2013_IJC_H1_Econs_Q1 Answer

Econ Prelim 2 H1 Case Study Q1 Suggested Answers  (a) (i) With reference to Figure 1, describe the trend in the world price for rare earths between 2002 and 2010. General trend – rise in world price for rare earths [1m] Specific trend – sharp increase/ spike in world price in 2010 [1m] (No mark awarded for decrease in price in 2008 since it is not a significant feature in the trend) [2] (ii) Explain how the trend in world price for rare earths would impact the market for hybrid cars. (The answer should be based on the trend given in a(i).) Rare earths are used as raw materials to produces parts of hybrid cars. The rise in the price of rare earths will increase the cost of production for producing hybrid cars. [1m] The supply curve will hence shifts left. [1m] A diagram is helpful although there is no specific mark awarded for diagram as it is not asked in the question). Assuming ceteris paribus, the equilibrium price of hybrid cars will increase [1m] and the equilibrium quantity sold will fall. [1m] Given that the demand for hybrid cars is likely to be price elastic (luxury good), the price will increase more than proportionately than the fall in quantity of cars sold. [optional 1m] [4] (b) (i) With reference to Extract 2, explain how the existence of 'external costs' leads to market failure.  Evidence from the extract: Some of the external costs identified in extract 2 include polluted air and water and radioactive residues.  Explain how external costs cause a difference between MPC and MSC. [1m]  Explain how both market and social equilibria are reached. [2m]  Explain how overproduction of rare earths occurs in this case with presence of deadweight loss. [1m] The mining of rare earths resulted in negative externality where these external costs (such as polluted air and water and radioactive residues) causes harm to the environment and people who are not involved in the production of rare earths. As such, the marginal social cost (MSC) is higher than marginal private costs (MPC) due to these external costs. [1m] Private producers acts in their own self-interest and will produce up to [4]

marginal private benefit (MPB) equal to marginal private cost (MPC). However, the society’s optimal production of rare earths is where marginal social benefit (MSB) equals marginal social cost (MSC). This results in an overproduction of rare earths from the society’s perspective. [2m] There is the presence of deadweight due to overproduction of rare earths which is allocative inefficient as MSC> MSB at that level of production of rare earths. [1m] (No additional mark is given for diagram separately but they can be considered in totality as part of the answer. Students are not expected to draw the diagram to access the full range of marks since it is not in the syllabus nor required in the question.) (ii) With reference to Extract 3, explain how China can reduce these 'extern