(2023) A Level H2 Econs Essay Q2 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)
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a.
Impact of Bad Weather on Vegetable Prices
Bad weather can damage crops or reduce harvests, leading to a decrease in the supply of vegetables.
This can be represented by a leftward shift of the supply curve for vegetables (from SS0 to SS1). If we assume that the demand for vegetables remains constant, this reduction in supply will lead to a higher equilibrium price for vegetables (from P0 to P1).
The degree of this price increase depends on the elasticity of demand for vegetables. Since vegetables are a staple and have a high degree of necessity (inelastic demand), the price increase may be quite significant.
Impact of Falls in Consumer Income on Vegetable Prices
Income elasticity of demand (YED) measures how the quantity demanded of a good changes in response to a change in consumer income.
For vegetables, which are considered a normal good and a necessity, the YED is likely to be positive but less than 1. This means that while an increase in income leads to an increase in the demand for vegetables, the response is not proportionally large, given their status as essential items in a typical diet.
When consumer incomes fall, as vegetables are a normal good with a YED of more than 0 but less than 1, the demand for vegetables decreases but at a rate that is less than proportionate to the income decrease. This is because, despite lower incomes, consumers still need to purchase essential items like vegetables, though they may reduce quantities or switch to less expensive varieties.
Consequently, a fall in consumer income leads to a decrease in demand for vegetables, represented by a leftward shift of the demand curve (from DD0 to DD1). However, this decrease in demand is less than proportional to the fall in income, due to the necessity nature of vegetables and their relatively low YED. This results in a relatively small decrease in the equilibrium price of vegetables (from P0 to P1), assuming that the supply remains constant.
Conclusion
While bad weather significantly drives prices up due to demand being price inelastic, the fall in consumer incomes tempers this rise to some extent, leading to an overall increase in vegetable prices that is less severe than it would have been in the absence of income changes.
2b.
Use of Price Ceilings for Food Price Stability
The policy of setting a price ceiling is usually implemented by governments in order to maintain affordability for necessities. The Russia-Ukraine war, drove up prices of chicken feed in Malaysia, which resulted in the government deciding to implement a price ceiling. We will use the example of Malaysia in our explanation of a price ceiling.
In a free market absent government intervention, the price and quantity of chickens would be determined at the equilibrium (P0 and Q0), where the demand curve (DD0) and supply curve (SS0) intersect.
A price ceiling (Pmax) is set below the natural market equilibrium price.
This new maximum price increases the consumer surplus, as consumers can now purchase chickens at a lower price than before. The area representing this surplus on a demand-supply graph would expand, reflecting the increased economic welfare for consumers.
However, while consumers initially benefit from lower prices, the price ceiling also disrupts the market equilibrium. At the new capped price, more consumers are willing to buy chickens (increase in quantity demanded from Q0 to Qd), but producers are less incentivized to supply (decrease in quantity supplied from Q0 to Qs), leading to a shortage (Qs-Qd).
Unintended Consequences and Market Distortions
The shortage created by the price ceiling has several unintended consequences. Firstly, it can lead to the formation of black markets where chickens are sold at higher prices, negating the affordability objective. This often occurs when the official market fails to meet consumer demand due to the artificially low prices.
Additionally, at the capped price, some producers might find it unprofitable to sell chickens, thus exiting the market or reducing their output, exacerbating the shortage. Moreover, the policy's domestic focus means that producers might redirect their supply to international markets like Singapore, where such price caps don't exist, further intensifying the shortage within Malaysia.
The Malaysian experience, including the temporary ban on chicken exports to Singapore and the subsequent shutdown of several chicken producers, highlights the complexities of implementing a price ceiling. This policy, while initially appearing to benefit consumers, can lead to reduced supply and even higher prices in the long run as the market adjusts to the distortions introduced by the price cap.
Stockpiling as an alternative
Stockpiling involves the government accumulating reserves of essential food items, like grains or vegetables, during times of surplus or low prices.
When prices begin to rise excessively or supply diminishes due to various factors like poor harvests or supply chain disruptions, the government intervenes by releasing part of these stockpiles into the market. This action increases the market supply of the food item. From a demand-supply perspective, introducing additional supply shifts the supply curve to the right. This rightward shift in the supply curve leads to a new equilibrium point where the supply curve intersects the demand curve at a lower price level than before. The increase in supply due to the release of stockpiles results in a downward pressure on prices, making the food item more affordable for consumers and helping to stabilize the market during periods of volatility.
Effectiveness and issues with stockpiling
However, the effectiveness of stockpiling is contingent on several factors. Maintaining such reserves incurs significant costs, including storage, quality control, and inventory management, to prevent spoilage.
Additionally, the timing of releasing these stockpiles is crucial; improper timing can lead to market distortions, such as excessively depressed prices that harm producers. There's also a risk of market complacency, where reliance on government stockpiles might discourage proactive market and agricultural practices.
Moreover, large-scale stockpiling, especially in major food-importing countries, can impact global food prices, potentially causing challenges for net food exporters. Therefore, while stockpiling can stabilize food prices and ensure security, its success hinges on precise market forecasting, effective logistics management, and strategic release policies to avoid further market disturbances.
Note: Clearly, in this essay question, any discussions involving reasonable policies to bring down prices would be acceptable. E.g. subsidies in food production or diversification import sources.
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