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 moreresourceshavebeenallocatedtotheproductionandconsumptionof chickens.At the market equilibrium, allocative efficiency is achieved, which refers to the situation inwhich the societyproducesandconsumesacombinationof goodsandservices, inthiscasechickens, that maximisessociety’swelfare.R2: To explain how the removal of price ceiling may affect consumer surplus andproducer surplusPrior to the removal of the price ceiling, the consumer surplus which is the differencebetween the maximum amount that consumers are willing and able to pay for a givenquantity of chickens and what they actually pay was ABCPc, while the producer surpluswhich is the difference between the amount received by producers for selling chickens andthe minimumprice that producers are willing and able to accept for supplyingthegoodwasPcCD.With the removal of price ceiling, the price increases from Pc to the eq. price, P0. Thequantity supplied and quantityconsumedincreasesfromQstoQ0. Sinceproducersbenefitsfrom selling a higher quantity at a higher price, producer surplus increases from PcCD toP0ED.The effect on consumer surplus is indeterminate. The increase in price may increaseconsumer surplusfor thosewhowerewillingtopaythehigher pricebut wereunabletodosounder the price ceiling. However, some consumers who were able to purchase the good orservice at the lower price ceiling maynowfindit moreexpensiveandmaynolonger beabletoaffordit. Thiswoulddecreasetheir consumer surplus.The impact on consumer surplus thus depends on the relative PEDand PESvalues. If theloss of consumer surplus due to the price increase (P0FCPc) is greater than the gain inconsumer surplus due to the increase in quantity consumed (BFE), the consumer surplusdecreasesfromABCPctoAEP0.

Knowledge, Application, Understanding, AnalysisL1 - Descriptiveresponsewithout applicationof economictools- Manyglaringconceptual errors 1-4 L2 - Developedbut one-sidedexplanationoneither of therequirements- Underdevelopedexplanationof bothrequirementseg: notincludingtheexplanationof thefunctionsof pricemechanismwhileexplainingtheeffect of pricechangeonresourceallocation. 5-7 L3 - Ananalytical responsewithout gapsinexplanationonbothrequirements–includinganalysisof howtheremoval ofpriceceilingwouldaffect themarket outcomes(i.e., priceandqty), howthepricechangeaffectstheallocationofresourcesanddistributionof output, whichwill alsoincludethefunctionsof pricemechanism, andhowtheconsumersurplusandproducer surpluswill beaffected. 8-10

(b) Discusstheappropriatemeasuresthat theMalaysiangovernment canadopt toensuretheaffordabilityof chickens. [15] IntroductionIn a free market, the equilibrium price of chickens will be determined by forces of demandand supply. Due to demand or supply factors such as rising incomes or rising cost, the eq.price of chickens may rise, making it less affordablefor Malaysianhouseholds, whichwouldmeanthereisaninequitabledistributionof chickens.The government’s objective is to bring down the price of chickens, so that it will be moreaffordablefor Malaysianhouseholds, andthismaypromoteequity.To promote equity, the government may impose a price ceiling like the one prior to 1 July2022, andprovidesubsidies.R1: To explain how the imposition of price ceiling may ensure the affordability ofchickenInitially, equilibriumpriceof chickensandequilibriumqtyof chickens, P0andQ0respectivelydeterminedbyforcesof demandandsupply.Diagram2: The Malaysian government may deemthe eq. price, P0 to be too high, and may impose amaximum price of Pc, which is set at a price level below P0. At a lower price, moreconsumers especially the low income will be able to afford chickens, hence this promotesequity, i.e., fairer distributionof chickens*Note: given that thegovernment'sgoal istomakechickensaffordable, analysingtheimpactonconsumer surplusisunnecessaryEV: to consider the limitations or the constraints of imposing price ceiling to increaseaffordability● However, the imposition of price ceiling to increase the affordability of chickens maycreate a shortage in themarket (Qd–Qs). That meansresourcesareallocatedinan

inefficient manner. There will be a welfare loss of Area XBY because the socialsurplusdecreasesfromAreaABCtoAreaAXYC.EV: toapplyPEDor PEStoconsider theextent of theshortage● Prior to July 2022, the government has decided to impose a price ceiling onchickens, which may suggest that chicken is a staple food for most Malaysianhouseholds, hence the government has intervened to make it affordable. So, it islikely that PEDof chickensinMalaysiaislessthan1. WhenpricedecreasesfromP0to Pc, quantity demanded is likely to increase by less than proportionate, hence theshortage will be less severe. Hence, price ceiling might be an appropriate measure.Furthermore, to prevent a shortage the Malaysian government may use a non-pricerationing system, where each household is given a specific quota to purchase thechickenseachweek.EV: consider theunintendedconsequencesonother stakeholders● However, the policy of price ceiling to i