VJC H2 ECONS P2 Suggested Answers

1 Suggested answers to 2018 VJC H2 Prelims Paper 2 Question 1 Electric Vehicles (EVs) that run on lithium batteries are gaining popularity due to the growing concern over air pollution. Advancements in EV technology has also led to cost improvements for carmakers. Discuss the impact of the above events on the market for electric vehicles and its related markets. [25] Introduction Prices of electric vehicles and prices of its related markets are determined by demand and supply in a free market. Demand refers to the quantity of a good or service that consumers are willing and able to buy at various price, in a given time period, ceteris paribus. Supply refers to the willingness and ability of a frim to offer a good or service for sale at various prices in a given time period, ceteris paribus. This essay seeks first to explain how price and quantity of EV and its related goods can be affected by the various events and a conclusion can then be made about the total revenue of each market. Body 1) Market for Electric Vehicles (EV) Rise in demand for EVs due to change in taste and preferences EVs are gaining popularity as governments worldwide are creating more awareness of the benefits to the environment of switching to EVs. This change in taste and preference towards EV will result in a rise in demand for EV as c onsumers increase their willingness to consume EVs, causing the demand curve to shift rightwards from D1 to D2 Rise in supply for EVs due to fall in marginal cost of production Advancements in EV technology could lead to more innovative and cost efficient production processes. These improvements in production methods is likely to lead to a fall in marginal cost of production, resulting in an increase in supply as production is now more profitable and hence firms are more willing to supply the good. This causes the supply curve to shift rightwards from S 1 to S2 Impact on P, Q and TR Extent of rise in supply is likely to be greater than the rise in demand of EVs The rise in demand and rise in supply of EVs will lead to an unambiguous increase in the equilibrium quantity of EVs. However, the impact on the equilibrium price will depend on the extent of the shifts in demand and supply. Currently, the DD for EV may be rising but to a smaller extent as consumers may not be very receptive to embrace the relatively new technology and a new type of vehicle. In addition, the lack of charging stations in the country may also make it less convenient to own an EV deterring consumers from switching. Government schemes to incentivize the use of EV may also have been introduced rather recently and it would take time for consumers to react and adjust their consumption patterns. On the other hand, with advancement in technology, the efficiency gains from improved methods of production may be significant such that marginal cost of production is significantly reduced, hence resulting in a stronger rise in supply. ↑DD < ↑SS will lead to  in equilibrium price and ↑ equilibrium quantity.

2 Suppose the market is initially at equilibrium E with price P and quantity Q. The increase in demand and supply will cause the demand and supply curves to increase from D 1 and S1 to D2 and S2 respectively. Since the rise in supply is likely to outweigh t he rise in demand, at the original price P, there will be a surplus, leading to a downward pressure on prices. As price fall, quantity supplied will fall (movement along S 2) and quantity supplied will rise (movement along D 2) until a new equilibrium is achieved at the intersection of D2 and S2. Hence, the new equilibrium would be at E’ where the equilibrium price of EV will decrease from P1 to P2 while the equilibrium quantity will increase from Q1 to Q2. ↑DD < ↑SS will lead to overall ↑ in TR Holding demand constant, the rise in supply will result in a rise in TR. The fall in TR due to a fall in price is less than a rise in TR from a more than proportionate rise in Q given that demand for EV is likely to be price elastic (PED >1) since EV is likely to take up a high proportion of consumer’s income. Since the rise in demand will lead to an increase in TR since both price and quantity increases when demand increases, this reinforces the increase in TR arising from the rise in supply, causing TR of producers in the EV market to rise. Evaluation: In the long run , with governments across the world creating wide-spread awareness for greater mass appeal, the shift to electric vehicles will come faster and in a more pronounced way, fueled by technology advancements and regulation especially in China and Europe. Another consideration as to whether global demand for EVs will continue to rise faster will also be dependent on other factors such as implementation of more charging infrastructure for convenience and the performance appeal of EVs. Alternative outcome: ↑DD >↑SS Extent of rise in demand is likely to be greater than the rise in supply of EVs [C, E] The rise in demand and rise in supply of EVs will lead to an unambiguous increase in the equilibrium quantity of EVs. However, the impact on the equilibrium price will depend on the extent of the shifts in demand and supply. The demand for EVs may be rising by a larger amount as governments are actively promoting the use of EVs. In China for example, EVs are exempt from licence-plate auctions in some Chinese cities, hence pushing more people to purchase an EV instead of fuel powered car as there is greater certainty of getting a car. In addition, with a more educated population, more people are becoming environmentally conscious and hence a larger proportion of consumers Qty of EV

3 will be more receptive to switch to EVs. A smaller rise in supply could be due to the other opposing factors that can offset the cost savings derived from the innovative process techniques such as rising wage costs especially if there is a need for higher skilled labour or costs of higher costs of producing other parts of the EV such as the use of higher quality materials for a lighter weight of the car body. Suppose the market is initially at equilibrium E with price P and quantity Q. The increase in demand and supply will cause the demand and supply curves to increase from D 1 and S1 to D2 and S2 respectively. At the original price P 1, there will be a shortage, leading to an upward pressure on prices, since the rise in demand is likely to outweigh the rise in supply. As price rises, quantity supplied will rise (movement along S 2) and quantity supplied will fall (movement along D 2) until a new equilibrium is achieved at the intersection of D2 and S2. Hence, the new equilibrium would be at E’ where the equilibrium price of EV will increase from P1 to P2 while the equilibrium quantity will increase from Q1 to Q2. ↑DD > ↑SS will lead to overall ↑ in TR As both equilibrium price and quantity rise, the total revenue earned by EV car manufacturers will rise from P 1 Q1 to P2 Q2. 2) Market for Lithium batteries Increase in demand for EVs will lead to an increase in derived demand for lithium batteries, increase TR for producers in the market for lithium batteries. Lithium battery is a factor input for EV. Therefore, with the increasing popularity of EV, the derived demand for lithium batteries that is used to power EVs will rise. In the short run, we expect PES<1 given the long period of time needed to extract the lithium minerals to produce the lithium batteries. With the rise in demand from D 0 to D1, there will be a shortage at the original price Po, resulting in an upward pressure on the price of lithium. With the rise in price, suppliers would increase the quantity supplied whereas quantity demanded might fall as consumers may not be willing and able to pay the higher price. The movement along the