CJC H2 ECONS P2 Mark Scheme

1 © Catholic Junior College 9732/02/Prelims /2016 Mark Scheme 2016 Catholic Junior College H2 Economics / 9732 Preliminary Examination Mark Scheme Paper 2

2 © Catholic Junior College 9732/02/Prelims /2016 Mark Scheme Question 1 (a) Based on economic theory, explain how society deals with scarcity. [10] Question Interpretation Command Word  “Explain how” – to elaborate in detail, the processes that lead to eventual effects/outcomes Content:  Central Problem of Economics - Scarcity  Rational decision-making by Consumers (to maximise satisfaction) & Producers (to maximise profits) using Marginalist Principle  Price adjustment process in Price mechanism Context:  Give examples of decisions made by consumers and producers Suggested Answer Introduction The central problem of economics is scarcity whereby the limited resources are unable to fulfil the unlimited wants of economic agents in the society. This situation necessitates choice making where rational decisions are made by consumers and producers. Consumers and producers will make rational decision based on the marginalist principle: Consumers choose how much to consume to maximize satisfaction; Producers choose how much to produce, how to produce and which goods to produce to maximize profits. The interactions between consumers and producers give rise to the market forces of demand and supply, where the price mechanism in the free market will help to allocate the resources efficiently. In this essay, we will be exploring how all these will be achi eved in the society. Body Paragraph 1 – Consumers’ Perspective P: In order to decide on how much good to consume, consumers will try to maximize the welfare (consumer surplus) / satisfaction from the consumption of the good. Figure 1: Demand Curve of a Consumer E: Consumers buy an additional unit of the good (for eg, a plate of chicken rice) if the satisfaction derived is greater than (or equal to) the price (P) he/she has to pay for the good (marginal cost).

3 © Catholic Junior College 9732/02/Prelims /2016 Mark Scheme E: According to the law of diminishing marginal returns, as the consumers consumes greater quantity of a good the marginal satisfaction (or marginal benefit, MB) keeps falling and hence the willingness to pay additional price falls. This also explains the downward slope of the demand curve. E: At any quantity lesser than q, the consumer’s MB (measured by the demand curve) is higher than the MC (measured by the market price, P) they are paying. Therefore it is optimal for them to increase consumption until MB=MC, i.e. until q. This is where MC=MB and the consumers have the greatest consumer surplus as illustrated by the shaded area on the diagram. Thus given price, P, consumers will decide to consume up to q. E: This is also the same for quantity beyond q, where the MC is more than the MB for consumption of additional plate of chicken rice, thus consumers will decrease consumption till q to maximize their consumer surplus. L: The similar principle also helps the producers to decide how much of the goods to produce using the scarce resources in order to maximize their profits. Body Paragraph 2 – Producers’ Perspective P: Firms aim to maximize profits and they will allocate scarce resources to achieve that by using the marginalist principle. Figure 2: PC Firm Profit Max Condition E: Using an example of an ice cream stall in a perfectly competitive industry, when producers are thinking of selling an additional cup of ice cream, they consider the additional revenue (marginal revenue, MR) they can earn from selling an additional cup. H owever, the firm also incurs a marginal cost (MC) of selling that additional cup of ice cream. E: Thus, as long as the marginal revenue of selling an additional cup of ice cream exceeds the marginal cost, the producers’ profits will increase and the firm should continue to sell more cups of ice cream. They will reach the maximum profit when the marginal revenue of the last cup of ice cream sold is exactly equals to the marginal cost, MC=MR. E: The marginalist principle also helps producers to decide how much to produce. When the price of a good increases, the new P becomes greater than MC, profits will increase by producing more, which explains the upward slope of SS curve. L: The interactions of consumers and producers in the free market will give rise to the forces of demand and supply. The price mechanism will act as a signal in allocating scarce resources efficiently. Body Paragraph 3 – Price Mechanism in allocating resources

4 © Catholic Junior College 9732/02/Prelims /2016 Mark Scheme P: Combining the self -interest driven decision making consumers and produ cers, resources in a perfectly free market are said to be allocated efficiency when there are no shortage and surplus. Figure 3: Price Mechanism in a Free Market E: Imagine an initial disequilibrium at P2. There is a surplus created as Q3 > Q2. This exerts a downward pressure on price. As prices fall, there is a fall in MC (from consumers’ point of view) from consuming an additional unit as compared to MB (i.e. MC<MB at Q2) and therefore consumers should increase consumption from Q2. Similarly, as prices fall, there is a fall in MR received (from producers’ point of view) from producing an additional unit as compared to MC (i.e. MR<MC at Q3) and therefore producers should cut back on production from Q3. Eventually, this price adjustment process, aided by marginalist thinking will eliminate the surplus and create a new equilibrium at P1 and Q1, where consumers and producers maximize their consumer and producer surplus respectively. L: This leads to efficient allocation in the free market. Conclusion In conclusion, the rational decisions by producers and consumers creates the forces of demand and supply, which then enables the free market to allocate a scare resource so that any shortage or surplus is eventually eliminated. This will help to address sc arcity as wastage of resources is prevented, where the both the consumer and producer surplus is maximized. LORMS Level Descriptors Marks L3 For a well-developed answer that demonstrates scope and detailed economic explanation of how the marginalist principle framework is being applied by consumers AND producers in maximising their satisfaction (CS) and profits (PS) respectively. Explanations of how the price mechanism allocates scarce resources efficiently are also well developed. Clear reference o f the above concepts made to the relevant diagrams. 7 - 10 L2 For an under-developed answer that demonstrates a narrow scope and weak economic explanation of how the marginalist principle framework is being applied by consumers AND/OR producers in maximising their satisfaction (CS) and profits (PS) respectively. (Either consumers OR producers ONLY, Max 6m) Explanations of how the price mechanism allocates scarce resources effici ently are missing or under - developed. (No 5 - 6

5 © Catholic Junior College 9732/02/Prelims /2016 Mark Scheme mentioning of price mechanism: Max 6m) Reference of the above concepts made to relevant diagrams is unclear. L1 For an answer that shows some knowledge of the concepts of scarcity and marginalist principle and how they are applied in the context of consumers and producers. Answer is lacking in economic analysis. No reference to relevant diagrams in explanations. 1- 4 (b) The free market should always be left alone. Comment. [15] Question Interpretation Command Word  Comment - Requires multiple perspectives on issue(s). Usually involves using a TAS framework Content:  Conditions for Price Mechanism to allocate resources efficiently  Sources of Market Failure  Government Intervention & Government Failure Context:  Give examples in