SRJC_H2_ECONS_P2_Essays_Suggested_Answers

1 ©SRJC 9757/02/Prelims/2018 2018 JC2 Preliminary Examination 9757 H2 Economics Paper 2 Suggested Answers 1 The rising price of healthcare is coming under closer scrutiny as medical inflation rate climbed up to 15% in 2015. (a) Explain the role of prices in addressing the fundamental problem of economics. [10] (b) Discuss the relative importance of demand and supply factors in influencing Singapore’s medical inflation rate. [15] Introduction The fundamental problem of economic is that of scarcity where there is limited resources to fulfil the unlimited wants. As a result that there is a need to make decision about resources allocation regarding what & how much to produce, how to produce and for whom to produce. This essay aims to explain how price mechanism will help address the above decisions such that resources will be allocated efficiently. Body P1: In a free market economy, prices help determine what and how much to produce The free play of market forces of demand and supply determines price which then acts as a signal to firms to allocate scarce resources. The consumers signal their demand for the goods by offering a price that they are willing and ab le to pay for the good. The producers will then respond by producing the quantity of the goods that they are willing and able to produce for the price that is offered to them. For example, in Figure 1, the initial equilibrium price is at P1 and the equilibrium quantity of private condominium exchanged between consumers and producers is Q1. If demand for private condominium rises and supply remains unchanged, a shortage will occur as quantity demanded is greater than quantity supplied. As a result unsuccessful consumer will signal their willingness and ability to purchase the good by bidding up the prices. Producers will then respond to the price signal by increasing allocating more resources towards the production of it to increase the quantity supplied since it is now more profitable to do so. At the same time consumers who are unwilling to pay the higher price will reduce the quantity demanded. Price will rise until new equilibrium is reached at price P2 and quantity Q2. At output Q2, quantity demanded equals to quantity supplied and consumer surplus and producers surplus are maximised as shown by area P2ce1 and P2ep respectively. The right amount of goods is thus produced from society’s point of view, assuming no externalities. p e e1 c Price market for private condominium Q1 Q2 P2 Qty D1 D2 S1 P1

2 ©SRJC 9757/02/Prelims/2018 L1: Hence prices which is driven by demand and supply forces helps address the problem of what goods and how much to produce such that there will be efficiency in resource allocation. P2: In addition, prices also help determine how to produce Firms make decisions on how to produce based on their profit maximising objective. The