H2 Prelims Paper 1 Q1 Suggested Answers

Answerallquestions. Question 1: The Nitrogen Fertilizers Crisis Table 1: Employment and consumption data on fertilisers 2015 2016 2017 2018 2019Number of workersemployed in US fertilizersindustry 19 133 19 580 20 058 20 837 22 179 Fertilizers consumed inUS (in million tons) 22.46 23.14 23.44 21.68 22.40 Fertilizers consumedglobally (in million tons) 213.27 215.13 217.42 213.77 215.37 Sources:IBISWorldand ourworldindata.org Extract 1: The US fertilizer production industry Fertilizers are critical input for crop production and represent a major variable cost forseveral US crops. Farmers represent the end users inthefertilizers’ supplychain, andthepricestheypayforfertilizersdependonseveral factorsincludinglocal demand,producttype,retailer mark-ups, and transportation costs. The US fertilizers sector has undergone substantial changes. Between the 1980s andmid-2000s, the combination of lower fertilizersdemandandhigher input costsfor fertilizersproduction caused the fertilizers sector to contract from59 to 22 production facilities. Theassumptionisthat highlyconcentratedindustriesaresynonymouswithmarketpower,whichcan be detrimental to the society. Whether that will happeninrealityrelyonmanyfactors,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 Americanfarmersbyincreasingthefertilizersproductionsoastoaddressitsrisingcosts. It isofferinga$250millionnewgrantto encourage greater production of fertilizers. Additionally, toaddressgrowingcompetitionconcernsintheagricultural supplychain,USDAwill launch a public inquiry, seeking information regarding agricultural fertilizers and theimpact of concentration and market power on agriculture farmers. The inquiry aims toenhance fairness and competition across America’s economy. “Concentrated market structures and potentially anti-competitive practices leave America’sfarmers, businesses, and consumers facing higher costs, fewer choices and less controlabout where tobuyandsell, andreducedinnovation—ultimatelymakingit harder for thosewho grow our food to survive,” said Agriculture Secretary of the United States. Source:US Department of Agriculture, 11 March 2022 ©ACJC2022 Preliminary Exam 9757/01

2 Extract 3: Fertilizer costs: what is driving the increase? Significant increase in the cost of fertilizersover thepast year hascausedalot of concernamong farmers in the United States. Given that the cost of fertilizers now account forapproximately 15-20%of total costs for corn production, fertilizer pricesanditsavailabilityare a major concern for farmers planning for the 2022 growing season. Farmers in someareasarereportingpricesmorethan300%higherthanlastwinter,anddeliverytimesseemstobeanyone’sguess. Thepriceincreasewasdrivenbystrongdomesticandglobal demandfor crops, low fertilizers inventories, and very slow adjustments in production by the USfertilizers industry. As fertilizers are global commodity, its prices can be influenced by various market factorsbeyondthecontrol ofUSproducers.Countriesthatimportfertilisersarealsoexportersoftherawmaterials needed to produce these fertilisers. Hence, this meansthat fertilizerspricesaremorevolatileasit issubjectedtoboththecost offactorinputsaswell astheproductioncostsof thecountryproducingit.Anotherfactoristhattwo-thirdsofglobal fertilizersdemandisdrivenprimarilybytheproductionof crops,ofwhichcorn,wheat,andsoybeansconstituteabout 36%of that total demand. So, aslargeproducersof corn, soybeans, andwheat, theUS is a large consumer of fertilizers. Tradesdisputesanddisruptionshavealsoplayedabigroleinfertilizersavailabilityandcost.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 countrywhich contributes to about 20% of the global production of potash. The uncertainty ofRussianactionsagainst Ukrainecreatesfurther volatilitysinceRussiaisalsooneofthetopglobal 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 increaseddomestic transport costsduetolabour shortagesinthefreight industrywhichthefertilizersindustryreliesonfortransportation.Domesticweatherconditionslikehurricanes,icestorms,as well as infrastructure breakdowns, have caused several production and distributiondisruptions. Source:Institute of Agriculture and Natural Resources,8 February 2022 ©ACJC2022 Preliminary Exam 9757/01

3 Question 1: The Nitrogen Fertilizers Crisis Suggested Mark Scheme: (a) With reference to Table 1, identify the difference in the trendof number of workersemployed in the US fertilizers industry and the consumption of fertilizers intheUSfrom 2016 to 2019. State one possible reason for the difference. [2] Suggested Response:● From2016to2019, number of workersemployedisgenerallyincreasingwhiletheconsumption of fertilizer in the US was decreasing [1m]● The increase in number of workers employed could be a result of US requiringmore factor inputs to producing a larger share for export to the global marketalthough domestic demand for fertilizer was decreasing [1m] Mark Scheme:1 difference in the trend of the two stated variables – 1m1 reason to account for the difference – 1m (b) (i) With reference to Extract 1, explain howthe lower demand for fertilizers andhigher 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 thefertilizer industrywouldhavetochargealowerpricethanbefore.Assuch,existingfirms’ 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 ARcould be lower than itsAC. Firmsexit theindustrybecause of earning subnormal profit Alternative response● A fall in demand results in a fall in the market price. The existing firms in thefertilizer industrywouldhavetochargealowerpricethanbefore.Assuch,existingfirms’ average revenue (AR) would fall.● A higher input costs implies that a firm’s average variable costs (AVC) wouldincrease● Intheshortrun,afirmisunabletocoverfixedcostsandpartoftheirvariablecostsif AR< AVC(or total revenue<total variablecosts). Firmswouldthenchoosetoshut down to minimize losses. Mark Scheme:Explain impact on average revenue – 1mExplain impact on AC – 1mExplain exit/shutdown decision – 2m(ii) Explain how market dominance could lead to an inefficient allocation ofresources in the US fertilizers market. [6] Suggested Response:● Efficient allocationof resourcesisachievedwhereMB=MCi.e.P=MCgiventhatprice reflects MB. Therefore, social welfare is maximised if the firmproduce thegood up to QAE where P = MC.● However, market dominanceimpliesthatafirmisapricesetteri.e.thefirmhasthepowertosetpricebyrestrictingoutput.Forexample,aprofitmaximizingfirmwouldproduceupQπ max whereMC=MR.Atthispoint,theprofitmaximizingpricePπ max isgreater than MC. ©ACJC2022 Preliminary Exam 9757/01

4 ● Society incursadeadweight lossasaresult of thefirmnot producingtheamountQπ max to QAE . This is because the marginal benefit to society is larger than themarginal cost to society of producing additional unts of fertilizer fromQπ max to QAE ● Therefore, market dominancecouldleadtoinefficientallocationofresourcesintheUS fertilizers market. Mark Scheme: Knowledge, Application, Understanding, AnalysisL2 ● Accurate and clear explanation of inefficient allocation ofresources arising from market dominance● An analytical response that can:o Establish point of allocative efficiencyo Explain why a firmwith market power can deviate fromallocative efficiencyo Explain implications of deviating away from allocativeefficiency 4 - 6 L1 ● Smattering of points● Several concept flaws 1 – 3 (c) Discuss howimproving the