. A B

EJC 2024 H2 Examiners’ report 3 (d) (i) Synthetic material like polyester, for example, should be taxed to reflect its true cost (Extract 3). Explain what is meant by ‘true cost’ of polyester. [2] The ‘true cost’ of a good in a market reflects all costs involved in producing and/or consuming it. The ‘true cost ’ is the marginal social cost (MSC) which is the sum of Marginal Private Cost (MPC) and Marginal External Cost (MEC) [1]. In the production of polyester, the MPC is the costs incurred by the firm eg to purchase factors of production and the MEC is the healthcare cost to third parties, for example people living near the factories that produces polyester, as “it is derived from nonrenewable resources, requires a great deal of energy for extraction and processing and releases significant byproducts” (Extract 3), in the process of production, harmful toxic waste could be released in to the air and water. [1] (ii) Discuss the appropriateness of UK’s government plan to tax polyester to ensure that its ‘true cost’ has been accounted for. [8] Negative externality in production exists when there are costs borne by third parties due to the production of a good or service, for which they are not compensated. Due to the negative externality in production, the social costs of producing polyester are higher than the private cost (MSC>MPC). T he MSC lies above the MPC by a vertical distance equal to marginal external cost (MEC). Assuming no positive externalities, the marginal private benefits (MPB) is equal to marginal social benefits (MSB). In the pursuit of self - interest, the firm considers only its private benefits and private costs when producing polyester. This leads to the market equilibrium output QP, where MPB=MPC. However, the socially optimal output is given by QS, determined by the intersection of the MSB with the MSC. Since QP>QS, the firm over - produces polyester , leading to an over -allocation of resources leading to allocative inefficiency and hence market failure. How taxation works to solve market failure The government could impose a tax per unit on production that is equal to the marginal external cost (MEC). An indirect tax on production has the same effect as an increase in the cost of production of the firm. Thus, the firm is forced to internalise the external costs it inflicts on third parties. The firm will C QS QP A MPC MSC Quantity B Cost/benefit MPB=MSB MEC

EJC 2024 H2 Examiners’ report 4 reduce its output level to the socially optimum output because of the higher cost and lower profits, ceteris paribus. The free market originally produces at Q P. The government could impose a tax per unit equals to MEC at Qs. In doing so, the tax forces firms to internalise the external costs caused by the firm. This shifts the MPC curve vertically upwards to MPC+Tax by the amount of tax, which now coincides with MSC. As a result, firms produce at QS. Hence, allocative efficient output is achieved, and the initial deadweight loss is eliminated. Limitations (therefore inappropriateness) of the policy The main problem of using taxes is a lack of information of how much to tax The damage from pollution is extremely difficult to assess, especially so in monetary terms. An over -estimation or under -estimation of the size of the external cost would lead to over- or under-taxation, which would mean either a less than (due to overesti mation) or more than social optimum level of output is produced. However, it is not feasible to use different tax rates for different firms. Each factory produces varying amounts of externality. A newer polyester factory might emit less pollutant due to th e use of pollutant abatement technologies. Hence, the MEC caused would be less compared to the older factories. It would be costly and difficult to measure and impose a different tax rate on different firms. Evaluation Overall, a tax is appropriate as it targets the root cause of the problem of overproduction of polyester and forces firms to reduce production to the optimal level. Moreover, the tax is also appropriate in the long run, if firms find it too costly to pay taxes for their emissions, they may choose to switch to cleaner methods of production thereby reducing MEC. However, there is limit to which the tax per unit can be in