2012 J2 H1 Prelim Exam Answers

1 © Jurong Junior College 2012 (H1) JJC H1 PRELIMINARY EXAMINATIONS 2012 - ANSWERS Case Study Question 1 (a) (i) Describe the trend in Base Metal prices between March 2009 and December 2011. [2]  Overall there is a rising trend. (1m)  Prices peaked in around March 2011, after which it fell continuously till Dec 2011.(1m) (ii) Explain possible reasons for the trend above. [4] [An explanation to support why there is an overall increase in price] Rising consumerism and income/affluence has increased the demand for final end products such as consumer goods. Metals is an important factor input in the production of these consumer goods, thus the increase in demand for consumer goods will increase the demand and need for metals as a resource. Production of metals generally lags beh ind the demand for metals. It takes more time for producers of metals to gather their various factors of production to ready the mines for extraction when demand rises. (2m) [Another explanation why prices fell] The effects of the global recession might ha ve reduced income and consumption of consumer goods significantly. This might have caused a fall in demand for consumer goods and the corresponding demand for metals and thus its price. (2m) (b) Using the concept of price elasticity of demand, analyse ho w a cut in export sales of rare earth metals by China affects the total revenue of consumer -based and precision weaponry firms in US. [6] Cut in export sales of rare earth metals will cause a shortage of this metal mineral. This reduc tion in supply will cause prices of rare earth metals to increase. Such an increase in price will lead to an increase in cost of production for many industries in US producing various consumer goods, such as desktops and smartphones as rare earth metal is an important factor input in these industries. This will shift the supply curve of these industries to the left causing a rise in prices of these products. (2m) The demand for consumer -based goods such as vehicles, computers, and smart phones is price elastic as there are many substitutes available from foreign producers. For such industries, an increase in price due to higher cost of rare earth metals will lead to a more than proportionate fall in quantity demanded causing total revenue to fall. This is because the rise in revenue from the price increase is less than the fall in revenue from the loss of revenue due to a fall in quantity. Total revenue for producers in consumer based products will fall. (2m) On the other hand, the demand for weapons is pr ice inelastic due to the lack of substitutes available for the US governments. In these industries the rise in price will lead to a less than proportionate fall in quantity demanded for the products. Total revenue for precision weapon producers will rise. (2m)

2 © Jurong Junior College 2012 (H1) 2m for explaining how the export restriction affects the rare metal prices and the cost of production for goods. 2m for explaining the impact on TR for consumer based firms with elastic demand. 2m for explaining the impact on TR for precision weaponry firms with inelastic demand. (c) Explain why the restrictions on the production of rare earth metals by China can be justified on grounds of efficiency. [4] Ext 2, Extraction of rare earth metals often results in substantial enviro nmental costs such as the disposal of large amounts of radioactive materials into the ground and pollution of water resources from the extraction. Hence the extraction of rare earth metals results in negative externalities which are not factored into the c ost of production in the extraction process. Due to the existence of external cost, it leads to the divergence between marginal private cost and marginal social cost. When left to the market, producers only take into account their private cost and benefi t, ignoring external cost. At equilibrium, they equate marginal private cost with marginal private benefit. This leads to an output level which is higher than the socially optimum level which occurs where marginal social cost is equal to marginal social benefit. Hence society welfare is not maximized and there is inefficiency in the allocation of resources. Reducing production by restricting the exports of these rare earth metals will reduce the amount of negative externalities and maximize society's welfare and reach an efficient allocation of resources. (Diagram is not a must but it will be helpful to explain the inefficiency in allocation of resources) L1 (1-2 marks) Undeveloped explanation on how the production of rare earth metals causes negative externalities such as pollution to relevant third parties, thus causing market failure L2 (3-4 marks) Well-developed explanation on how the production of rare earth metals causes negative externalities such as pollution to relevant third parties, thus causing market failure (d) With reference to Extract 3, comment whether rising inflation in UK is d ue to rising commodity prices. [6] As mentioned in Extract 3, a rise in price of commodities would contribute to rising inflation. Th is is because commodities such as metals and fossil fuel are important input in modern manufacturing and generation of energy. Food grains are also important ingredients for production of food for consumption. Hence a rise in the prices of commodities will increase cost of production for many production processes leading to a fall in profit level. This leads to a fall in aggregate supply causing AS curve to shift to the left. This leads to cost-push inflation. (Illustration using graph is optional)

3 © Jurong Junior College 2012 (H1) However, cost -push inflation in UK in 2011 is not only caused by higher commodity prices. As mentioned in Extract 3, the VAT has increased in January 2011. This has also led to a one-time increase in price level and hence inflation. A weaker pound also means that prices of imports become relatively more expensive in terms of pound. This leads to a higher level of imported inflation. Besides cost-push inflation, inflation in UK can also be due to demand -pull inflation. A weaker pound causes prices of export s to become relatively cheaper. Assuming that demand for exports is price elastic, this leads to a more than proportionate increase in quantity demanded causing export revenue to rise. As net exports fall, demand -pull inflation also worsens. Thus inflation in UK in January 2011 is not only caused by rising commodity prices. It is also caused by a weaker pound and the implementation of an increase in value -added tax on goods and services. L1 (1-3 marks) For an explanation that shows how rising commodity p rices lead to cost push inflation in UK. L2 (4-6 marks) For a well-developed explanation on how rising commodity prices and other possible factors can contribute to both cost -push and demand-pull inflation in UK. (e) Discuss the economic case for US in imp osing protectionist measures on Chinese solar panels. [8] US anti-dumping measures on imported solar power from China can be justified if the Chinese producers are indeed receiving government assistance and selling the solar power below their marginal cost of production. Such assistance can be in the form of subsidies and cheap credit (cheap loans) from the Chinese government. This will enable the Chinese producers to price their domestic producers of solar power out of the m arket by selling it at a much lower price than them (predatory dumping). This causes the domestic solar power industry in US to face unfair competition which results in a fall in output and employment. When US impose import tariffs onto Chinese solar panels as a form of retaliation, it will increase th