JPJC H2 Prelim 2024 P1 Solutions

1 2024JPJCJC2PrelimH2P1SuggestedAnswer Question1: Winnersandlosersinthecoffeemarket (a) (i) From Table 1, account for the change in the consumption of coffee beanbetween2020to2022. [2] Suggestedanswer:Consumptionofcoffeebeanhasincreasedfrom2020to2022.Futurepriceofcoffeebeanisexpectedtoriseandhence,countriesarestockingupnowcausingdemandtoincrease.Thiswillleadtoanincreaseinthedemandofcoffeebeanwhichinturnincreasetheconsumption. (ii) Using a supply and demand diagram, explain why the price of coffee bean isexpected to increase when ‘consumption of coffee bean is estimated toexceedproduction’ (Extract 1). [2] Suggestedanswer:Whenconsumptionofcoffeebeanisestimatedtoexceedproduction,thiswillleadtoashortagesituationasquantitydemanded(Qd)exceedquantitysupplied(Qs).Price S P1 P0 D O Qs Q1 Qd Qty Figure1:CoffeeBeanmarket Duetoashortageofcoffeebean,therewillbeanupwardpressureonprice.ThiscausesthequantitydemandedtofallfromQdtoQ1whilequantitysuppliedtorisefromQstoQ1.ThepricewillriseuntilP1whereanewequilibriumisreached. (b) Explain why many small-scale farmers in countries such as Burundi, Uganda, andHonduras exit the market when faced with lowprices and higher productioncostsintheshort-run. [2] Suggestedanswer:Afirmshouldshutdownandleavethemarketimmediatelyintheshortrunwhenaveragerevenue(Price) fallsbelowtheaveragevariablecost. Thus, whenfacedwithhigherproductioncosts,afirmcannotevencoveritsAVCanditwillminimiseitslossbyshuttingdownimmediately. (c) Explain one measure used by economists to determine the level of competition inthecoffeeroaster industry. [2] Suggestedanswer: 1

2 One measure used by economists to determine the level of competition is theconcentrationratiooftheindustry. Thesmallerthevalueof concentrationratio,thehigherthelevelofcompetitionintheindustry. (d) (i) With reference to Extract 2, explain how coffee bean production using thesun-grown method would lead to an inefficient allocation of resources in thecoffeebeanmarket. [4] Suggestedanswer:Coffeebeanfarmerscanopttousethesun-grownmethodofcoffeebeanproduction. TheMPCwouldbetheadditionalcostofproductionforcoffeebeanwhichincludelabourcosts, rental andetc. TheMPBforthecoffeebeanproducerswouldbetherevenuegainedfromthesellingof anadditional unit of coffeebean. Inthiscase, sun-grownmethoddepletesthenutrientsinthesoil andcoffeefarmershavetoclearmorelandresultinginmoredeforestation.Thiscontributestoglobalwarmingandclimatechangewherefarmers’sufferfromfallingincomeduetolowercropyieldsandharvests,orpeoplearoundtheworldwouldfallsickmoreoftenandincursmoremedicalcosts. Duetothepresenceof negativeexternalities, it leadstothedivergencebetweenthemarginalsocialcost(MSC)andthemarginalprivatecost(MPC). Assumethattherearenopositiveexternalities(MSB=MPB). Whenlefttothefreemarket,producerspursuingtheirself-interest considersonlytheirownprivatecostsandbenefit, ignoringexternalcosts. ProducerswillproduceatQpwhereMPB=MPC.However,thesociallyoptimumlevelofoutputoccursatQswhereMSC=MSB.SinceQpisgreaterthanQs,itmeansthatthepricemechanismonitsowncannotachieveanefficientallocationofresources.Thereisover-productionof coffeebean, leadingtomarket failure. BetweenQpandQs,thesocialcostofanadditionalunitofcoffeebeanproducedishigherthanthesocialbenefitgain,resultingindeadweightlossorwelfarelosstothesocietyasshownbytheshadedarea. (ii) Discuss whether the EU landmark law would improve the efficiency ofresourceallocationinthecoffeebeanmarket. [8] Suggestedanswer:TheEUlandmarklawrequiredcoffeeroasterstoonlybuycoffeebeanfromcoffeebeansourcesthat doesnotrelatestodeforestation.Coffeeroastershavetonowproduceaduediligencestatement provingtheirgoodsarenot contributingtothedestructionofforests(Extract3)Assuch,coffeeroasterswillnotbuycoffeebeanfromfarmersusingthesun-grownmethod. Thiswouldreducethedemandforcoffeebeanfromfarmers 2

3 usingthesun-grownmethodandmorefarmerswillstopusingthesungrownmethodandswitchtousingshadegrownmethodduetothelowerrevenuegainedfromsun-growncoffee. Thiswill reducedeforestationandreducetheMECgeneratedfromsun-growncoffee.Atthesametime,thereishighercostofproductionastheshadegrownmethodismore expensive. MSCwill nowfall while MPCwill rise, and they will coincide atMSC1=MPC1. Withreferencetothediagram,withthefallinMSC,thereisanewsociallyoptimallevelofproductionatQs1whileproducerwillnowchoosetoproduceatQp1whichisalsoQs1.Thereisnomoreoverproductionofcoffeebeanandhence,nodeadweightloss. Benefit/cost MSCMSC1=MPC1MPC MEC1 MPB=MSB O Qs Qs1 Qp Quantityofcoffeebean=Qp1 Figure3:EULandmarklaw However,thereare2mainlimitationsofthispolicy. Firstly,forsmallfarmersfromlowlydevelopedcountriessuchasEthiopiaandUganda,theylacktheinfrastructuretousetheshadegrownmethod.Hence,thesesmallfarmersmaysufferandshutdown.Thiswillworsenunemploymentissues.Furthermore,supplyofcoffeebeanwill fall andworsentheshortageproblemscausingcoffeebeanpricestoincreasefurther. Anotherpossiblescenarioisthat thesecoffeebeanfarmerscanstillchoosetosell theircoffeebeantootherregionbesidetheEU,andthedeforestationproblemwillstillpersist. Secondly,thereislowtraceabilityforcoffeebean,andthismeansthatitwouldbedifficulttotraceandcheckif thecoffeebeanisgrownusingthesungrownorshadegrownmethod. TheEUgovernment mayincurhighenforcingandmonitoringcost. Thus, itwouldmakethepolicyineffectiveinimprovingallocativeefficiencyinthecoffeebeanmarketandmarketfailurewillstillexistsandmayevenworsen. ConclusionInconclusion, theEUlandmarklawisunlikelytoimprovetheefficiencyof resourceallocationinthecoffeebeanmarket duetothelimitationsdiscussedwhichcannotbeeasilyresolved. Astheissueofclimatechangeisaglobalissue,EUwouldneedthecooperationofothercountriestoalsoimplementsimilarlawsforthepolicytobeeffective.ItisnotsufficientforEUtobetheonlycountriestobeimplementingthelandmarklawtofullyresolvetheissue. 3

4 A better policy instead would be to provide subsidies to the farmers in the lowlydevelopedcountriestoaidtheminmovingawayfromthesungrownmethodtolowertheproblemsofdeforestation. (e) Discuss whether new entrants to the coffee roaster industry without the bulkbuying power of large-scale roasters will find it increasingly difficult to compete(Extract 4). [10] Suggestedanswer:Thecoffeeroasterindustryishighlycompetitiveanddominatedbyafewlargefirms,suchasLavazzaandNestlé. Theselargefirmsisresponsibleforroasting35%of world’scoffeewhichisasignificantshareofthemarketasseeninExtract4.Thisoligopolisticstructurecreateshighbarrierstoentryfor newentrantsduetoeconomiesof scaleenjoyedbythelargescaleroaster.Asaresult,newentrantsoftenstrugglewithhighercostsandmayfindit hardtocompete. However,newentrantstocoffeeroasterscansucceedthroughdifferentiationandnon-pricecompetitionstrategies. Asexplainedabove,thecoffeeroastermarketisdominatedbyafewlargecompaniesthatallowsthemtobenefitfrominternaleconomiesofscale.Internaleconomiesofscalerefertothecostadvantagesthatfirmsexperiencewhentheyincreaseproduction.Forexample,firmslikeLavazza,Nestlé,andStarbuckscanpurchaseenormousquantitiesofcoffeebeansatlowerpricesperunitduetotheirbulkbuyingpower.Thisabilitytobuyinbulkatdiscountedratessignificantlylowerstheiraveragecostsofproduction.Asaresult,theselargefirmscanpassonthesecostsavingsintheformoflowerpricestoconsumerswhilemaintainingtheirlevelofprofits.Incontrast,newentrants,whocannotachievesuchinternaleconomiesofscale,facehigherper-unitcosts.Thisdisparityincoststructuresmakesitincreasinglydifficultfornewentrantstocompeteonprice,astheycannotaffordtolowertheirpriceswithoutcompromisingprofitability. Inaddition,ifnewentrantfirmsdecidetocompeteviapredatorypricingandpricetheircoffeelowerthanmarginalcost(pricingcompetition),thelarge-scaleroasterswilllikelyreacttoitandalsolowerthepricesoftheircoffee.Thismaygiverisetopricewarandnewentrant maylikelybeforcedtoexitthemarketastheyarelikelytonotwithstandlossesbetterthanthelarge-scaleroasters.Thisisbecauselarge-scaleroastersarelikelytohavelargesupernormalprofitstowithstandtheselosses. However,newentrantstothecoffeeroasterindustrycanstillcompeteeffectivelywithoutthebulkbuyingpowerof large-scaleroastersbyengagin