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 mig