H2 Prelims Paper 1 Q1 Suggested Answers

©ACJC2022 Preliminary Exam 9757/01 Answer all questions. Question 1: The Nitrogen Fertilizers Crisis Table 1: Employment and consumption data on fertilisers 2015 2016 2017 2018 2019 Number of workers employed in US fertilizers industry 19 133 19 580 20 058 20 837 22 179 Fertilizers consumed in US (in million tons) 22.46 23.14 23.44 21.68 22.40 Fertilizers consumed globally (in million tons) 213.27 215.13 217.42 213.77 215.37 Sources: IBISWorld and ourworldindata.org Extract 1: The US fertilizer production industry Fertilizers are critical input for crop production and represent a major variable cost for several US crops. Farmers represent the end users in the fertilizers’ supply chain, and the prices they pay for fertilizer s depend on several fac tors including local demand, product type, retailer mark-ups, and transportation costs. The US fertilizers sector has undergone substantial changes. Between the 1980s and mid - 2000s, the combination of lower fertilizer s demand and higher input costs for fertilizers production caused the fertilizers sector to contract from 59 to 22 production facilities. The assumption is that highly concentrated industries are synonymous with market power , which can be detrimental to the society. Whether that will happen in reality rely on many factors, one of which is the level of government regulation in the fertilizers market. Source: Choices and the Agricultural & Applied Economics Association, 2020 Extract 2: USDA announces plan to support US farmers The US Department of Agriculture (USDA) will support American farmers by increasing the fertilizers production so as to address its rising costs. It is offering a $250 million new grant to encourage greater production of fertilizers. Additionally, to address growing competition concerns in the agricultural supply chain, USDA will launch a public inquiry, seeking information regarding agricultural fertilizers and the impact of concentration and market power on agriculture farmers. The inquiry aims to enhance fairness and competition across America’s economy. “Concentrated market structures and potentially anti -competitive practices leave America’s farmers, businesses, and consumers facing higher costs, fewer choices and less control about where to buy and sell, and reduced innovation—ultimately making it harder for those who grow our food to survive,” said Agriculture Secretary of the United States. Source: US Department of Agriculture, 11 March 2022

2 ©ACJC2022 Preliminary Exam 9757/01 Extract 3: Fertilizer costs: what is driving the increase? Significant increase in the cost of fertilizer s over the past year has caused a lot of concern among farmers in the United States. Given that the cost of fertilizers now account for approximately 15-20% of total costs for corn production, fertilizer prices and its availability are a major concern for farmers planning for the 2022 growing season. Farmers in some areas are reporting prices more than 300% higher than last winter, and delivery times seems to be anyone’s guess. The price increase was driven by strong domestic and global demand for crops, low fertilizers inventories, and very slow adjustments in production by the US fertilizers industry. As fertilizers are global commodity, it s prices can be influenced by various market factors beyond the control of US producers. Countries that import fertilisers are also exporters of the raw materials needed to produce these fertilisers. Hence, this means that fertilizers prices are more volatile as it is subjected to both the cost of factor inputs as well as the production costs of the country producing it. Another factor is that two -thirds of global fertilizer s demand is driven primarily by the production of crops, of which corn, wheat, and soybeans constitute about 36% of that total demand. So, as large producers of corn, soybeans, and wheat, the US is a large consumer of fertilizers. Trades disputes and disruptions have also played a big role in fertilizers availability and cost. The US have restricted imports of selected factor inputs such as potash from Belarus. Potash is an essential raw material used to produce fertilisers, and Belarus is a country which contributes to about 20% of the global production of potash. T he uncertainty of Russian actions against Ukraine creates further volatility since Russia is also one of the top global exporters of all three fertilizers raw materials — nitrogen, phosphate, and potash. Price of fertilizers in the US can also be influenced by internal factors such as increased domestic transport costs due to labour shortages in th e freight industry which the fertilizer s industry relies on for transportation. Domestic weather conditions like hurricanes, ice storms, as well as infrastructure breakdowns, have caused several production and distribution disruptions. Source: Institute of Agriculture and Natural Resources, 8 February 2022

3 ©ACJC2022 Preliminary Exam 9757/01 Question 1: The Nitrogen Fertilizers Crisis Suggested Mark Scheme: (a) With reference to Table 1, identify the difference in the trend of number of workers employed in the US fertilizers industry and the consumption of fertilizers in the US from 2016 to 2019. State one possible reason for the difference. [2] Suggested Response: • From 2016 to 2019, number of workers employed is generally increasing while the consumption of fertilizer in the US was decreasing [1m] • The increase in number of workers employed could be a result of US requiring more factor inputs to producing a larger share for export to the global market although domestic demand for fertilizer was decreasing [1m] Mark Scheme: 1 difference in the trend of the two stated variables – 1m 1 reason to account for the difference – 1m (b) (i) With reference to Extract 1, explain how the lower demand for fertilizers and higher input costs could cause firms to exit the US fertilizers industry. [4] Suggested Response: • A fall in demand results in a fall in the market price. The existing firms in the fertilizer industry would have to charge a lower price than before. As such, existing firms’ average revenue (AR) would fall. • A higher input costs implies that a firm’s average costs (AC) would increase • In the long run, the firm’s AR could be lower than its AC. Firms exit the industry because of earning subnormal profit Alternative response • A fall in demand results in a fall in the market price. The existing firms in the fertilizer industry would have to charge a lower price than before. As such, existing firms’ average revenue (AR) would fall. • A higher input costs implies that a firm’s average variable costs (A VC) would increase • In the short run, a firm is unable to cover fixed costs and part of their variable costs if AR < AVC (or total revenue < total variable costs). Firms would then choose to shut down to minimize losses. Mark Scheme: Explain impact on average revenue – 1m Explain impact on AC – 1m Explain exit/shutdown decision – 2m (ii) Explain how market dominance could lead to an inefficient allocation of resources in the US fertilizers market. [6] Suggested Response: • Efficient allocation of resources is achieved where MB = MC i.e. P = MC given that price reflects MB. Therefore, social welfare is maximised if the firm produce the good up to QAE where P = MC. • However, market dominance implies that a firm is a price setter i.e. the firm has the power to set price by restricting output. For example, a profit maximizing firm would

4 ©ACJC2022 Preliminary Exam 9757/01 produce up Qπmax where MC = MR. At this point, the profit maximizing price Pπmax is greater than MC. • Society incurs a deadweight loss as a result of the firm not producing the amount Qπmax to Q AE. This is because the marginal benefit to