2013 HCI H1 Econs CSQ 1

HWA CHONG INSTITUTION Year Two H1 Economics 2013   Section A: Case Study Question 1 Japan and The Future of Energy Suggested Mark Scheme (a) (i) Compare the change in price of crude oil and natural gas between 2009 and 2011. [2] Similarity: Both increased from 2009 to 2010. [1m] Difference: While price of crude oil continued to increase thereafter, price of natural gas fell. [1m] (ii) Using supply and demand analysis , account for the difference above. [3] Use dd-ss analysis Ext 1: “Fukushima nuclear accident leading to a sharp rebound in the demand of conventional oil-based energy in 2010”  rise in demand [1m] Ext 1: “turmoils in Middle East”  fall in supply [1m]  Rise in prices in crude oil Ext 1: “technological enhancement” for natural gas  rise in COP  rise in supply [1m]  fall in prices of natural gas 1m for each factor identified and link to dd/ss & price. (b) With reference to Extract 2, explain two demand factors that have led to the booming alternative fuel vehicle market. [4] Change in price of related good Ext 2: “Rising diesel costs last year… buying trucks that will run on cheaper natural gas...”  relatively cheap natural gas (substitute)  rise in qty dd for natural gas  rise in dd for AFVs that run on natural gas (complements) Change in tastes & preferences Ext 2: “Driving cars that run on alternat ive fuels like liquefied natural gas can cut emissions and reduce dependence on foreign fuels…”  changing tastes and prefs  rise in demand for AFVs (c) Using a diagram, explain how the production of conventional oil-based energy leads to market failure. Cost-benefit diagram to analyse ineffici ent resource allocation (neg ext) in the [5]

HWA CHONG INSTITUTION Year Two H1 Economics 2013   production of energy (Refer to Ext 1: carbon emissions) Market failure is said to occur when free markets, operating without any government intervention, fail to allocate scarce resources efficiently, in a way that maximises society’s welfare. <SMB-SMC diagram showing negative externality and welfare loss> An individual power plant which genera tes conventional oil-bas ed energy will only take into account its privat e costs and benefits. In a free market, the equilibrium occurs at Qe where PMB=PMC Its private benefits include revenue from the sale of conventional oil-based energy. Its private costs would be labour costs and costs of running the power plant. However, this plant does not consider the negative externalities that would be generated – e.g. carbon emissions leading to global warming and pollutants resulting in air pollution. The costs of suc h effects e.g. healthcare costs to third parties (residents staying in the vicini ty/ farmers experiencing poor harvests) not involved in the production and consumption are not taken into consideration by the individual plant (EMC). Hence, due to the presence of negative externalities, there exists an EMC in energy production. Social costs of energy production is higher than the private costs (SMC lies above PMC in diagram above) and social equilibrium occurs at Qse where SMB=SMC (assuming no positive externality, PMB=SMB). As the free market level of conventional oil-based energy production is higher than the socially efficient level (Qe>Qse), there is an over-production by the amount (Qse-Qe). This over-production results in an increase in social cost of area ABQeQse while an increase in social benefit of only ACQeQse, hence creating a welfare loss of area ABC. Thus market failure results as there is an over-allocation of resources to production of conventional oil-based energy. (d) If you were the advisor to the Japanese Ministry of Environment, would you recommend that the government adopt the policy of taxation on nuclear plants? Recommend taxation on nuclear plants: ↓SS  ↑P, ↓Q  ↓risk of nuclear power plant accidents (in view of Fukushima disaster) Besides generating power via nuclear energy, there are alternative energy sources such as hydropower Japan can turn to instead. [8]

HWA CHONG INSTITUTION Year Two H1 Economics 2013   Do not recommend taxation on nuclear plants: Limitations of measure electric generators incorporate all costs – including taxes – into the price of their product (esp. when electricity is price inelastic in demand)  put upward pressure on electric rates, stunt economic development and job growth Alternative sources of energy are still undeveloped Hydropower is however a relatively small share of generation Promoting the use of hydropower via subsidies  trade-offs in spending on other areas (health, education, etc) nuclear energy emits no carbon dioxide, generating electricity via nuclear power reduces Japan’s carbon emissions by about 14 percent per year  helps in overcoming market failure from the over-production of conventional energy Ext 3: Japan’s world’s third largest consumer and producer of nuclear power  made a great contribution to Japan’s energy security by reducing its energy imports requirements. Ext. 4: With taxation on nuclear energy and a fall in production, Japan has to import other sources of energy (rise in import expd) + utilities companies turn to more expensive electricity. Conclusion with justification Should not impose taxation on nuclear plants due to the limitations and the costs it brings along. Further, tax does not solve the root cause of the problems  should be looking at regulations on precautions and safety measures to prevent site accidents. L3 Thorough, balanced approach to analyzing the strengths and limitations of taxation, citing evidence from case materials to support the arguments, good consideration of context. Considered alternative energy sources. With justified conclusion. 7-8 m L2 Correct, balanced approach but limited or underdeveloped explanation. Need to explain how the taxation works to reduce risk of disaster. Some attempt in making reference to the case materials. No / little evaluative comments made. 4-6 m L1 Very superficial analysis. Mere listing of points. Inaccurate knowledge of concepts. One-sided answer. 1-3 m

HWA CHONG INSTITUTION Year Two H1 Economics 2013   (e) Discuss the extent of the adverse impact of the Fukushima disaster on Japan’s macroeconomic performance in view of the government’s effort in rebuilding the economy. Impact on the 4 macro goals: Potential Growth (↓AS) Japan to lose considerable physical and human capital  ↓pdv capacity ↓AS ↓Potential Growth Actual Growth (↓AD) ↓C  loss of wealth (destruction of homes) ↓X  semiconductor equipment and materials; automobiles, etc ↑M  increase Japanese demand for oil to 4.5 million barrels a day, at an additional cost of about US$100 million a day. ↑G  on rebuilding (pledged more than 20tn yen ($249bn) on reconstruction) ↓AD  ↓Actual Growth Impact on employment Fall in employment resulting from the fall in AD The extent of fall in AD, hence actual growth and employment, depends on whether government can stimulate the economy considering the huge amount of debt she is in (“government cannot afford to spend so freely because it is already straining under a debt load which is double the size of the economy…”) Impact on GPL Higher electricity bills  ↑COP  ↓SRAS “Utilities companies would have to turn to coal, oil and gas-fired power plants to keep industry and households supplied with more expensive electricity” “power shortages could force them to cut production” “additional spectre of higher electricity bills would hit earnings” BUT Downward dd-pull inflationary pressures due to fall in AD Cost-push inflationary pressures may be cushioned by the deficiency in AD. Impact on BOP ↓BOT (imports had contributed to Japan's first trade deficit for more than 30 years last year) Possible