(2021) A Level H1 Econs CSQ 1 Suggested Answers by Mr Eugene Toh (A Level Economics Tutor)
(2021) A Level H1 Econs Paper 1 CSQ Q1
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CSQ1: Intervention in the market for oil
ai. Crude oil prices were relatively stable at around US$110 per barrel between Jan – Jun 2014.
Crude oil prices fell from US$110 per barrel in Jun 2014 to below US$30 per barrel in Jan 2016.
Crude oil prices increased from US$30 per barrel in Jan 2016 to US$80 per barrel in mid 2018.
aii. A fall in demand for crude oil will lead to a leftward shift in demand from DD0 to DD1.
An increase in supply will lead to a rightward shift in supply from SS0 to SS1.
Explain price adjustment process & show increase in price as a result of simultaneous shifts
b. Change in price of oil in US & significance of elasticity of dd/ss
Prices of oil declined in the US due to a steep fall in demand.
Oil is a factor input used in the production of goods & services. The pandemic has resulted in a significant fall in demand for goods & services which in turn, led to a fall in demand for oil to produce such goods & services.
As the supply for oil is price inelastic, any decrease in demand will lead to a very sharp fall in prices for oil
Show supply curve with steep gradient together with a leftward shift in demand to show a sharp decrease in prices. Possible to also show a reference curve (comparing difference with supply that is price elastic)
Change in price of food in Guatemala & significance of elasticity of dd/ss
Subsidies for biofuel has resulted in the increase in supply (production) of biofuel as the cost of producing biofuel would have decreased.
Given that biofuels are made from certain crops grown on farmland – biofuels are in competitive supply with food crops.
The increase in production of crops to produce biofuel will reduce farmland made available for food crops.
Decrease in farmland available for food crops will increase the cost of production for producing food decrease in supply increase in price.
Demand for food is price inelastic any decrease in supply will lead to very sharp rise in prices for food
Show demand curve with steep gradient together with a leftward shift in supply to show a sharp increase in prices. Possible to also show a reference curve (comparing difference with demand that is price elastic)
c. From Extract 3
Subsidising biofuel to encourage use of biofuels instead of fossil fuels have created an unintended consequence where farmers switched to producing crops for biofuel which is more profitable. The decreased production of food crops has made food more expensive which is an unintended consequence.
Your own example
Lockdowns & restrictions for social distancing are meant to reduce the incidence of infection to improve public health.
This however results in an unintended consequence as it also creates a mental toll on people as human beings require social interaction, causing a likely increase in people suffering from mental illness.
di. Clean air, clean water, unspoilt landscapes
There are certain parts of a healthy natural environment that satisfy the characteristics of a public good of being non-excludable
Clean air, clean water, unspoilt landscapes are non-excludable
Goods like clean air, clean water & unspoilt landscapes are non-excludable. You cannot exclude any specific groups of individuals from enjoying clean air, water and unspoilt landscapes, i.e. clean air can be enjoyed by anybody in the area
Clean air, clean water, unspoilt landscapes are non-rival in consumption
Goods like clean air, clean water, unspoilt landscapes do not diminish in quantity even with the consumption by an additional user, i.e. increased number of individuals in an area will not reduce the amount of clean air, water or quality of the unspoilt landscapes made available to the next individual.
Certain parts of the healthy natural environment do not fulfill such characteristics
You can isolate parts of an unspoilt landscape via erection of barriers – for example, you can charge individuals a ticket fee to visit a specific part of Grand Canyon National Park. This makes parts of an unspoilt landscape possibly, excludable.
Oil, a good extracted from the healthy natural environment, is a good that is rival in consumption. Increased extraction of oil will deplete the reserves available – showing that oil is rival in consumption.
dii. Explain how a tax on oil helps reduce negative effects of oil consumption on the natural environment
1. The purpose of a tax is to increase the cost of production
2. This will make it more costly to extract / produce oil, shifting supply of oil to the left
3. Output of oil will thus fall to a more socially optimal level, reducing consumption of oil.
Is a tax on oil the best way?
1. To address market failure & eliminate the negative externalities, tax that is implemented needs to be charged at the value = MEC
2. This quantification of MEC is difficult as the negative effects of oil consumption is not easy to monetise / calculate
3. May cause cost-push inflation since oil is used to produce many goods & services
Consider any 2 other policies + evaluate
1. Tradable permits
2. Encourage use of more sustainable substitutes (by subsidizing alternatives e.g. social power)
e. Case of the public good
1. Explain that public goods non-excludable & non-rival
2. Non-excludability results in a lack of ability to exclude non-payers from consuming the good, resulting in a free-ridership problem
3. Non-rivalry in consumption means the marginal cost to provision of the good to an additional user = 0. Allocative efficient pricing is where P=MC and it is not feasible for firms to charge P=MC=0
4. As firms need to be able to recover the costs of provision of a good, and in the case of a public good, they are unable to – public goods are left unprovided for by the free market
In this specific instance – the market has failed completely and government intervention is absolutely necessary and does lead to a more efficient outcome, there is simply no other choice.
Case of the merit good
1. Explain that merit goods are goods that are deemed by the government to be socially desirable but yet underconsumed
2. COVID-19 vaccines would be a case where the government deems to be socially desirable but yet underconsumed due to positive externalities, imperfect information & income inequity
3. In a free market – vaccines would be underconsumed because of positive externalities
4. Individuals will only consider & weigh their own marginal private costs (cost of vaccine, physical pain from side effects, inconveniences of being absent from work) against their marginal private benefits (reduce chance of infection & falling severely ill) and thus consume at Qm where MPC = MPB
5. This ignores the positive externalities (MEB) which are benefits conferred to 3rd parties not directly involved in the consumption or production of the vaccines. Young children who are not eligible for vaccinations will be protected by those who have received the vaccines as they have less risk of infection.
6. Due to presence of MEB, MSB diverges from MPB. The socially optimal level of consumption is at Qs where MSC = MSB. Since consumption is at Qm < Qs, there is underconsumption
In many governments around the world – COVID-19 vaccines are provided for free by the government. And in this extreme case, it can be argued that the government’s act of intervention leads to a more efficient outcome than if the government did not intervene to provide vaccines – most countries will still be in a lockdown mode.
Note: provision of other reasonable points / other reasonable examples will likely be acceptable. This is only a suggestion
f. Inclusive growth is economic growth that is distributed fairly across society and creates opportunities for all.
Why slow but inclusive growth is more desirable?
Malaysia’s economy has been steadily improving in the periods between 2017 and 2019. Both Table 2 and the extracts mentioned the economic growth prospects of the country, most of which has been contributed from the demand side. As mentioned in extract 6, the main sources of growth in Malaysia “were from domestic consumption, private investment and several major infrastructures”. As C, I and G increase, AD increases which results in RNY rising from Y0 to Y1 as seen in the figure. However, while Malaysia’s inflation rate is low according to the available data in the sources, as AD continue to rise at the higher rate of growth seen, demand-pull inflation might occur as AD approaches the classical range of the AS curve. This can be represented by an increase in AD from AD1 to AD2 and GPL increases from P1 to P2. This increase in inflation will reduce the real incomes of households and thus purchasing power, leading to a fall in material SOL.
At the same time, growth that is not inclusive can have damaging impacts on the SOL of individuals in an economy. As the fruits of growth go into the hands of the high-income minority, others will not be able to experience an increase in their real incomes and hence have greater purchasing power to consume goods and services. For the individual, this leads to a fall in material SOL. The greater social unrest resulting from an unequal society can lead to falling non-material standards of living. On the economy-wide level, we may see a fall or stagnation in consumption levels, making it difficult for the economy to grow further through Consumption. This is even more important in the case of Malaysia as it was noted that Consumption is one of the country’s main drivers of growth.
Lastly, many of the policies that aid the goal of attaining inclusive growth can help Malaysia achieve sustained growth. For example, subsidies or programmes to upskill and retrain low-income workers so that they can gain relevant skills to command a higher wage can improve the productive capacity of the economy. This shifts the LRAS curve right hence achieving both actual and potential growth.
Why higher but less inclusive growth is more desirable?
There can be an argument to make that Malaysia’s economy is still reasonably inclusive given that the GINI coefficient has been continuously improving and is currently around 0.4. Hence, there might be a pressing need to put more resources into continued efforts to achieve inclusive growth.
Also, as mentioned in extract 8, purposefully slowing down the economy just to achieve inclusive growth can have negative impacts on the productivity of the country. A slowdown in economic growth can deter foreign investments and create poorer consumer sentiments. C and I might fall as a result, causing AD to fall and hence RNY to decrease. Hence, while trying to improve the income equality situation by slowing growth, an unintended consequence of falling incomes might be created. As real output falls, firms will scale back on production and hire less factor inputs including labour. This leads to a rise in unemployment rates which will further worsen income inequality in the country.
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