PJC_H2_ECONS_P1_Q1_Suggested_Ans

1 2018 PJC JC2 Prelim Exam H2 Econs Paper 1 Question 1: Disruption in the oil market and a new low price norm (a) Referring to Figure 1, explain the relationship(s) between the trend in oil price and that of OPEC oil production from 2004 to 2016. [4] Suggested answer: Overall, there exist a positive relationship between oil price and OPEC oil production with the exception of from 2010 to early 2016 where th ere exist an inverse relationship between the two. The positive relationship is due to the increase in demand which outweighs supply of oil from OPEC, resulting in an overall rise in both price and equilibrium quantity. The negative relationship is due to OPEC incr eased supply of oil, holding demand unchanged, oil prices fall. (b) Falling oil prices impacted countries differently. (i) Explain the macroeconomic impact of falling oil prices on both oil importing and exporting countries. [4] Suggested answer: Many oil exporting countries such as Russia, a fa ll in oil prices reduces price of exports. Given that the price elasticity of oil is inelastic, it will lead to a less than proportionate rise in quantity demanded, leading to a fall in export revenue. Assuming import expenditure remaining unchanged, this reduces AD and through the multiplier effect will result in multiple fall in real GDP in the short run. Oil importers such as India benefited from a falling oil price. As oil is a main source of energy, a fall in oil prices will reduce cost of production for most if not all industries. This shifts SRAS to the right, reducing GPL and increase real GDP. (ii) Explain whether a complete removal of subsidy on petrol and diesel will affect total expenditure of motorists in India. [4] Suggested answer: Total expenditure is obtained by taking price times quantity sold. Given that the price elasticity of demand for petrol and diesel is less than one, a complete removal of subsidy will result in a rise in cost of production, shifting supply curve to the left, resulting in an increase in price and a less than proportionate fall in quantity demanded, resulting in a rise in total expenditure. However, given that price of oil has been falling (a raw material needed to produce petrol and diesel), a complete removal of subsidy may not nec essary result in a rise in total expenditure if the amount of subsidy removed is less than the fall in price of petrol and diesel. Total expenditure of households may actually fall rather than rise.

2 (c) Discuss the extent to which OPEC is able to effectively cut production to raise price. [8] Suggested answer: Price of oil is determined by the demand and supply of oil in the world market. The extent to which OPEC is able to effectively cut pr