2025 VJC Paper 2 - Mark Scheme

Victoria Junior College Economics Department1 2025 H2 Economics Preliminary Examination Paper 2 – Suggested Responses & Mark Scheme Question 1 In many parts of the world, essential goods and services such as rice and electricity are scarce due to limited natural resources and increasing demand. In deciding how best to address the problem of scarcity, economists typically assume that consumers and producers act in self - interest. (a) Explain how the pursuit of self -interest and price signals could help to address the question of how much essential goods and services to produce. [10] (b) Discuss possible policy measures that a government can use to ensure a fairer distribution of essential goods and services. [15] Part (a) R1: Explain how the pursuit of self-interest could help to address the question of how much essential goods and services to produce [Use of marginalist principle] R2: Explain how price signals could help to address the question of how much essential goods and services to produce. Introduction Economists often assume that individuals act out of self -interest, guided by the marginalist principle, which states that rational agents make decisions at the margin —consuming or producing an additional unit as long as the marginal benefit outweighs the m arginal cost. In markets, this behaviour is coordinated through price signals, which convey information about scarcity and preferences. Together, self-interest and price signals help determine how much of essential goods and services (e.g., electricity, ri ce, public transport etc.) should be produced. Body R1: Explain how the pursuit of self-interest could help to address the question of how much essential goods and services to produce [Use of marginalist principle] In a free market system, consumers’ and producers’ buying and selling decisions are driven by their self-interests. Consumers consume based on self -interest, seeking to maximise net total private benefits from consuming goods and services. Consumers signal their preferences for different goods/services to firms by the different prices that they are willing and able to pay for them. The demand curve, which maps the relationship of quantity demanded of a good to its price, shows the highest prices that consumers are willing and able to pay for an additional unit of a good. This is equal to the marginal private benefit (MPB) derived from the good. Consumers are willing to buy an additional unit of a good/service when the MPB derived from

Victoria Junior College Economics Department2 consuming it (which is the additional satisfaction enjoyed) exceeds or is at least equal to the price of the good (marginal private cost (MPC) incurred by consumers). According to the marginalist principle, if MPB>MPC, it is rational for consumers who are self-interested to consume more of the good since the addition to their total benefit exceeds the addition to total cost which means net total benefit is rising. Hence, they consume up to the point where MPB = P (MPC) at Q 0. From the diagram, the consumer will consume at Q 0 (where demand intersects supply) to maximise their net total private benefits. Firms seek to maximise total profits from producing goods and services. Producers signal their willingness to produce different goods/services by the different prices they are willing to accept. In a perfectly competitive market, the marginal revenue (MR) is the price of the good. Being profit -maximisers, firms are willing to produce and sell an additional unit of a good/service when the MR from selling it exceeds or is at least equal to the MPC of producing it. This is because in producing one more unit, the addition to their total revenue exceeds the addition to total cost which means profits will rise. Thus, the lowest prices that producers are willing and able to accept for an additional unit of a good must at least cover their MPC. In the diagram below, the supply curve which maps the relationship of quantity supplied of a good to its price reflects the MPC incurred by firms in producing the good. Hence, producers will increase production up to the point where MPC = P at Q0 (where demand intersects suppl y) to maximise profits [Figure 1]. Figure 1: Market for an essential good/service (e.g Rice) R2: Explain how price signals could help to address the question of how much essential goods and services to produce. Consumers and firms make their consumption and production decisions independently of each other. Consumers decide what to buy, and by “voting with their dollars,” they signal to producers what goods are in demand. This reflects consumer sovereignty. Firms decide what to produce based on which goods are most profitable. There is no one person or authority (such as the government) that is planning and directing the economy, yet the economy moves towards producing certain goods in certain quantities. In a free market, allocation of resources is achieved via the operation of the price mechanism which refers to the coordinating

Victoria Junior College Economics Department3 mechanism by which the independent decisions of consumers and producers result in the allocation of scarce resources in a free market economy. In a free market, price signals coordinate the independent decisions of consumers and producers, guiding them on how much to consume and produce respectively. Figure 2: Increase in demand for essential goods When there is an increase in demand for essential goods, prices tend to rise, signalling producers to increase output while encouraging consumers to moderate consumption. The initial increase in demand due to factors such as population growth or rising incomes will shift the demand curve to the right from D to D’. At the initial equilibrium pr ice of P, the quantity supplied would be 0Q but the new quantity demanded would be 0Q”, i.e., Qd>Qs, leading to a shortage of QQ”. This exerts an upward pressure on pr ice. Faced with the shortage at the original price P, consumers who are willing to pay higher prices in a bid to obtain the good will cause the prices of these essential goods to rise . The rise in price acts as a signal to producers that they will be able to earn more revenue to cover their marginal cost of production. This rise in profitability incentivises profit -motivated firms to allocate more resources to expand production and hence quantity supplied rises. At the same time, as prices rise, the quantity demanded falls. To increase quantity supplied, firms would need to enter factor input markets e.g., labour market and purchase more factor inputs. This channels resources toward producing more of the good. But the new, higher price is also a signal and incentive for consumers: it signals that the good is now more expensive, and is an incentive for them to buy fewer units. As illustrated in Figure 2, the consequent movements along the (new) demand and (existing) supply curves lead to a new equilibrium at E’ (shortage is eliminated) where equilibrium quantity has increased. At the new equilibrium, E’, there is no tendency to change as consumers and producers consume and produce the amount they want to maximise their self- interest. Thus, an increase in demand leads to an increase in equilibrium price from P to P’ and an increase in equilibrium quantity from Q to Q’ where prices act as a signal to decide on how much essential goods and services to produce.

Victoria Junior College Economics Department4 Mark Scheme Level Descriptors Marks L3 Analytical and diagrammatic explanation of how the pursuit of self - interest and price signals could help to add