PJC H2 ECONS P2 Suggested Ans Markers Report

Pioneer Junior College (Economics Department) 1 PJC 2016 H2 Prelim Exam Paper 2: Question 1 Question: Global warming has reduced the harvest of high quality coffee beans. This has affected many independent boutique cafes in Singapore which have grown in recent years due to rising affluence and more sophisticated taste for specialty coffee. In addition, these cafes are also facing soaring rents, alongside labour shortages and stiff competition. Using economic analysis, discuss the impact these ev ents are likely to have on farmers of coffee beans, consumers of specialty coffee and owners of boutique cafes. [25] Introduction These events that are mentioned in the preamble will affect the demand and supply hence affecting the consumers and producers differently through changing the market equilibrium price, quantity, total expenditure and total revenue. Body Para 1 The farmers of high quality coffee beans are likely to be badly affected by the experience rising total revenue due to the effects of growing taste for high quality coffee beans and global warming. However, the impact on their profits is less certain. With growing taste for high quality coffee beans, there will be higher demand for high quality coffee beans causing the demand curve to shift rightwards from D1 to D2 as shown in Figure 1. At the same time, global warming reduces the harvest of high quality coffee beans causing the supply of high quality coffee beans to fall, thus the supply curve shift leftwards from S1 to S2 in Figure 1. The combined effect of a rise in demand and a fall in supply will lead to a sharp rise in the equilibrium price of high quality coffee beans from P 1 to P 2. However, the change in equilibrium quantity is uncertain as a rise in demand will lead to a rise in equilibrium quantity while a fall in supply will lead to a fall in equilibrium quantity. Thus, the effect on equilibrium quantity depends on the extent of change in demand and supply. Figure 1 Fall in Supply > Rise in Demand for high quality coffee beans E1 Price of high quality coffee beans D1 D2 S1 S2 P1 P2 0 Q1Q2 Qty of high quality coffee beans E2

Pioneer Junior College (Economics Department) 2 If demand for high quality coffee beans were to rise more than the fall in supply, the equilibrium quantity will rise. This is favourable for the coffee bean farmers as both the rise in equilibrium price and quantity will cause the total revenue to rise for the farmers. However, if the supply of high quality beans were to fall more than the rise in demand, then the equilibrium quantity will fall from Q 1 to Q2 as shown in Figure 1. In this case, since equilibrium price rise but equilibrium quantity falls, the effect on total revenue is uncertain. Evaluation In this case, the effect on total revenue will depend on the size of price elasticity of demand (PED). Since the demand for coffee beans is a derived demand, meaning coffee beans is a raw material that is demanded to produce the final product, specialty coffee, thus the demand is likely to be price inelastic. Even if the price were to rise, café owner s will still have to pay for it as they have no other better substitute. Hence, when the price of high quality beans rise, the quantity demanded will fall less than proportionately. Thus, total revenue for the coffee beans farmers is likely to rise from 0P 1E1Q1 to 0P2E2Q2. However, the impact on profits may be less certain because coffee beans farmers may have to incur higher cost in reducing the negative effects of global warming. For example, they may have to water the plants more frequently or replace plants that are affected by global warming. Thus, if the total cost rise faster than total revenue, profits of the farmers need not rise. In the short run, coffee beans farmers are likely to experience higher total revenue given a price inelastic demand but the impact on their profits is uncertain. In the long run, if the farmers can engage in research and development and develop coffee seeds that are more resistant to the effects of poor weather, there are likely to experience higher revenue and profits if the taste for high quality beans continues to grow. Body Para 2 Consumers of specialty coffee will tend to benefit from the growing number of independent boutique café and stiff competition in the market while owners of the café may tend to lose out given rising cost of production and the stiff competition. With rising affluence, there has been a rise in demand for specialty coffee, the extent of increase depending on the size of YED. Since specialty coffee is likely to be a luxury good with +YED > 1, the demand will rise more than proportionately from D1 to D2 with a rise in the level of income as shown in Figure 2. The effect on supply of specialty coffee is less certain. With the rising cost of coffee beans, wage cost and cost of rental, this will reduce the ability and willingness of cafe owners to supply specialty coffee. Some café owners who cannot survive the high cost may close down resulting in a fall in supply of specialty coffee. However, in recent years, there has been a growth of new independent boutique cafes as many young Singaporeans aspire to set up their own businesses. Coupled with stiff competition which may force the café owners to increase efficiency and lower their cost of production to stay competitive, supply of specialty coffee will continue to rise. Overall, if the effect of new café opening up and stiff competition is larger than the rise in cost of production, supply of specialty coffee will still rise from S1 to S2 as shown in Figure 2. The combined effect of a rise in demand and a rise in supply for specialty coffee will result in an overall rise in equilibrium quantity of specialty coffee while the equilibrium price remains uncertain. If the demand rises more than the supply, overall equilibrium quantity and price of specialty coffee will rise and this will lead to a rise in total expenditure (TE) of specialty coffee by consumers and a

Pioneer Junior College (Economics Department) 3 rise in total revenue (TR) of specialty coffee for the café owners. However, if the supply rises more than the demand, overall equilibrium quantity will rise but the equilibrium price of specialty coffee will fall. Thus the effect on TE and TR is uncertain. Figure 2: Rise in supply of specialty coffee > Rise in demand Evaluation 1. The effect on TE and TR depends on the PED of specialty coffee. The PED varies for different groups of consumers. Specialty coffee lovers and middle/high income consumers may have relatively more price inelastic demand due to higher ‘addiction’ to specialty coffee and they may find the price of a cup of specialty coffee to be a small proportion of Y. Thus when equilibrium price falls, quantity demanded rise less than proportionately and hence their total expenditure falls. On the other hand, consumers who are sensitive to price of specialty coffee e.g. lower income consumers who do not mind the lower quality but cheaper coffee from the neighbourhood coffee shops may have more price elastic demand and hence when equilibrium price falls, quantity demand rises more than proportionately and their total expenditure rises. 2. The effect on the café owners depends on their ability to differentiate their products and adopt efficient methods of production to cut cost. Given stiff competition, close substitutes are available, and hence the café owners face high positive cross price elasticity (CED) for the specialty coffee that they sell. If the competitor café lowers price, the quantity demanded for their coffee will fall more than proportionately causing their total revenue to fall by large extent. To increase TR, caf