ACJC H2 Prelim 2024 P2 EQ1 Solutions

Q1. With effect from 1 July 2022, the Malaysian government has decided not to float theprice of chickens, instead a new price ceiling has been implemented. This decision wasmade tosafeguardtheinterestsof Malaysianfamiliessothat theyarenot burdenedbyrisingpricesandcost of living. Source: Channelnewsasia, 24June2022(a) SupposetheMalaysiangovernment decidestoremovethepriceceilinginthemarket forchickens. Followingtheremoval of priceceiling, explainhowthepricemechanismwill allocatethescarceresourcesandhowconsumer andproducer surpluswill change. [10] IntroductionThe price mechanism is the systemwhere the forces of demand and supply determine theprices of goods and services, and the changes in prices cause changes in resourceallocation. The price mechanismis theinvisiblehandthat allocatesscarceresources, basedon the self-interest of consumers and producers, to result in the right mix of goods andservicesfor society, i.e., allocativeefficiency.The Malaysian government hasintervenedinthemarket prior toJuly2022andhasimposeda price ceiling – this is a legally established maximum price to prevent prices from risingaboveacertainlevel, andit isset belowthemarket equilibriumprice.R1: To explain how the removal of price ceiling will affect the shortage and price ofchickens, changingtheallocationof scarceresourcesInitially, the price of the chickens in Malaysia is Pc, which is the maximumprice set by thegovernment. At Pc, the quantitydemandedisQd, andquantitysuppliedisQs, soashortageof Qs–Qdarises.Diagram1:

Should the Malaysian government remove the price ceiling, the price is allowed toincreasefromPc, andtheinitial shortagewouldcauseanupwardpressureonthepriceasconsumerstrytooutbidoneanother for thelimitedquantityof chickens.As price increases, quantity demanded of chickensfall asconsumers’ abilityandwillingnessto purchase chickens fall due to income and substitution effect (Note: thetermsincomeandsubstitution effect are optional / good to know). Hence price mechanism serves as arationing function as those consumers who are not willing and/or not able to pay for thechickens at the higher price will be rationed out of the market. This addresses theresourceallocationquestionof ‘for whomtoproduce’.At the same time, when price increases, the quantity supplied increases since it is moreprofitable for firms to produce. Hence price mechanismserves as a signaling function, asthe higher price signals topotential producerstoenter thechickenmarket. Pricemechanismalso serves as an incentive function, as the higher price motivates the chicken producersto increase output due to the possibility of higher revenues and profits. This addresses theresourceallocationquestionof ‘what andhowmuchtoproduce’.The price will keep increasing until the shortage iscleared. Eventually, themarket returnstoequilibrium where the equilibrium price is at P0, and the equilibrium qty is at Q0. Thequantity supplied increases from Qs to Q0 following the removal of price ceiling, implyingthat moreresou