(2014) A Level H2 Econs Essay Q2 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

(2014) A Level H2 Econs Paper 2 Essay Q2

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2. In 2012 the UK had very poor harvests for grain and potatoes, which are major ingredients of many foods of UK consumers and also provide feed for much of Britain’s livestock. At the same time there was a decline in the incomes of many UK citizens, especially those on low incomes.

Using economic analysis, discuss the impact these events are likely to have had on UK consumers and farmers. [25]

Question analysis

• Impacts on UK consumers & UK farmers

• Events: 1) Poor harvests for grains and potatoes, 2) decline in real incomes

• Identify that for consumers we are looking at consumers’ expenditure while for farmers we are looking are producers’ revenue. The constituents of consumers’ expenditure and producers’ revenue is made up of P X Q (price x quantity)

Poor harvest for grains and potatoes

• Poor harvest for grains and potatoes -> reduce supply of feed -> increase price of feed -> increase cost of inputs for livestock -> increase price of foods

• Poor harvests for grains and potatoes -> reduce supply of grains and potatoes -> increase price of grains & potatoes -> increase cost of inputs for foods -> fall in supply of foods -> increase price of foods

• Demand for food is price inelastic -> increase in price of food -> less than proportionate decrease in quantity demanded -> total consumer expenditure on food increases

• Impact on consumers -> consumers will pay more for food, but are unlikely to spend less on food

• Impact on farmers -> impact varies for livestock farmers vs farmers producing grains & potatoes. While spending on such goods will go up, the livestock farmers also face an increase in costs due to cost of feed going up -> if the increase in cost > increase in revenue, profitability falls

Decline in real incomes

• A fall in real incomes -> demand for normal goods will fall

• Food in general (without looking at type) is considered a necessity -> demand for food is income inelastic -> a fall in real income will lead to a fall in demand for food, but the fall will be less than proportionate -> spending on food will thus fall -> total consumer expenditure on food will decrease (in general)

• Some types of foods (for example fastfood) -> can be considered to be inferior goods for above-average income consumers -> as incomes fall -> demand for inferior goods goes up -> and if such inferior foods comprises of grains, potatoes & livestock as ingredients (we’d expect so) -> consumer expenditure for inferior goods will go up

• Note: this is something that can be debatable, but the logic here is that fastfoods are generally considered to be unhealthy. Inferior goods are defined to be goods that when your income goes up you consume less of, and when your income goes down, you consume more of. The logic here is that when your incomes go up, you would tend to avoid more unhealthy foods as you may be more concerned about health (or have more bandwidth to consider such matters)

• Thus for consumers in general -> we are unclear of their total consumer expenditure on food as a whole, as demand for food (of non-inferior nature) will fall but we expect consumers to switch to some other forms of food (of inferior nature). However, since the purpose of such a switch is to spend less on food, we can assume that overall consumer expenditure on food will still fall.

• For producers of inferior foods (like fastfood) -> revenue goes up as some consumers consider switching to consuming inferior foods

• For producers of foods in general (non-inferior foods) -> revenue goes down, but not significantly considering demand is income inelastic

• For producers of inputs like grains, potatoes & livestock -> considering that these form constituents of food in general, overall changes in demand by producers of foods are unclear since inferior food producers will buy more inputs while producers of foods in general will buy slightly less inputs -> changes in demand is unclear -> impacts on revenue is unclear but we do not expect it to change significantly -> impact is likely insignificant

Synthesis

UK Consumers

• Rise in cost of inputs for food (fall in supply) + decline in real incomes (fall in demand)

  • Expenditure on food is expected to fall but not likely to be significantly

  • Consumers will pay more for food as supply is expected to fall more than demand which should lead to price going up (insignificant fall in demand as food is income inelastic)

• Comment: You can split consumers up to above-average income and below-average income for analysis as evaluation.

UK Producers of Food (in general) à not required because question said ‘farmers’ (but we discuss for completeness)

• Rise in cost of inputs for food (fall in supply) + decline in real incomes (fall in demand)

  • Revenue from food sales is expected to fall but not likely to be significantly

  • Profitability may likely fall as costs increases but revenue falls

UK Producers of Inferior Foods à not required because question said ‘farmers’ (but we discuss for completeness)

• Rise in cost of inputs for food (fall in supply) + decline in real incomes (rise in demand)

  • Uncertain impact on revenue for inferior goods

  • Profitability is unclear, but if we assume that increase in revenue > increase in costs, then profits will increase

UK Producers of Inputs like grains, potatoes & livestock

• Rise in cost of inputs for food (fall in supply) + decline in real incomes (unclear impact on overall demand)

  • While a fall in supply is a certainty, there are 2 opposing impacts on demand (inferior foods producers will be demanding more inputs while normal foods producers will be demanding slightly less inputs)

  • Our answer will depend partly on what is the assumed impact on demand

  • When supply falls while demand is highly price inelastic, the quantity demanded falls less than proportionately -> which will mean that revenue will still increase

  • Likely insignificant increase in revenue considering the unclear impacts on demand

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