2026 ACJC H2 Econs Paper 2 Q1 Prelim ANS

Essay Q1 Suggested Answers: 1 Persistent supply disruptions have pushed the costs of coffee beans to the highest in 13 years. This will cause the price of a cup of coffee to increase sharply. (a) Explain why persistent supply disruptions lead to a sharp increase in the price of coffee and explain how the impact on related markets depends on cross elasticity of demand. [10] Requirement 1: Explain the sharp increase in price of coffee Topic Sentence: Persistent supply disruptions will cause the supply of coffee to decrease, leading to a sharp increase in the price of coffee. Factor (Decrease in Supply) : Persistent supply disruptions such as adverse weather conditions, crop diseases, or logistical bottlenecks affecting coffee-growing regions mean that supply of coffee beans would fall and price of coffee beans will increase. Since coffee beans are a factor of production for coffee, firms producing coffee experience a higher cost of production. Firms are therefore less willing and able to produce coffee. This leads to a decrease in the supply of coffee, represented by a leftward shift of the supply curve from SS ₀ to SS ₁ , as shown in Figure 1 below. Note: Students are not expected to draw the price elastic demand curve Interaction (Price Adjustment Process): At the original equilibrium price P ₀ , the decrease in supply creates a shortage, where quantity demanded exceeds quantity supplied. This shortage puts upward pressure on the price of coffee. Consumers who still wish to purchase coffee will compete for the limited supply and bid up the price. As price rises, producers become more willing and able to supply coffee, causing quantity supplied to increase along the new supply curve SS ₁ . At the same time, the higher price deters some consumers from purchasing coffee, causing quantity demanded to fall along the demand curve DD, according to the Law of Demand. This process continues, with quantity supplied rising and quantity demanded falling, until the shortage is fully eliminated. A new equilibrium is established at a higher price P ₁ and a lower quantity Q ₁ . Thus, the price of coffee increases. Explaining the Sharp Increase in Price (using PED):

2 The demand for coffee is likely to be price inelastic (|PED| < 1). This is because coffee is a habitual good. Many consumers are regular coffee drinkers who find it difficult to reduce their consumption significantly even when prices rise. Furthermore, for many consumers, coffee is perceived as a necessity in their daily routine, and there are limited close substitutes that can fully replicate the experience of drinking coffee. As such, when the price of coffee rises, the quantity demanded falls less than proportionately from P 0 to P 1 , and not just P 2 . When supply decreases and a shortage arises, the price must rise sufficiently to eliminate the shortage. Because demand is price inelastic, each unit increase in price brings about only a small reduction in quantity demanded. This means that a large increase in price is required before the shortage is fully eliminated and a new equilibrium is reached. Hence, the price of coffee increases sharply. Requirement 2: Impact on Related Markets Depends on Cross Elasticity of Demand (XED) Definition of XED: Cross elasticity of demand (XED) measures the degree of responsiveness of the quantity demanded of one good to a change in the price of another good, ceteris paribus. The sign of the XED value indicates the nature of the relationship between the two goods (positive for substitutes and negative for complements) while the magnitude indicates the closeness of that relationship. Impact on the Market for Substitutes (E.g. Tea) Topic Sentence: The sharp increase in the price of coffee will lead to an increase in demand for tea, causing the price and quantity of tea to rise, and the extent of this impact depends on the magnitude of the XED between tea and coffee. XED Value (Sign and Magnitude): Tea is a substitute for coffee, as both goods satisfy a similar want for a hot caffeinated beverage. The XED of tea with respect to the price of coffee is therefore positive (XED > 0). Since tea and coffee are reasonably close substitutes for many consumers, the XED value is likely to be positive and relatively large in magnitude (e.g. XED > 1, positive cross elastic), reflecting a strong substitutability between the two goods. Direction of Change in Demand: As the price of coffee rises sharply, consumers who find coffee too expensive will switch to tea as a relatively cheaper alternative. This causes the demand for tea to increase , represented by a rightward shift of the demand curve for tea from DD ₀ to DD ₁ , as shown in Figure 2 below. Impact on Price and Quantity:

3 At the original equilibrium price of tea P ₀ , the increase in demand creates a shortage, where quantity demanded exceeds quantity supplied. Consumers compete for the limited supply of tea and bid up its price. As price rises, quantity supplied increases along the supply curve while quantity demanded falls, until the shortage is eliminated. A new equilibrium is established at a higher price P ₁ and a higher quantity Q ₁ . Thus, both the price and quantity of tea increase. Role of XED Magnitude: The extent of the rightward shift in demand for tea depends on the magnitude of the XED. If the XED between tea and coffee is large (i.e. they are close substitutes), a greater number of consumers will switch from coffee to tea when the price of coffee rises, causing a larger rightward shift in demand and a more significant increase in the price and quantity of tea. Conversely, if the XED is small (i.e. they are poor substitutes), fewer consumers will switch, and the impact on the tea market will be more modest. Impact on the Market for Completements (E.g. Coffee Creamer) Topic Sentence: The sharp increase in the price of coffee will lead to a decrease in demand for coffee creamer, causing the price and quantity of c