YJC H2 ECONS P2 answers

2018 H2 Prelims P2 Q1 The use of drones for aerial photography and racing are growing in popularity among the wider public. In the next five years, consumer drone sales volume is expected to increase more than tenfold, while average selling price for drones will continue to decline. Discuss the different demand and supply factors and their likely importance in determining the anticipated changes in sales volume and price of consumer drones. [25] Suggested answer Introduction The anticipated changes in sales volume and price of consumer drones can be explained through the application of demand and supply analysis along with elasticity concepts of PED and PES. The projected increase in sales volume (or increase in equilibrium quantity) can be explained through anticipated increases in both demand and supply of consumer drones whilst elasticity concepts can be applied to explain the significant increase in the sales volume of consumer drones. The projected price of consumer drones could be explained through the simultaneous increases in both demand and supply, with analysis on the extent of shift in the curves. DD factors DD factor #1 (change in taste and preferences) DD factor #2 (rise in income or expected rise in future income) DD factor #3 (changes in technology) The anticipated increase in sales volume for consumer drones could be explained by a rise in demand for consumer drones. The increase in demand could be due to a change in taste and preferences towards the use of consumer drones. As there is a trend towards the application of consumer drones in areas such as aerial photography or a hobby, this increases the desirability of consumer drones to consumers which increases their willingness to purchase consumer drones at the different price levels. This results in an increase in demand for consumer drones. The increase in demand could be due to an improvement in household income. Given the positive economic sentiments in economy and the anticipated positive economic growth into the next 5 years, income of households is likely to rise thereby increasing the purchasing power of consumers. Given that drones are likely to be a normal good (or even luxury good), when the income levels of consumers rise, they are likely to increases the ability and willingness of consumers in purchasing drones at different price levels. This increases the demand for drones. The increase in demand could be due to an improvement in the technology of consumer drones (e.g. more power – faster, fly higher, carry heavier load, more lasting batteries). As one of the uses of the consumer drones is in racing, consumers could be always looking to upgrade to more powerful drones. This will create an increasing willingness of consumers in purchasing drones, causes the demand for drones to increase.

Relative importance of the DD factors (evaluation) While all 3 factors are likely to cause increase in DD for consumer drones. The change in taste and preferences and rise in income could be more significant factors contributing to the increase in the next five years. This is because as flying consumer drones becomes more popular, it will generate a lot of interest in consumers to own one, especially as a hobby or toy. Improvement in technology of consum er drones would likely affect the commercial users and racers, these are users who require more powerful performances. SS factors SS factor #1 (falling COP) SS factor #2 (increasing size of industry) The anticipated increase in the sales volume consumer drones could be explained by the expected rise in supply for consumer drones. The anticipated increase in supply of drones could be due to falling cost of production. When there is a falling price of computer parts and inputs, the unit cost of production falls and more profits is made by the producers at every price level. For instance, there are improvements in manufacturing techniques of computer chips, economies of scale, and software advances which continues to drive down cost of drone sensors. This causes firms to have greater willingness and ability to increase production of consumer drones and the supply of drones is expected to increase. The anticipated increase in supply of drones could be due to the increasing size of the drone industry. Rising venture capital investment in the drone industry will drive growth in both number of and size of drone start-ups which results in increasing ability to produce drones at different price levels. As a result, there is anticipated increase in the market supply for drones. Relative importance of the SS factors (evaluation) Both supply factors are likely to work in tandem. This is because when the COP decreases, the production and sale of consumer drones becomes more profitable and more producers will enter the industry. Also, when there are more producers in the industry, this will drive competition amongst themselves to drive improvements in production technology which drives COP down. Simultaneous shifts in DD and SS to explain extensive increase in quantity and fall in price The anticipated increases in both supply and demand of drones will explain the anticipated increase in sales volume. Simultaneous shifts in DD and SS could be used to explain the anticipated fall in price, the anticipated increase in supply of drones has to be larger than the anticipated increase in demand for drones. The rapid increase in supply of drones is likely due to rapid technological advancements which is expected to c ontinuously lower cost of production significantly. On the other hand, the increase in demand for drones might be relatively smaller than the increase in supply as the market may reach a point of saturation (i.e. consumers already own a drone and there is no real need for more drones except for the professional users) and the increase in demand may taper off.

Since the increase in DD is less than the increase in SS, there will be surplus of drones which causes a downward pressure on the price of drones. Price will continue dropping until both quantity demand and quantity supplied of droids arrive at a new equilibrium price and quantity. Application of PES to explain the sharp increase in output of drones Furthermore, application of PED and PES can be used to explain the sharp increase in the equilibrium quantity of drones. As the PES for drone production is likel y to be price elastic in supply as drones are manufactured, non-perishable products and there is likely to be availability of spare capacity in terms of a buffer stock of. As a result, firms are likely to be more responsive to changes in prices as the producers can draw down on the inventories to meet increases in demand, resulting in a relatively flat SS curve. Hence, increase in demand with a relatively flat SS curve will lead to a sharp rise in output of drones. Application of PED to explain the sharp increase in output of drones PED for drones is likely to be price elastic in demand since drones are less of a necessity for consumer users. There could also be different substitute toys or hobbies. Hence, consumers are likely to be price sensitive to changes in the price of drones leading to relatively flat DD curve. Hence, increases in supply is likely to lead to sharp increases in output. Conclusion Both demand and supply factors are important in determining the anticipated changes in sales volume and price of consumer drones however not all factors are of equal importance. The rise in supply is likely to exceed the rise in demand – and hence said to be more important than demand factors in determining the anticipated fall in price of consumer drones. Mark scheme Level Knowledge, Application, Understanding, Analysis L3 (18