NYJC H2 ECONS P2 (Micro Suggested Answers)

1 2018 JC2 H2 Econs Prelim Paper 2 Section A 2018 JC2 H2 Econs Prelim Paper 2 Question 1 1 Analysts are forecasting a sharp rise in oil prices by t he end of this year as a re sult of a reduction in oil flows in Iraq due to fighting between government forces and Kurdish militant groups. In addition, oil production is still being withheld as part of a pact between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC producers to tighten the market. In the main growth areas of Asia, consumption remains strong especially in China and India, the world’s top importers. Adapted from https://www.reuters.com/article/oil-prices, 23rd Oct (a) Explain how the above-mentioned factors might hav e caused a sharp rise in oil prices. [10] (b) Discuss whether a subsidy or a maximum price control is more effective in increasing the affordability for petrol due to the rise in oil prices. [15] (a) Question Analysis Command Explain Content Demand, Supply, Elasticities Context Oil Market Synopsis: Students are required to identify the 1 demand and 2 supply factors from the preamble that caused the increase in oil prices. After which, they have to use PED and PES concepts to account for the sharp (magnitude) increase in prices. Intro: - State what determines price in a free market. (demand and supply) - The reason for the ‘sharp’ rise in oil prices can be attributed to: o Rise in Demand “…consumption remains strong especially in China and India…” o Fall in Supply “…fighting between governm ent forces and Kurdish militant groups…” together with “…a pact between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC producers…” Coupled with: o The PED and PES of oil being price inelastic. Body 1: • Demand for oil rose due to rapid growth of emerging economies, China and India. Oil is required as a factor input for production processes. Thus, due to industrialisation in China and India, the demand for oil rose. • Supply falling due to reduction in flows in Iraq due to fighting between government forces and Kurdish militant groups. As there was political and social instability in Iraq, the supply of oil was disrupted. (Iraq holds 12.1% of OPEC crude oil reserves). • Supply of oil production being withheld as part of a pact between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC producers to tighten the market so as to reduce the glut due to the boom of US shale oil output. This will help to maintain the price of oil so that oil producers will not suffer from low oil prices if supply continues to rise. Body 2:

2 • Demand of oil is price inelastic as it is a form of necessity for production processes. • Supply of oil is also price inelastic as the construction time of oil rig is likely to be long. Changes in quantity supplied is also likely to be less resp onsive to price changes as oil production is being withheld as part of a pact between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC producers to tighten the market. Body 3: • As shown in the diagram above, the increase in demand for oil will cause the demand curve to shift rightwards from DD1 to DD2 and the fall in supply for oil will cause the supply curve to shift leftwards from SS1 to SS2. • A shortage of Q2Q3 now exists at the original price, P0. During a shortage, consumers will bid for hi gher prices to get the limited amount of oil. And as price rise s, quantity supplied will also increase according to law of supply. Thus, shortage will drive up prices and price of oil will now increase from P0 to P1. The magnitude of the increase in price will also be larger as demand and supply are price inelastic. At P1, the quantity demanded is the same as quantity supplied and hence, the market is in equilibrium. Conclusion: • Sharp rise in oil prices will raise the cost of production in the country and this will have negative consequences on the macroeconomic goals. • Hence, governments will have to implement policies such as subsidy and maximum price controls to curb the negative effects of rising oil prices. Qn 1 part a) Mark Scheme: Knowledge, Application, Understanding and Analysis L3 • Question requirements are interpreted accurately. • Appropriate economic concepts (Demand, Supply and Price Elasticities of Demand and Supply) are used. • Well-developed explanation of how the factors mentioned in the preamble caused a sharp rise in oil prices. • Appropriate Demand/Supply diagram/s is/are used to support economic analysis. Makes reference to the context. - SS change in drastic (Military conflict together with the Pact amongst both OPEC and non-OPEC) - DD change is small (“remains strong ”, rather than ‘increased growth’) - DD inelastic (provides anecdotal support) - SS inelastic (provides anecdotal support) 8 – 10 L2 • Addresses some question requirements accurately. • Some appropriate economic concepts (Demand, Supply and Price Elasticities of Demand and Supply). • Undeveloped explanation of how the factors mentioned in the preamble caused a sharp rise in oil prices. • Appropriate Demand/Supply diagram/s is/are used but might not be explained or used to support economic analysis. Competent use of economic theory and tools of analysis (to account for the sharp rise in prices) - Shows double shifts - Relates to PES and PES - Single shift with no reference to elasticity concepts. 5 – 7 L1 • Question requirements are interpreted inaccurately. 1 – 4

3 • Inappropriate economic concepts, theorie s and principles are used. Inaccurate economic analysis. • Inappropriate or wrong diagrams are used. Weak/no use of economic tools of analysis - Single sided shift. - Confused btwn dd & ss concepts - Incorrect analysis (b) Discuss whether a subsidy or a maximum price control is more effective in increasing the affordability of petrol due to the rise in oil prices. Question Analysis Command Discuss whether Content Workings of subsidy and maximum price control Context Oil prices rising, no particular country required (students will need to bring in relevant examples to explain the answer) Synopsis: Students need to recognise that oil is a factor input for producing petrol. Hence, the price of petrol will rise due to rising oil prices. Students will then be required to explain how a subsidy and maximum price control work to increase the affordability of petrol and analyse which method is more effective. Intro: • State the importance of keeping petrol affordable : Petrol is used to power private transport and is important to maintain mobility of labour and commerce in the economy. Efficient low cost trans port is important for the running of a market economy. • Outline the criterion to assess ‘effectiveness’: We will examine two approaches available for gover nments to keep petrol affordable; subsidies and maximum price controls. The effectiveness of these measures will be assessed against the ability to reduce price, the costs of implementation as well as the potential side-effects. Body 1: How a subsidy works: • Subsidy  reduce cost of production  SS increase from SS1 to SS2 as shown in the figure below  Price will fall from P1 to P2 and Quantity will rise from Q1 to Q2 Body 2: Effectiveness of subsidy • PRICE: Subsidy  P falls from P1 to P2 and Qty will rise from Q1 to Q2. Therefore, consumers can consume more petrol than before at a lower price (affordable for consumers). • IMPLEMENTATION: Subsidising t he producer is fairly easy to do by directly funding pr oducers/suppliers of oil producers/retailers. • SIDE-EFFECTS: Government also has to have su fficient funds to subsidise the consumers. If the government does not have sufficient budget to do so, it will have to either borrow or raise taxes such as personal income tax and/or corporate tax so as to ra