ASRJC H1 econs CSQ1 2021 Suggested Answers

1 © Anderson Serangoon Junior College Economics Department H1 CSQ1 GCE A Level Examinations 2021 Suggested Answers (a) (i) With reference to Figure 1, summarise the main changes that occurred in the crude oil price during the period 2014-2018. [3] • Crude oil prices generally decreased during the period 2014 to 2018. • The most significant period of decrease happened from 2014 to 2015. • After which, crude oil prices gradually increased from 2016 to 2018. (ii) Extract 1 states that 'If indeed demand for crude oil falls and supply rises, price will be bound to respond in the predicted direction.' Using a supply and demand diagram, explain the impact of these changes on the price of crude oil. [4] The fall in demand due to slowdown in China and increase in supply due to agreed increase within OPEC would likely lead to a fall in the price for crude oil. The slowdown in major economies such as China and Europe would likely lead to a fall in consumers’ income and hence purchasing power would decrease. With that, demand for consumer goods and services decreases. Since oil is an input to produce energy that in turn, is an input for production of goods/services, the (derived) demand for oil falls in the crude oil market from D1 to D2 as shown in Fig 1. Extract 1 states that “OPEC countries agreed to increase oil production”. This would lead to an increase in supply of crude oil, shown by the rightward shift of supply curve from S1 to S2 as Fig 1 shows. The fall in demand and rise in supply led to a surplus of Q2Q0 at the original price P0. Producers will find that they are unable to sell all of their output at P 0 and compete to sell their excess stock by lowering prices. As price decreases, consumers seeking to maximise satisfaction will increase quantity demanded while producers reduce quantity supplied. This downward pressure on price causes a movement along the demand curve (D2) as well as a movement along the supply curve (S2). The process continues until the surplus is eliminated with a new market equilibrium at E 1. Thus equilibrium price for crude oil would decrease to P1. 1m for fully labelled diagram (b) With reference to Extract 2 and Extract 3, explain the different causes of the changes in the price of oil in the US and the price of food in Guatemala and comment on the significance of the elasticity of demand or supply in these cases. [6] In Extract 2, because of the lockdowns across the world due to the Covid-19 pandemic, it had kept people at home and severely restricted mobility. Without being able to travel out for work or leisure, there is lack of commuting between places via any form of transport and it was almost impossible to head out to consume goods and services. With the various economies suffering from the lockdowns, production in many countries will S2 Surplus E2 E1 Price Quantity of crude oil D2 D1 P1 P2 S1 Fig 1 Q2 Q0 Q1

2 © Anderson Serangoon Junior College Economics Department be affected too. Hence the (derived) demand for oil which is a major factor of production will fall. Demand shifts leftwards from D0 to D1. At original price P0, quantity supplied exceeds quantity demanded (Q0>Q2) causing a surplus and downward pressure on price . Oil price thus falls until the equilibrium price P1, quantity demanded equals to quantity supplied again at Q1. Diagram above is updated Separately, the increase in the price of food in Guatemala is caused by other factors. As stated in Extract 3, government has been subsidising the production of biofuel, which reduces cost of production , increase s profitability of biofuel production and led to increase in the supply of biofuel. Biofuel and food are both made from crops. Hence biofuel and food are goods in competitive supply, competing for crops. Since it is more profitable to produce biofuel, the increase i n supply of biofuel diverts crops away from food production into biofuel production. This leads to a fall in the supply of food , shown by the leftward shift of the supply curve from S0 to S1. At original price P1, quantity demanded exceeds quantity supplied (Qd> Qs) causing a shortage and upward pressure on price to develop. Hence, food prices rose until the new equilibrium price P2, quantity demanded equals to quantity supplied again at Q2. Diagram above is updated The concept of price elasticity of demand is relevant in the case for food. The demand for food is price inelastic (PED<1) because food is necessary for survival and there are no close substitutes for food. Hence when supply falls and there is a shortage, the price of food has to increase significantly to remove the shortage, as given an increase in the price of food, there will be a less than proportio nate fall in quantity demanded for food. This explains why Extract 3 states that “growing crops for biofuel has caused big increases in food prices globally”. Price of oil Quantity of oil P0 Q0 D1 0 S0 E1 E0 P1 Q1 D0 Q2 Price S0 S1 Quantity of food D0 P2 P1 Q2 Qd Qs

3 © Anderson Serangoon Junior College Economics Department The concept of price elasticity of supply is also relevant in the case for oil. The supply of oil is price inelastic (PES<1) because it is not easy to store oil which requires massive storage space and it is already filling fast on land and at sea as mentioned in Extract 2. Hence there is limited space to store the surplus of oil , making the supply of oil price inelastic. Thus when there is a fall in demand for oil and fall in prices, producers are less responsive to the price fall – quantity supplied falls less than proportionately to remove the surplus, hence prices fall significantly to remove the surplus, “forcing the price of US oil into negative territory”. Hence price elasticity of demand and price elasticity of supply are significant in explaining the “big increase” in the price of food in Guatemala and the large fall in the price of oil in the US respectively. (c) Using one example from Extract 3 and one other example of your choice, explain 'an unintended consequence' of an economic decision in each case. [4] Subsidising the production of biofuel, to reduce the use of crude oil, has led to an unintended consequence of shortage of food and rise in food prices. When governments decide to subsidise biofuel production, they wanted to reduce the use of diesel and petrol fuel, which is harmful to the environment. However, it has led to an increase in the price of food, making it unaffordable especially to the lower-income, increasing inequity. One common policy that governments use to control food prices is through a price ceiling, which is set below the market equilibrium price. A price ceiling on food would immediately reduce its price and help make it more affordable and increase equity. However, a price ceiling would lead to a shortage and could lead to an unintended consequence of the emergence of a black market where food is sold at an even higher price, making it even more unaffordable. (d) With reference to Extract 4: (i) Explain the meanings of both non-rivalry and non-excludability, and comment on the extent to which a healthy natural environment has these characteristics. [6] Public goods are goods that are non-excludable and non-rivalrous in consumption. Non-excludability in consumption means that it is technically impossible or extremely costly to exclude any individual from the benefits of a good once it is provided. Non-rivalrous in consumption means the consumption of the good by any individual does not reduce the amount of the good available for consumption by other individuals. A healthy natural environment such as the sea or mountains is non -rivalrous in consumption because a per