SAJC 2024 JC2 H2 Econs CSQ Prelims Suggested Answers

St Andrew’s Junior College JC2 Preliminary Examinations H2 Economics – Paper 1 (9570/01) Suggested Answers

2 © SAJC 2024 9570/01/Aug/24 (a) (i) Explain the likely market structure that global chemical fertiliser companies are likely to be operating in. [2] • Likely market structure is oligopoly. • From extract 1, it was mentioned that the global fertiliser market is controlled by a handful of companies, which implies a high 4 firm concentration ratio. (ii) Explain how the type of market structure identified in a(i) has allowed these firms to “capture mega profits” (Extract 1). [2] • Oligopoly firms have high pricing ability due to their large market share given the high barriers to entry. • With a high ability to set high prices at profit maximising point where MC=MR , each firm can earn high total revenue at a higher price and the corresponding output. High revenue allows high profit, if cost remains low or remain unchanged. OR • Due to their large market share and high output, each firm can benefit from significant internal economies of scale , which in turn lowers their average costs. If total revenue remains constant, the reduction in average costs leads to lower total costs, thereby increasing profit. (b) In the light of the current and potential challenges faced by chemical fertiliser firms, discuss whether firms should consider expanding their production of fertilisers. [8] Introduction: First requirement: Should • Governments are encouraging increased fertiliser production to address shortages and support agriculture. Firms may benefit from government incentives and support. • High global demand for fertilisers can address food security. Expanding production can increase market share and revenue. Higher demand can lead to increased profits Second requirement: Should not • Constrained natural gas supplies are expected to keep production costs high and volatile for nitrogen fertilisers, raising operating expenses and reducing profits for firms as increased costs are passed on to consumers. • Environmental and sustainability concerns are decreasing demand for chemical fertilisers, leading to lower sales and profits for firms as regulatory pressures and shifts towards sustainable practices reduce prices and output. Synthesis: Consider both sides and come to a valid conclusion Intro As firms aim to maximize profits through expansion, both their costs and revenues are significantly impacted. If the increased output aligns with market demand and effective pricing strategies are implemented, the firm can benefit from improved profitability through higher sales and reduced average costs. Thus, while expansion presents opportunities for greater reve nue, it requires careful management of costs and operational efficiency to achieve long-term profit maximization. Requirement 1: • Given the current and potential challenges faced by chemical fertiliser firms, there are several reasons why expanding fertiliser production might be considered. Some governments are actively seeking to increase chemical fertiliser production as part of

3 © SAJC 2024 9570/01/Aug/24 their strategy to address fertiliser shortages and support agricultural productivity. Firms expanding production may benefit from government incentives or support aimed at boosting domestic production and ensuring a stable supply of fertilisers . As a result of government support such as through per -unit subsidies, the MC and AC of the firm will decrease. As a result, profits change from P1C1ab to C2P2ef. • Despite the rising costs and challenges, there remains a substantial global demand for fertilisers to support food production. With the potential for a global food shortage, increasing production can help meet this demand and stabilize food supplies, addressing immediate concerns of food security. Fertiliser firms with significant market control have the opportunity to capture substantial profits. Expanding production can allow these firms to leverage their market power more effectively, potentially increasing their revenue by meeting more of the existing demand and capturing additional market share. An increase in demand from AR₁ to AR₂ will result in higher profits from P₁c₁ab to c₂P₂ef. 0 Price, Revenue, Cost P2 AC2 P1 MC1 AC1 C1 MC2 a b e C2 f MR D=AR Output Q1 Q0 Figure: Effect of government support on profits

4 © SAJC 2024 9570/01/Aug/24 Requirement 2: • Natural gas supplies constrained and that could result in costs being too much to bear – both for farmers and government. Prices are strongly influenced by the cost of natural gas, a key raw material for nitrogen fertilisers. The volatility and expected constraints in fossil fuel supplies due to climate change measures suggest that production costs could remain high and volatile in the long term. This poses financial risks to firms heavily reliant on gas -intensive production methods. Higher costs of natural gas can significantly increase the operating expenses for fertiliser firms, which in turn reduces their profits. Natural gas is a key raw material in the production of nitrogen fertilisers, so when its price rises, the cost of producing fertilisers also increases. This directly impacts the firm's profitability as the higher production costs are often passed on to consumers in the form of increased prices. Natural gas, a form of variable cost, will increase MC and AC from MC₁ and AC₁ changing to MC ₂ and AC₂ respectively. This will result in a fall in profits from c₁P₁ef changing to P₂c₂ab (subnormal). 0 Price, Revenue, Cost P1 AC1 P2 MC2 AC2 C2 MC1 a b e C1 f MR D=AR Output Q1 Q2 Figure: Effect of higher costs on profits 0 Output Price, Cost, Revenue MR1 D1=AR1 D2=AR2 MR2 MC P1 P2 Q0 Q1 a e AC c1 C2 b f Figure: Effect of higher market share on profits

5 © SAJC 2024 9570/01/Aug/24 • Environmental and sustainability considerations are increasingly pressing. The mining and production of fertilisers, whether from natural gas or mineral deposits like potash and phosphate, are energy -intensive processes with significant environmental impacts. There is growing global awareness of these impacts, leading to calls for more sustainable agricultural practices such as agroecology, which reduce reliance on chemical inputs. Hence it is likely that despite government support, demand for chemical fertilisers may eventually dwindle due to such concerns. A fall in demand for fertilisers due to climate concerns could significantly reduce fertiliser firms' profits in several ways. As regulatory pressures and shifting consumer preferences drive farmers away from traditional chemical fertilisers, companies may face a decrease in sales volume. This reduction in demand can lead to lower revenue, especially if firms are unable to quickly pivot to alternative products or markets. With the fall in demand, the new profit maximising output falls to Q2 and the corresponding price falls to P2. Profits will fall from c1P1ef to P2c2ab. • However, whether firm’s profits fall depends on (1) ability of firm to mitigate through other pricing/non-pricing or cost cutting strategies (2) extent of environmental concerns of consumers or government that will reduce demand. The firm might even suffe