RVHS_H2_ECONS_P2_Essay_Q1_Soln

1 2017 RVHS Y6 H2 Econs Prelim II Paper 2 Q1 Just a year ago, anticipation of higher profits prompted cattle farmers in the European Union (EU) to switch to produce dairy, which is a m ajor ingredient of many dairy- based products such as cheese. At the same time, EU abolished dairy production quotas while China, a key importer of EU products, saw slower economic growth. The Economist, August 2015 Using economic analysis, discuss the impact these e vents are likely to have had on EU consumers and farmers. [25] Introduction: The demand for dairy arises from dairy-based produc ts manufacturers (e.g. the laughing cow) who manufacture and sell cheese. Hence they buy/consume dairy as it is a factor input to produce cheese. On the other hand, supply comes from cattle farmers who produce dairy for sale. The impact of these events on dairy consu mers and farmers can be measured via changes in the consumer expenditure and total reven ue received by farmers. This will then affect consumer expenditure and total revenue for d airy-based products in a range of markets, such as premium cheese and house brand bread. ❶ Impact of events on EU consumers and farmers of dairy Firstly, in the past year, there is an increase in the number of farmers producing dairy. This is due to the anticipation of higher profits to be made in the dairy market, resulting in some farmers switching from rearing cows for beef to dairy. As such, at every price level, there are more farmers willing and able to supply dairy and the supply of dairy increases. Secondly, the abolishment of dairy production quota s affected the supply of dairy. A dairy quota imposes a physical limit on the quantity of dairy t hat can be produced within EU in a given period of time. It restricts the supply of dairy to keep prices hi gh. The abolition of production quota will lead to an expansion of EU da iry production, leading to significant increases in EU net exports to the world market, hence supply of dairy increases. Taken together, the supply of dairy will rise from S 0 to S 1 as shown in Figure 1 . This will cause the price of dairy to fall, which is accompanied by a rise in its quantity demanded. The extent of this increase in quantity demanded depends on the price elasticity of demand (PED) for dairy as PED measures the degree of responsiveness of quantity demanded to a change in its price, ceteris paribus. Figure 1: Increase in supply Pe Qe Qi Q0 De Price Quantity S0 P0 0 Di Pi A B C S1

2 If the demand for dairy is relatively price inelastic, the fall in price from P 0 to P i will cause the quantity demanded to rise less than proportionately from Q 0 to Q i. This will result in a fall in the consumer expenditure/total revenue from 0P 0AQ 0 to 0P iCQ i. And if the demand for dairy is relatively price elastic, the fall in price from P 0 to P e will cause the quantity demanded to rise more than proportionately from Q 0 to