SAJC H2 ECONS P2 Essay Questions and Answers

1 ST. ANDREW’S JUNIOR COLLEGE PRELIMINARY EXAMINATIONS – 2018 (JC2) General Certificate of Education Advanced Level Higher 2 ECONOMICS Paper 2 Additional Materials: Answer Paper 9757/02 11 September 2018 2 hours 15 minutes READ THESE INSTRUCTIONS FIRST Write your name and class on all the work you hand in. Write in dark blue or black pen on both sides of the paper. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters, glue or correction fluid. Answer three questions in total, of which one must be from Section A, one from Section B and one from either Section A or Section B. Start each question on a fresh sheet of paper. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question. This document consists of 3 printed pages. © SAJC 2018 [Turn Over]

2 1. Besides possessing dominant positions in many of the world’s most important markets, budget airlines are stealing passengers from full- service carriers. Fierce cost-cutting, unbundling of services as well as booming economies of the developing world are but some contributin g factors to the roaring su ccess of budget airlines. Last year, for the first time, they carried mo re than one billion fliers – nearly 30% of the 3.7 billion who took to the air. Adapted from The Wall Street Journal, Aug 2017 (a) Explain the factors that determine the price elasticity of demand, income elasticity of demand and cross elasticity of demand of a good. [10] (b) Discuss the relative importance of the above demand elasticity concepts in explaining the rise in popularity of budget airlines among air travelers in the past decade. [15] (a) Introduction The various elasticity of demand concepts allow economists to determine the responsiveness of consumers to the change in the causal factor. Each of the elasticity concepts is in turn affected by its own sets of factors. Body - PED measures the responsiveness of quantity demanded of a good with respect to a change in price of the good itself c.p. (provide formula). - The PED value is always negative – a ssumes Law of Demand applies to the good - Size of PED value informs of the res ponsiveness of consumers to the change in price of the good itself, c.p. The larger the (absolute) value, the more responsive consumers are. Suggested Factor – E.g. Degree of necessity - PED value of a necessity is expected to be low and less than 1 (i.e. PED<1). - Given a rise in price, a consumer will only reduce the quantity demanded of the goods less than proportionately due to the continued need to consume the good. - For example, even if the price of sa lt rises by 10%, a consumer will unlikely reduce his consumption by more than 10%, if at all. This is as salt is one necessary component of one’s diet to maintain a healthy body. - Likewise, it is unlikely for a consumer to increase consumption of salt more than proportionately to the given a fall in its price, as there is absolutely no need for an average healthy and rational person to do so. Hence, the PED value of salt is said to be less than one; demand for salt is price inelastic.

3 - YED measures the responsiveness of the demand of a good to a given change in income c.p. (provide formula). - The YED value is positive for normal good) and negative for inferior good. - Size of YED value informs of the res ponsiveness of consumers to demand for a good when they experience a change in inco me, c.p. The larger the absolute value, the more responsive they are. Suggested Factor – Nature of good - When a good is Inferior in nature, a gi ven change in income will lead to opposite change in demand for good. For example, a consumer will increase demand for an inferior good (e.g. lower quality meat, canned meat) and a decrease in demand for normal/luxury goods when he experiences a fall in his income. - Fall in income  desire to conserve financial means to fulfil basic needs by giving up ‘good-to-haves’ such as luxury food items (e.g. expensive cuts of meat) and increasing demand for ‘must-haves’ such as potato or rice for subsistence purpose. Hence, YED for potato is negative. - XED measures the degree of responsiveness of the demand for a good to a given change in the price of a related good or service, ceteris paribus. - The XED value is positive for substi tutes) and negative for complements. - Size of XED value informs of the re sponsiveness of consumers to demand for Good X when the price of Good Y changes, c.p. The larger the absolute value, the more related Good X and Good Y are. Suggested Factor – Degree of relatedness of good - Degree of substitutability between two goods (i.e. Weak vs close substitutes) determine the absolute value of the XED between them. - For example, Pepsi and Coca Cola are close substitute s. The fall in price of Pepsi will lead to a much more than proportionate fall in demand for Coca Cola than the fall in demand for coffee. This is because Cola drinkers are more ready to switch to cheaper Pepsi (and henc e demand much less Coca Cola) than coffee drinkers. - Coffee drinkers generally do not view Pepsi and coffee as close substitutes. Hence, XED for Coca Cola and Pepsi wi ll be much higher and that for coffee and Pepsi will be much lower. CONCLUSION - There may be multiple factors which co uld ultimately determine each of the elasticity values. In such a situation, the dominant factor would usually be the sole determinant of the elasticity value of the good prevailing at that time in consideration.

4 Level (Marks) Knowledge, Application, Understanding, Analysis L3 (8 – 10) Answer shows thorough knowledge and an excellent ability to explain at least one factor for all three elasticity concepts in a precise, logical and reasoned manner. Top grade answer ought to include the following: - Definitions - Examples to illustrate - Explanation of how the factor affects th e elasticity values (EITHER different size of values – big vs small OR signs the values take – positive vs negative) L2 (5 – 7) Answer explained at least one factor each for at least two elasticity concepts. Answer is mostly accurate but there may be undeveloped explanation of concepts. L1 (1 – 4) Answer shows some knowledge of elasticity concepts (mere definitions and formulae given). Factors are more stated than explained. Meek attempts at s uggesting examples to support answers. There may be basic errors in phrasing of the key terms and highly inadequate explanations. The answer co uld be mostly irrelevant or inaccurate. (b) Introduction - The rise in popularity suggests a signifi cant increase in the equilibrium quantity of passenger flights, i.e. Qe. (Important to explain why there was a huge rise in Qe.) Body - Fierce cost-cutting – suggest that supply rises (bring in PED) o Increase in supply of budget carrier s leads to movement down demand curve o Hence, P falls and Quantity demanded rises. o The value of PED for budget air-trave l is likely to be high. This is because the customers are largely lower income / budget conscious travelers. Hence, they are more pr ice sensitive; would rather forego comfort/convenience, etc. o Evaluation:

5  Likely to be a big reason as budget airlines are new phenomenon in the air travel market over the past decade.  Budget airlines can attract many price sensitive customers who previously did not have a choi ce but to fly with full-service carriers.  Can also attract significant am ount of low income travelers who previously could not afford to fl y at al