RVHS H1 Econs P1 Soln

© RVHS 2024 8843/01 Suggested Answers for JC2 H1 CSQ 1 (a) Compare the change in food prices between 2017 and 2022 with the change in petroleum prices over the same period. [2] Similarity: Prices of both food and petroleum have increased. [1] Difference: Prices of petroleum has increased more rapidly than that of food. [1] (b) Russia’s invasion is placing pressure on global physical supply chains. Additionally, panic buying from consumers as the global economy recovers from the COVID-19 pandemic have further contributed to significant price changes of food. (i) Using a supply and demand diagram, explain the impact of these effects on the changes in the price of food and comment on the significance of price elasticity of supply in this case. [6] Due to the disruption on global physical supply chains, producers will find it more difficult to obtain key resources from abroad so they may have to source elsewhere or incur higher transport costs in order to maintain the steady flow of factor inputs they could get. Due to the increase in input prices, unit cost of production increases, thus producers will be less willing and able to produce food at each price level since it is less profitable to do so, resulting in a fall in the supply of food from So to S1. On the other hand, the panic buying has affected the taste and preferences in favour of food of as consumers started to buy necessities like food supplies in bulk in view of hoarding them in case of future food depletion or price increases. This results in increase in demand for food from Do to D1. With the simultaneous increase in the demand for and decrease in supply of food, there is a reinforcing effect on equilibrium price. At Po, there is a severe shortage QdQs as quantity demanded exceeds quantity supplied. This will cause an upward pressure on the prices of food as the competing buyers bid up the prices of food. Consumers will be less willing and able to buy the food, causing a fall in quantity demanded for food, while producers will be more incentivized to produce more food, causing a rise in quantity supplied of food. This process continues until the shortage is eliminated. This results in a significant increase in the prices of food from Po to P1 in Figure 1.

2 © RVHS 2024 8843/01 urn over Figure 1: Market for Food Significance of PES: PES is significant in accounting for the huge rise in the price of food. The PES of food is likely to be less than 1 since the gestation period for agricultural products especially is long given the time it requires to harvest. [Justify PES value with a PES determinant: 1m] <OR> Disruptions in global supply chains have impeded the mobility of resources , thereby prolonging the time required for producers to mobilize them. [Justify PES value with a PES determinant: 1m] With reference to the diagram, this causes the larger change in prices of food from Po to Pi. [1m] shortage P1 D1 S1 Po Price Do So 0 Qs Qo Q1 Qd Qty P1 Po Do 0 Qo Q1 Qty D1 Se Si

3 © RVHS 2024 8843/01 urn over (ii) With reference to Extract 1, explain the likely effects on the food retailers’ total revenue in view of the change in food prices in bi. [5] As food prices increase in bi, the cost of production for food retailers will increase. This will result in a fall in profitability for the food retailers as they will be able to produce less with the same amount of financial resources as before. This results in less willingness and ability of the food retailers to produce, causing a fall in supply of food. The fall in supply will result in an increase in the price of food. From Extract 1, the retailers selling non-essentials are expected to incur losses. This is because the demand for non-essential foods is price elastic due to the availability of substitutes and nature of the product. Quantity demanded for the non -essential foods will decrease more than proportionately, causing a decrease in total revenue. However, for the retailers selling essentials, demand for their goods will be price inelastic due to the nature of the product, the rise in the price of food will cause a less than proportionate decrease in quantity demanded for food, resulting in a rise in total revenue for these retailers. (c) Using the information in Extract 2, discuss the view that price cap is the best policy to address the soaring food prices. [8] Intro: The Russian Ukraine war has disrupted food supplies of “ wheat, barley and other cereals” from the two world’s major exporters. The conflict also resulted in a supply crunch in other essential food items such as bread, eggs and milk, and hence the hiking of prices of these items. This gives rise to inequity among the poor population in the UK as high prices reduce their access to essential food items. Thesis: Price cap can address soaring food prices. The price cap on essential items was introduced by the UK government to keeps the prices of essential food items within an affordable range such that every citizen, even those belonging to the lower income strata, have access to them. Thus, promoting equit y. The price cap determines the maximum permissible price that sellers can legally charge for their products.

4 © RVHS 2024 8843/01 urn over Figure 2 With reference to Figure 2, Pc represents the price cap imposed on essential food items by the UK government. Pc should be below the initial equilibrium price P0 to be legally binding. As a result, the price cap causes a fall in quantity supplied of essential food items from Q0 to Qs, and an increase in quantity demanded from Q0 to Qd. However, the introduction of price caps results in a shortage in the market of essential food items. At Pc, the quantity demanded exceeds the quantity supplied. This results in a shortage in the market for essential food items. This means that despite the lower prices, fewer consumers consume the good. The shortage may perversely result in a black market where those who cannot get their hand on essential food items turn to an illegal market where prices are charged higher than the initial equilibrium price. In a black market, illegal vendors may charge as high as P BM, which is the maximum price consumers are willing and able to pay at Qs which is the amount of essential food items available in the market. As such, a price ceiling may not be effective in bringing about a fall in price. Anti-thesis: Sales tax can address soaring prices Another solution proposed in extract 2 was to “cut sales tax on food”. The sales tax on food is imposed on food producers for the quantity sold. Therefore, the tax is perceived to add onto a firm’s cost of production. With the reduction of the sales tax, it reduces their cost of production, making their food products more profitable to pro