VJC H2 Econ P1 Answer

1    2014 H2 Economics Prelim Exam Paper 1 Answers Question 1 (a) i) Describe the trend of the price of natural gas in USA between 2008 and 2012. [1] Overall, price of natural gas decreased from 2008 to 2012. ii) Using the data and a diagram, account for the trend observed. [4] Improvement in extraction of natural gas has reduced marginal cost of producing gas, leading to a rightward shift in the supply cu rve. Evidence: “Improvement in fracking to obtain natural gas” (Extract 1 para 1) [2m] The “growth in demand” for natural gas was also slow (Extract 2 para 1), suggesting that the increase in supply exceeded the increase in demand  supply shift right more than demand  surplus  overall price of natural gas decreased [2m] Award max 3m if only supply side reason is mentioned. 1m for diagram (b) i) With reference to the data, explain the type of market structure in which the US natural gas industry operates in. [2] Oligopoly industry. [1m] Evidence: ‐ Presence of “energy giants such as ExxonMobil, Shell and Chevron” suggest that the market is concentrated in the hands of a few large firms. [Any 1 evidence + explain  2marks] No marks for theoretical explanation that is not backed up by evidence from the extract. (b) ii) Explain why big natural gas producers may be better able to withstand low prices of their output. [2] Big natural gas producers have more market power  likely to have consolidated some supernormal profits [1m]  deeper pockets to sustain the fall in revenue because of lower prices of output. [1m] Or Big natural gas producers have a larger market share, hence produce a larger amount of output. As a result, they are able to reap internal economies of scale  unit cost of production falls with output. [1m] The lower unit cost of production helps to cushion the fall in revenue as a result of lower prices of their output. [1m] Max of 1m for identification of 2 points, but without any explanat ion of any of the points. (c) The price of natural gas is typically much higher outside of USA. Explain how you would expect this price differential to change over time. [3] Currently, the price of natural gas is typically higher outside of USA due to the high demand and limited supply in those countries . As US exports natural gas to these

2    countries, the supply of natural gas increase s in these other markets, causing prices of natural gas in other countries to fall [1m]. At the same time, the supply of natural gas in US will decrease, causing the prices in US to rise [1m], and hence the price differential should fall over time [1m]. Other possible answer: As mentioned from the extract, gas-cons uming American businesses object to the idea of exporting LNG. With US not supplyi ng much to the overseas markets, there will be little change to the prices of natural gas outside of US. As such, there might not be much change to the price differential over time. (d) Assess how the export of natural gas will impact producers and households in USA. [8] Introduction Export of natural gas reduces the supply for domestic economy  fall in supply leads to higher domestic prices of natural gas. The effects can be assessed by looking at the impact on different producers’ cost and revenue and the impact on prices for consumers and jobs for members of households. Producers: ‐ Related industries e.g. petrochemicals, agriculture, automobile that rely on oil as a factor input will experience hi gher COP. Assuming revenue unchanged, firms may experience fall in profits. (Evi: Extract 1 para 2) ‐ Ev: extent of impact depends on the degree of dependence on natural gas. Greater the degree of dependence  more inelastic the demand for natural gas is, greater the increase in COP. ‐ For natural gas producers, exporting natural gas to countries where demand exceeds supply  open up new markets for natural gas producing firms in US (extract 2 para 4)  increase demand for natural gas  higher revenue ‐ Ev: however cost of building liquefaction facility is capital intensive and costs have been increasing steeply (extract 3 para 2)  higher costs of production means it may be hard for export of natur al gas to be profitable despite the extra source of revenue for the firms. Households: ‐ Households face higher prices lowers consumer surplus ‐ Pay higher prices for electricity bills  increase cost of living; less ability to spend on consumption of goods and services fall in material SOL ‐ Ev: impact more significant for lower income families as utility bills form a larger proportion of their expenditure  rising inequity ‐ Domestically, higher COP for natural gas might result in some firms (car exporters) off-shoring, leaving for count ries with low labour costs to reduce their COP to maintain/increase profitability ( Extract 1 para 3)  increase in layoffs  those working for these industries will suffer from unemployment and loss of income. Synthesis Based on trade theory, exports disadvan tage domestic consumers (households and domestic firms) due to the rise in price (l ose consumer surplus) but is advantageous to exporting firms (gain in producer surp lus). Using DD/SS analysis, if the gain in producer surplus > loss in consumer surplus and there is supposed to be a net gain in welfare  society as a whole gains. But the gas firms are gaining at expense of the

3    consumers  rising Y inequity. Conclusion: ‐ Extent of impact on different party differs ‐ Gainers likely to be gas producing firms that are able to export gas to overseas market ‐ Domestic producers and consumers lik ely to be adversely affected, with those producers heavily reliant on nat ural gas, as well as lower-income consumers affected most. ‐ While society as a whole gains, there will be a fall in equity of distribution. The US govt would need to address this if it were to allow the export of natural gas. Level Descriptors L3 6 - 7 Well-developed and balanced answ er, analysing the impacts on different producers and consumers. Answers also well-supported by evidence. L2 3 - 5 Able to provide well-explained answer but limited in scope, not covering the impact on both producers and consumer, as mentioned in the question. OR Covers scope but under-developed explanations (gaps in explanation) or lack evidence L1 1 - 2 Answers largely inaccurate and theore tical, with little use of evidence from case materials; E 1 Able to make reasoned conclusion, weighing the extent of the impacts on the various parties. Answers should not focus on the macroec onomic effects. Max 1m given for the explanation on the macroeconomic effect s e.g. on households (effect on income and jobs) (e) Assuming that you are an economist, discuss the extent to which the increased availability of natural gas can address the problem of global warming. [10] Introduction Global warming  market failure Natural gas is an alternative fossil fuel to coal and switching to natural gas can help to reduce greenhouse emissions, reducing global warming. The extent of which it can address the problem depends on the benefits vs the costs of switching to natural gas. Explain market failure problem

4    ‐ There is market failure because of the presence of negative externalities. Production of goods and services release greenhouse gases brings about global warming which affects third parties, other than the producers and consumers in the market. Global warming results in melting of ice caps, increasing flooding. It also disrupts ecosystems, causing animal species to become extinct. ‐ The presence of negative externalitie s will cause a divergence in the cost curves, where MSC> MPC. Assuming no externalities in consumption, MPB=MSB. When l