HCI H1 ECONS P1 ans

HWA CHONG INSTITUTION C2 Preliminary Examination 2016 Higher 1 Economics Case Study Question 1 Suggested Answer (a) With reference to Extract 3, explain why the value of the price elasticity of supply of new housing in UK might change over time. Define PES [1m] Price elasticity of supply measures the degree of responsiveness of quantity supplied of a good to a change in its own price, ceteris paribus. State + Explain that in SR: PES<1 [1m] Need time to build houses and in the short term, there is a "lack of materials and labour… bricks running out… construction workers left the industry" State + Explain that in LR: PES likely >1 [1m] Availability of materials as "brick makers reopen plants" and skilled workers as former military personnel join the construction industry and traini ng schemes help to train them to become skilled workers. [3] (b) (i) What is meant by price elasticity of demand? Price elasticity of demand measures the degree of responsiveness of quantity demanded of a good to a change in its own price, ceteris paribus. [1] (ii) With reference to Table 1, how far does the concept of price elasticity of demand help to explain the difference in the electricity charges during day and night? State that the electricity charges are higher in the day, compared to the night. [1m] Explain that the different prices charged for the usage of electricity could be due to difference in the price elasticity of demand. [2m] - Firms/producers would raise price to increase its total revenue if the demand for the good is price inelastic. However if the demand for the good is price elastic, the firm would lower price to increase its total revenue. - The difference in the electricity charges could be due to differences in price elasticity of demand. Day prices are higher as demand for electricity is more price inelastic due to higher degree of necessities in the day time where electricity is required for the functioning of the economy when most people are awake, e.g. business and production activities, school, households etc. Night prices are lower as demand is more price elastic due to lower degree of necessities. Most activities are not essential to be conducted in the night when most people will be resting. - In this case, the electricity company, Good Energy, would charge a higher price during the day, compared to the night. Explain that the different prices charged could be due to difference in demand (for electricity to function the economy) and supply (cost of production). [2m] - During the day (peak period), there is a higher level of demand for electricity to function the economy. Thus, the demand for electricity during the day (peak period) is higher, compared to the demand for electricity at night (off-peak period). [6]

- The cost of production is also higher in the day (peak period) compared to the night (off-peak period). During the night (off-peak period), nuclear and coal-fired stations, with lower operating costs, will be used. However, during the day (peak period), power stations with higher operating costs (e.g. oil-fired stations) will have to be activated. - With higher demand and higher operating costs in the day, Good Energy would charge a higher price during the day, compared to the night. Conclude that the data on PED is not available hence the difference in the charges is likely due to peak period vs off-peak period. Any other possible conclusion is acceptable. [1m] (c) Explain what is meant by the term ‘negative externality’. Externalities occur when the production or consumption of a good affects the well-being of third parties who neither receive nor pay any compensation for that effect. [1m] Negative externalities are harmful spill over effects or external costs imposed on third parties. [1m] [2] (d) Using demand and supply analysis, account for the difference in average house prices in London and the Yorkshire as shown in Table 1. Price difference likely due to differences in demand and supply. London has a higher average house price because: Higher demand due to higher annual income earned (£79,000) leading to higher purchasing power and higher population (8.5m) leading to higher number of people seeking for lodgings (houses) + Lower supply due to lack of land in the capital (1,572km2) available for building new houses. Yorkshire has a lower average house price because: Lower demand due to lower annual income earned (£49,000) leading to lower purchasing power and lower population (5.4m) leading to lower number of people seeking for lodgings (houses) + Higher supply due to more land available outside of the capital (15,420km2) for building new houses. Explain the difference in the Demand Factors – Income and Demographics (Population Size) [2m] Explain the difference in the Supply Factor – Price of input  In this case, the price of land (for building new houses) is affected by the size of the land area [1m] Link the above explanations to difference in prices. [1m] [4] (e) Extract 4 mentions various policies that the UK government adopts to reduce greenhouse gas emissions in the Power and Industry as well as Buildings sectors. Discuss the effectiveness of any two policies that the UK government currently adopts to achieve economic efficiency in resource allocation. Introduction: The presence of greenhouse gas emissions (negative externalities) suggests that the free market has failed in the allocation of resources. Hence, the UK government targets to cut emissions by at least 80% from 1990 to 2050 to achieve economic efficiency in resource allocation. Whether the target is achievable or not would depend on the economic policies currently adopted. Body: Explain how each policy works and assess its effectiveness and limitations Power and Industry Explain how Carbon Trading with Carbon Price Floor scheme works. [6]

- The EU estimated the socially efficient level of emissions and decided on the number of permits to be issued to the big factories and power plants, and they are allowed to pollute up to the permitted level only. If any of the big factories or power plants wants to pollute beyond the permitted level, it can purchase extra permits from others who might not need them. That is, the big factories and power plants can trade these permits among themselves, where the price of the permits is determined by the forces of demand and supply. The total level of emissions produced by all the big factories and power plants will not exceed the level set by the UK government. Assess its effectiveness and limitations. - The EU government lowers the overall cap on the emissions progressively to give firms time to react (e.g. to cut emission by adopting green technology) but with the intention for the level of emissions to reach the socially efficient level eventually. Explain how Transition to a Low-carbon Power Sector works. - By transiting to a low-carbon power sector, which uses renewables (such as wind, and solar), nuclear and carbon capture and storage (CCS), the UK government aims to reduce the amount of emission and hence EMC, so that the new market output will be closer to the socially efficient level. Assess its effectiveness and limitations. - The transition will require massive capital outlays, which will put a strain on the government's budget. (Extract 4, ‘Government’s support has also been provided…….’) - Moreover, CCS is a new and untested technology that might not produce results. Hence, the opportunity cost is high. Buildings Explain how retrofit improvement in the energy efficiency of homes works. - By insulating loft and cavity walls and replacin g old inefficient boilers, the demand for gas for heating will fall. This policy aims to reduce PMB/ demand to coincide with the PMC at the socially efficient level. Assess its effectiv