2013 SRJC H2 Econs P2

© SRJC 9732/02/JC2 Prelim Exam/2013 ECONOMICS 9732/02 Higher 2 Paper 2 Essay Questions 2013 2 hours 15 minutes Additional Materials: Writing paper SERANGOON JUNIOR COLLEGE JC 2 Preliminary Examination READ THESE INSTRUCTIONS FIRST Write down your name and civics group on all the work you hand in. Write in dark blue or black pen on both sides of the paper. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters, glue or correction fluid. Answer three questions in total, of which one must be from Section A, one from Section B and one from either Section A or Section B. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question.

© SRJC 9732/02/JC2 Prelim Exam /2013/Suggested Answer Outline 2 1 Most people buy luxury wristwatches for their perceived excellent quality or higher status. Others can only afford cheaper brands. Critically examine the likely impact of a large fall in cost of production in the midst of a recession on the revenue earned from the sales of different categories of wristwatches. [25] Question requirement  Wristwatches range from higher-end luxury brands like Rolex and TAG Hauer to cheaper brands.  A supply (fall in cost) and a demand (incomes fall in a recession) triggers are given.  Focus on elasticities of demand – the use of PED and YED would be sufficient, given the triggers.  Appropriate diagrams are necessary.  Focuses on the impact of each trigger and combined impact of both triggers on the sales revenue (PxQ) of different wristwatches.  Answer should conclude with some generaliz ation on the similarities and differences observed in the revenue earned. Suggested Answer Introduction  Wristwatches have different brands, ranging from the higher-end luxury brands like Rolex or TAG Hauer to the mid-range Citizen or Rado and cheaper unknown brands.  There is a wide variety to cater to the different consumer wants based on their ability & willingness to pay.  A supply (cost) and a demand (incomes) triggers are given.  The elasticities of demand – namely price-elasticity of demand (PED) & income- elasticity of demand (YED) – would affect the equilibrium prices and quantities of different brands of wristwatches when there is a large fall in cost of wristwatch manufacture and a fall in incomes. Body When there is a large fall in the cost of wristwatch manufacture, ceteris paribus, the equilibrium quantity would increase while the equilibrium price would fall in the market. The large fall in the cost of wristwatch manufacture could arise from decreases in prices of inputs like labour or metals used in their manufacture. Due to the lower production costs, there would be a rise in supply/ output by manufacturers. However, given the same rise in supply, the extent of the effect on the revenue would differ for different wristwatch brands, depending on whether they are the luxury, normal or inferior brands.  Luxury and normal wristwatches are likely to have price-elastic demand where Qdd would rise more than proportionately due to a fall in their prices from the fall in production costs, ceteris paribus.  In comparison, luxury brands would have a more price-elastic demand than other brands because consumers perceive them to be of excellent quality or of higher status.

© SRJC 9732/02/JC2 Prelim Exam /2013/Suggested Answer Outline 3 A fall in prices means consumers will be more likely to be able to afford them. A fall in their prices would mean a higher real purchasing power (income effect) and consumers would switch from a cheaper substitute (subs titution effect), in this case, a normal or even an inferior brand. Although still price elastic, normal wristwatches would face a smaller increase in Qdd compared to luxury brands.  In the case of inferior wristwatch brands, as real purchasing power is increased by the fall in prices (income effect), Qdd would rise less than proportionately, ceteris paribus as demand is price-inelastic. This is because when their prices fall due to the large fall in costs of production, there are now better substitutes available in the wristwatch market for consumers who had intended to buy inferior wristwatch brands.  With price-elastic demand for luxury and normal wristwatches, the fall in prices from the large fall in costs of production would be less than the fall in prices in the case of inferior wristwatch brands which have more price-inelastic demand. This is because luxury and normal wristwatch production are likely to use more skilled labour or better quality materials and their costs are likely to fall less than those used in inferior wristwatch manufacture. Hence, the price fall for luxury wristwatches would be less than that for normal and inferior wristwatches.  With price-elastic demand for luxury and normal wristwatches, the large fall in costs of production would cause increases in revenue as the price falls cause more than proportionate increases in their quantities dema nded. In the case of inferior wristwatch brands which have more price-inelastic demand, the fall in price would cause a less than proportionate increase in quantity demanded, resulting in a fall in revenue. With a recession, incomes will fall, ceteris paribus, and the equilibrium quantity and price would fall more than proportionately for the luxury brand, fall less than proportionately for the normal brand & rise more than proportionately for the inferior brand. A fall in incomes means consumers will have a lower purchasing power to upgrade from a normal or inferior to a luxury brand or from an inferior to a normal brand. The fall in demand is shown by the leftward shift in demand curve as seen in diagram 2, resulting in a decrease in revenue for both the luxury and normal brands. A luxury brand has a positive income elasticity of demand so that as consumers’ income falls, there is a more than proportionate decrease in quantity demanded at each price, ceteris paribus. A normal brand has an income elasticity of demand of between 0 and +1 e.g. if income falls by 10%, there is a less than proportionate fall in demand by less than 10%. The inferior brand has a negative income elasticity of demand i.e. demand increases as income falls. This is because it is a better substitute in times of falling real incomes if the consumer in in the market to purchase wristwatches. The inferior brand gains due to the need to cut down on luxury and even normal brands in difficult economic times, resulting in a more than proportionate increase in demand.

© SRJC 9732/02/JC2 Prelim Exam /2013/Suggested Answer Outline 4 Combined impact of a large fall in costs in a period of recession when incomes are falling: Combined impact of decreases in costs and incomes on total revenues of the different brands is indefinite if there is a fall and increase in tota l revenues from the 2 triggers separately. This occurs in the 3 brands when the decrease in costs and the decrease in incomes are analysed separately. The actual result on revenue will depend on whether the impact of the fall in costs on total revenue or the fall in incomes on total revenue is greater. Conclusion Different brands of wristwatches would have different price elasticities and income elasticities of demand which would cause the quantities to respond differently in either magnitude or direction or both to the changes in the market such as fall in cos