(2017) 8823 H1 Econs Paper CSQ 2 Suggested Answers by Mr Eugene Toh (A Level Economics Tutor)

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ai.

Average crude oil prices were largely stable between 1946 and 1970, with prices ranging from US$21.6 to US$25.5 per barrel. 

Average crude oil prices rose sharply from 1966 to 1985 from US$21.6 to US$72.9 before falling sharply from US$72.9 to US$27.3 between 1985 to 2000. 

Average crude oil prices doubled between 2001 to 2010 and remained relatively stable from 2010 to 2014.

aii.

Table 3 shows the 'inflation-adjusted' average price—which means in years of high inflation, the actual fluctuations could be higher than reflected. In addition — the peak price was US$107.4 and the low was US$17.3, these values were not reflected because the average prices for an S-year period do not include dramatic fluctuations in individual years. Thus — the data gives us an idea of the fluctuations but does not give us a full extent of the actual fluctuations from year to year. 

bi.

In the short run, PES for oil is likely to be inelastic as suppliers can only draw on existing inventory of oil to respond to changes in prices and it takes time to build new oil rigs. In the long run, producers can step up production to increase the quantity supplied for oil once the oil rigs are built.

bii. It is given that an output cut, therefore leading to higher prices, will lead to a less than proportionate fall in quantity demanded, which has led to OPEC countries' oil revenues rising substantially. This suggests that the demand for oil is price inelastic.

c.

The rising income levels of affluent countries lead to an increase in demand for goods & services. This leads to an increased derived demand for oil since oil is a factor input in the production of most goods, from DD0 to DD1. At P0, the quantity supplied remains at Q0 while quantity demanded increases to Q2 when demand increases. Since Q2 is greater Q0 there is an initial market disequilibrium, a shortage. The competition between consumers will put upward pressure on prices. As prices increases, producers are will to produce more. Price will continue to increase until a new equilibrium price is achieved at P1 and the new equilibrium output is at Q1.

There are restrictions to supply especially in Iraq & Nigeria, possibly due to the war causes a decrease in number of sellers / higher factor input prices due to difficulties in moving raw materials. This causes a fall in supply from SS0 to SS1. With the initial price P0, the quantity demanded remains at Q0 while the quantity supplied falls to Q2. Due to the excess demand, competition between consumers will put upward pressure on prices. As prices increases, producers are will to produce more. Price will continue to increase until a new equilibrium price is achieved at P1 and the new equilibrium output is at Q1.

d. A non-oil producing country such as Singapore will import oil as a raw material to produce goods & services. It will benefit from fluctuations whenever prices of oil fall as there will be a fall in the cost of production and thus SRAS will shift right as seen from the figure. This causes GPL to fall from P0 to P1 and RNY increases from Y0 to Y1 showing economic growth. As real output increases, firms will employ more factors of production, leading to a fall in cyclical unemployment. 

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