RI T2W8Price+Mechanism+and+FirmsMark+Schemes

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution Economics Department 1 Case Study 1 (Housing) (a) Using examples from the case material, explain the difference between fixed costs and variable costs. [4] Suggested Answer: Fixed costs are costs that do not vary with output while variable costs are costs that vary directly with output. One example of fixed costs is the cost of land purchase, as the developer can vary the number of housing units on the same plot of land yet the cost of the land will remain fixed/constant. And even if the developer did not develop the land and build any housing units, the cost of land will still need to be incurred. On the other hand, an example of variable cost is the ‘average hourly wages’ of construction workers. By choosing to build more housing units, the developer will need to hire more workers or require workers to work longer hours thus incurring more costs in terms of total wages paid to these workers. These costs rise as the number of housing unit rises, and will not be incurred when production is zero. Mark Scheme - 2m for correct explanation of the difference between fixed vs variable cost . - 2m for relevant explanation of how the examples given are fixed and variable (1m for each type of cost) - Note: Typically, an explain the “difference”-type question requires explicit comparison of fixed cost vs variable cost – if the students did not use comparison words such as “however”, “but”, “while” – max 3m. (b) With reference to Extract 2, explain one type of economies of scale experienced by Hong Kong’s real estate developers. [2] Suggested Answer: i) Marketing IEOS As the developers have a large market share (Ext 2: dominated by few local giants) and hence high level of output production, they will buy their raw materials and components in bulk. This gives them significant bargaining power and are often accorded preferential treatment by their suppliers such a s discounts. As indicated in Ext 2, the ‘long term contracts with suppliers’ allows developers to purchase materials such as sand and cement at lower cost. As the rise in TC is spread over large output → this lowers the firm’s long run average/unit cost. OR ii) Financial IEOS Due to the large scale of production, these developers hold larger land reserves (Ext 2), which enables them to use these land reserves as greater collateral when they apply for loans with banks. Such collaterals enhance the credit worthiness of the developers as they are now perceived as low risk borrowers. Hence, developers are able to secure larger loans at lower interest rates→ cheaper cost of borrowing →As the cost of financing is spread over large output where rise in TC < rise in output → this lower firm’s long run average/unit cost. Mark Scheme: - 2m for correctly identifying and explaining a type of IEOS using relevant case evidence.

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution Economics Department 2 (c) With use of relevant elasticity concept(s), account for the sharp increase of housing prices in Hong Kong. [4] Suggested Answer: Figure 1 shows an overall increase in (private) housing prices that have more than doubled over the period 2008-2018. An increase in demand contribute to the increase in housing prices in Hong Kong. However, the sharp increase in price of housing is due to the price inelasticity of supply for housing. • Strong income growth and low unemployment (Extract 1) contribute to higher disposable income and purchasing power for the average consumer/buyer. Given that housing is a normal good with YED > 0, there is now a greater willingness and ability to purchase houses at every given price level→ increase in demand (DD) for housing→ rightward shift of DD curve from D0 to D1. • OR House buyers increase DD for housing for speculation purposes (Extract 1). This is because buyers have expectations of future price increases, hence more of them are willing and able to invest and purchase houses now so as to be able to sell at them at hi gher prices later → increase in DD • Given that supply for housing is price inelastic, PES<1 due to lack of available spare capacity, in this case, low availability of land parcel as govt failed to increase land supply (Extract 3), the increase in demand will lead to a more than proportionate increase in price, accounting for the sharp increase in price relative to when supply is price elastic • From figure 1, with the increase in DD, there is a shortage of QsQd at original equilibrium price P0. This creates an upward pressure on prices as consumers try to outbid each other for the existing housing units. As prices increase, it becomes more profitable for firms to increase their output and quantity supplied increases while the higher price reduces consumers’ ability to pay and willingness to pay which leads to fall in quantity demanded. The price adjustment process continues until market clears at new equilibrium E1. Since the supply for housing is price inelastic, it requires a significant increase in price from P0 to P1i to be able to clear the shortage at Q1 , as compared to a case when SS is price-elastic. Alternatively, • Cost of production is increasing due to rising land prices and higher wages of workers (Extract 3). The failure of the government to increase land supply has driven up land costs while the lack of skilled construction workers has caused the average hourly wages to rise as well. As a result, profitability in the property market fell, hence suppliers (property developers) are less willing and able to produce and make available for sale the same quantity of housing at every given price level. This decreases the SS of housing in the market. • Given that the demand for housing is price inelastic (PED<1)- as inferred from Extract 1 : residents consider owning a home a top priority as well lack of substitutes since there is no alternative to housing / private housing is poor substitute due to sev ere shortages of public housing (Ext 4) , the fall in supply would lead to a sharp rise in price as it requires a signi ficant increase in price to be E1 E0 Q1 Q0 P0 Si c P1i Price Quantity of housing Se cc D0 D1 P1e Figure 1

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution Economics Department 3 e able to clear the shortage as consumers are not responsive to price changes → thus causing the sharp increase in price of housing as compared to if demand is price elastic. Mark Scheme - 1m for explanation of a relevant demand factor (or supply factor and supported with case evidence - 1m for a relevant explanation of how PES (or PED) is price inelastic using case evidence - 1m for explain how the increase in demand (or fall in supply) results in a sharp or more than proportionate increase in price of housing when PES (or PED) is <1. - 1m for brief market adjustment processok, (d) Discuss whether price controls or direct subsidies is a better policy to respond to rising private housing prices in Hong Kong for low income households. [10] Introduction • Clarify problem/issue: rising prices in Hong Kong faced by low -income households in Hong Kong due to shortage of affordable (public) housing (Extract 4) • Both measures can help address the problem of rising housing prices for low -income households in Hong Kong but have their own set of limitations. • Which policy is ‘Better’ may be discussed using the yardsticks of effectiveness, desirability and sustainability. Body Requirement 1: Discussion of pri