2024 RI H1Econs Prelims Answers

1 RAFFLES INSTITUTION 2024 YEAR 6 PRELIMINARY EXAMINATIONS Higher 1 ECONOMICS 8843/01 Examiners’ Comments Question 1 (a) With reference to Figure 1, summarise the main changes that occurred in the price of rice between July 2022 to July 2023. [3] • Overall trend: Price generally rose sharply between Jul 2022 to Jul 2023. • Refinement: o Price fell between Jan to Mar 2023 and May to Jun 2023. o Rose at faster rate between Jul 2022 to Jan 2023 compared to Jan 2023 to Jul 2023. (b) With reference to Extract 1 and using a supply and demand diagram, explain how and comment on the extent to which the Russian -Ukraine war might have contributed to the surge in the price of rice. [6] Explain how Russian-Ukraine war has contributed to the surge in price of rice • ‘Russia, the world’s top fertilizer exporter, halted hundreds of exports’ including fertilisers, ‘in response to economic sanctions… after Russia invaded Ukraine ’ → ‘rising fertilizer prices’ → increase cost of production of rice, since fertilisers are an important input in rice production → fall in SS of rice due to decreased profits → SS curve shifts left from S1 to S2. • Moreover, ‘Russia’s withdrawal from the Black Sea grain deal’ → ‘constrained global supply of wheat and corn’ → increase in price of wheat and corn → consumers switch to rice which is now relatively cheaper → increase in demand for rice → DD curve shifts right from D1 to D2. • With reference to Figure 1, initial equilibrium price and quantity are P1 and Q1 respectively. Fall in SS, from S1 to S2 will lead to a shortage of QSQ1 at initial equilibrium price → upward pressure exerted on price. H Figure 1: Rice market

2 • As price increases, quantity demanded falls while quantity supplied rises → this continues until the shortage is resolved at a higher equilibrium price , P2 and equilibrium quantity Q2. • In addition, the rise in DD from D1 to D2 resulted in yet another shortage Q2QD at P2 → following the market adjustment process → this resulted in price rising even higher to P3 with equilibrium quantity at Q3. • Hence, the Russian-Ukraine war resulted in a ‘surge’ in price from P1 to P3. Comment on the ‘extent’: • Explain any alternative contributing factor (must be non-war related): o Weather conditions o PED of rice as a staple o India rice ban • Provide a final conclusion by taking a stand. (c) Explain the statement ‘a stable climate is essentially a global public good’. [4] Explain non-excludable and non-rivalrous characteristics of a stable climate: • Non-excludable: o A public good is non -excludable meaning that it is impossible or prohibitively expensive to exclude non-payers from consuming the good. o For example, a stable climate offers global benefits, such as favorable weather conditions, which would improve agriculture yields . It is impossible to exclude any farmer from the benefits of such favourable weather, even if the farmer did not ‘pay’ or contribute to maintaining a stable climate. • Non-rivalrous: o A public good is non-rivalrous in consumption, meaning that one person’s use of the good does not reduce its availability for others. o For example, if an Indian rice farmer benefits from favorable weather conditions due to a stable climate, this does not diminish the favorable conditions available to a rice farmer in the Philippines. Both farmers can enjoy the benefits of increased rice yields, and the marginal cost of extending the stable climate to the additional farmer is zero. Since a stable climate displays the two main characteristics of a public good and its benefits extends to every single country in the world, it is essentially a ‘global public good’ (d) Explain how reducing subsidies on fertilisers can improve the signalling and incentivizing functions of the price mechanism to a farmer. [4] Signalling function: • Reducing subsidies on fertili sers leads to an increase in the price of fertiliser, causing farmers to pay a price closer to the true market value. This improves the signal ling function, as the price more accurately reflects the scarcity /shortage of fertilisers. As a result, farmers are prompted to reconsider their decisions regarding the excessive use of fertilisers. Incentivizing function: • An increase in the price of fertiliser will raise the marginal cost for farmers. If they continue to use fertili sers excessively, their profits will decrease . This incentivises the farmer to reduce inefficient usage in order to maximize profits.

3 (e) With reference to Extract 3 and your own knowledge, discuss whether the use of a price ceiling can ever be justified to address the Philippines rice crisis. [8] Why it is justified: • Price ceiling is a legally established maximum price set by the government. Sellers are prohibited from selling above the stipulated price. • To be effective, it has to be set below market equilibrium price as shown by Pmax in Figure 2 below. • It is implemented to ensure that price does not increase by too much → protect consumers and ensure that rice as a ‘staple food item’ remains affordable for the average Filipino household. • This is largely justified as the price ceiling will address the surge in rice price ‘caused by forces such as external global pressures beyond the Philippines’ control’ as well as ‘alleged illegal price manipulation attributed to hoarding by traders.’ • As analysed in part b, external global events such as the Russian-Ukraine conflict caused a rapid and sharp increase in the price of rice. • If left to the free market, the market price will be established at P0, where D0 = S0, which the Philippines government considers too high. • Rice is a staple in the Philippines , meaning PED < 1 → increase in price → less than proportionate decrease in quantity demanded → increase total expenditure on rice, which constitutes a large proportion of income for low-income households → many low-income households may be unable to afford rice. • When price cap is implemented → price of rice decrease s from P 0 to P max → fall in expenditure → increase affordability of rice in the Philippines. • Furthermore, hoarding behaviour is disincentivized. When traders expect future price increases → withhold supply and release it later at higher price to increase profits → exacerbate the initial decrease in SS caused by external global events , driving prices even higher. • With the price cap in place, prices are legally restricted from rising → discourage hoarding behaviour. Limitations: • Price ceiling will result in a persistent shortage. When price decreases from P0 to Pmax → qty demanded increases from Q0 to Qd and qty supplied falls from Q0 to Qs → persistent shortage of QsQd → could lead to the emergence of a black market. • With only Qs units of rice available in the market, some consumers may be willing to pay up to Pb (the black market price, which reflects the highest price consumers are willing Quantity of rice Figure 2: Price ceiling

4 to pay) to secure rice supplies. This creates a perverse incentive for sellers holding stocks of rice to engage in illegal sales at Pb to increase their revenue (PmaxPbab). • As a result, those with higher ability to pay will obtain the rice , while low-income households, whom the policy is meant to help, will be unable to secure rice. • Therefore, price ceiling may be ineffective. Conclusion/Evaluation: • The price ceiling can be justified as a temporary measure and substantiate with possible reason(s). • Although there is a risk of black-market formation, this can be minimi sed through increased government monitoring and enforcement. Knowledge, Application, Understanding, Analysis L1 - Limited understanding of how the price ceiling can address affordability issues. - Limited application to the Philippines rice c