MJC_H2_ECONS_EQ1

Prelim 2018 H1 Paper 2 Essay Q1_Suggested Answer Essay Q1 1 Due to scarcity, resource s have to be allocated between competing uses. For instance, farmers in India are increasingly allocating mo re land to growing cotton instead of tea leaves. Such decisions ma y be influenced by fast-changing clothing trends. (a) Explain how the price mechanism can allocate scarce resources efficiently with increasing demand for a product. [10] (b) Given these farmers’ decision on t he use of their land, assess the relevance of elasticity concepts in explaining the impact on consumers’ expenditure on tea and other beverages. [15] Part (a): Explain how the price mechanism can allocate scarce resources efficiently with increasing demand for a product. [10] Intro The central economic problem of scarcity arises due to limited resources and unlimited wants. As society cannot have all the output it desire s, choices have to be made by consumers and producers. The price mechanism is the proce ss in a market economy where consumers and producers interact to determine the allocation of these resources among competing uses. Development: Roles of the price mechanism Prices perform two key roles which are the signalling function and rationing function. [Signalling Function] Consumers use prices to signal to producers their changing preferences and ability to buy goods and services. Price is the value consumers place on for each unit of good consumed. Producers use prices to signal to consumers their ability and willingness to produce each unit of good. Producers are profit motivated and will charge prices which maximize their profits. Adjustment process Assume that there is perfect competition and there are no externalities. Referring to the figure above, the initial equilibrium is where demand (D1) = Supply (SS) and price will be at P1 and quantity will be at Q1. Given that there is now an increase in demand for cotton, it means that there are more dollar votes cast for cotton. Demand will increase from D1 to D2. At initial price P1, a shortage of Q1Q3 is crea ted. This causes an upward pressure on price.

Prelim 2018 H1 Paper 2 Essay Q1_Suggested Answer This will signal to producers to allocate more resources to increase production to Q2 due to possibility of earning greater profits, thus quantity supplied increases from Q1 to Q2. In the long run, the increase in price may lead to increase in producers entering the market, resulting in an increase in supply and even more resources like land allocated into the market for cotton. What to produce Hence, higher prices signal to producers what they need to produce and lower prices signal what need not be produced. Producers allocate more resour ces to the market of cotton. Resources like land used to produce tea leaves are reallocated to produce cotton. Hence, price mechanism determines what to produce in the market. How to produce In the market for