NJC H1 ECONS P1 ANS

National Junior College Economics Department Preliminary Examination 2015 Answer Booklet Senior High 2 H1 Economics (Syllabus 8819)

2015 SH2 H1 Economics Preliminary Examinations National Junior College Economics Department 2 Section A: Case Study Questions Suggested Answer Scheme Question 1: (a) (i) Using Table 1, compare the overall change in global palm oil prices between 2009 and 2011 with that between 2012 and 2015. [2] Similarity: • The price of palm oil fluctuates for both periods of time. Differences: • The price of the palm oil has increased between 2009 and 2011, but decreased between 2012 and 2015. • The increase in the price of palm oil between 2009 and 2011 is more significant than the decrease in its price from 2012 to 2015. 1m each, 2 comparisons. (a) (ii) Using demand and supply analysis, account for the change identified in (a)(i). [4] The increase in the price of the palm oil between 2009 and 2011 is due to the rising demand for palm oil in EU. [Extract 2] By 2010, EU members need to replace 5.75 percent of all transportation fuels with biofuel. This increases the demand for biofuel. The demand for palm oil is derived from the demand for biofuel (palm oil is used to produce biofuel and it is cheaper to produce than other vegetable oils). Therefore, this leads to the increase in the demand for palm oil, which drives the global prices of palm oil upwards between 2009 and 2011. [Extract 1] The price of palm oil has decreased between 2012 to 2015 due to the record high output in Southeast Asia and the weakening of demand in China and India who are the top buyers of palm oil. India may set higher tax imports on edible oil imports and China launches strict quality curbs for imports on 1st Jan 2013. These regulations will decrease the demand for palm oil. On the other hand, there is a record high supply of palm oil in the palm oil producing countries. Therefore this leads to a surplus of palm oil at the existing price level, which will have a downward pressure on the price of palm oil. 2m each for explaining the reasons for the direction of the price changes. 1m for using the data and 1m for explanation using dd-ss analysis. (b) Explain why the government in India may want to set a higher tax on edible oil imports from Indonesia. [2] This is to protect the oilseed farmers in India. It may be cheaper for the producers of edible oil in India to import the products from Indonesia instead of producing it in India. This will decrease the demand for oil as a raw material. As such, this decreases the revenue of the oilseed farmers.

2015 SH2 H1 Economics Preliminary Examinations National Junior College Economics Department 3 Marks to be awarded to students if they are able to link to the revenue or profits of the oilseed farmers. (c) (i) With reference to Extract 2, explain how negative externalities arise in the palm oil production. [4] Define negative externalities [1]: Negative externalities occur when the production and/or the consumption of a good or service impose external costs on third parties who are not involved in the production and/or consumption of the good or service for which no appropriate compensation is paid. Explain how the air pollution problem arises from the production of palm oil: The farmers use the slash-and-burn method to clear patches of land for oil palm plantation. Under this practice, farmers cut down part of the vegetation on a patch of land and then set fire to the remainder. The fire is extremely difficult to stop and produces thick and pungent smog. It pollutes the environment and deteriorates the air quality. Identify the third parties involved and explain the external cost on them [3]: The residents living in Malaysia and Singapore could likely have more breathing difficulties and subject to an increase in medical costs. If the haze problem persists, the tourists may refrain from travelling to these places such as Singapore. The tourism-related industries such as retails, sales, hotels, food and beverage will suffer a decline in their business and hence profits. Marking tips: 2 mark for identifying one 3rd party and the external cost to the 3rd party. Capped at 3 if definition of negative externality is not given. (c) (ii) Discuss whether the use of a Pigovian tax or a system of tradable permits is more effective in tackling the problem of negative externalities in the production of palm oil. [10] Explain the market failure in the production of palm oil Private cost: cost of raw materials, salaries paid to the workers and etc to produce the palm oil Private benefit: profits made from selling palm oil External cost: as mentioned in (c)(i) Show there is a divergence between private costs and social costs. Diagram that is well explained to show how the market failed in optimal resource allocation with clear identification of MPB = MPC and MSB = MSC. At the free market equilibrium, producers and consumers will only consider private costs and benefits and produce at MPB = MPC. With the existence of negative externality, MSC>MPC. Assuming that MSB=MPB (no positive externality), the market will consume at the output Qm where MPB = MPC, which is greater than the socially optimal output of Qs where MSC=MSB. The free market leads to an over production of palm oil by QsQm units, where the welfare loss to society is represented by area AE1E0 thereby resulting in allocative inefficiency.

2015 SH2 H1 Economics Preliminary Examinations National Junior College Economics Department 4 Analyse the use of Pigovian tax: The government can levy a specific tax that approximates the money value of external costs (known as Pigovian tax), created by the negative externality, generated per unit of output at the socially optimal level of output. For example, in figure 1, a specific tax at the socially optimal level of output 0R will increase the firm's unit cost, shifting the supply curve from MPC to MPC + tax. The result is that the equilibrium output will decline so that it corresponds with the socially optimum level of output of 0R units. There would therefore be no over-production of the good as MSB = MSC and allocative efficiency is attained. The taxation forces the palm oil producers to internalise the externality hence producing at the socially optimum level of output where MSB equates MSC, this outcome removes the dead-weight loss to society (AE0E1); the gain due to the reduction in production (AE1QsQm) offsets the lost due to the reduction in consumption (E1E0QmQs), but it does not remove the external costs entirely. Limitations: However, there are problems with the imposition of Pigovian taxes. There is the problem of accurately assessing the exact monetary value of external costs at the socially optimal level of output (e.g. measuring the external costs generated by negative externalities like noise pollution), which in turn implies that the appropriate level of tax is difficult to determine. Despite this, the use of Pigouvian Tax is more effective than a system of tradable permits as the firms know for sure how much the cost savings from each tonne of emission reduction is. The return from investment in green technology is more uncertain under the tradable permits system. The cost savings to be had from investment in green technology depends very much on the price of the tradable permits which fluctuates from year-to-year depending on the demand and supply conditions. It is this uncertainty that is keeping firms from spending on R&D and investing in green technology. In addition, the administrative costs of collecting the tax may be very high. Firms may also have the incentive to evade such taxes, for example by not registering the operation of the companies which has made it more difficult for the government to track the source of fires in Indonesia. Figure 1: Internalising negative externality