Case Study Q30

7/30/2019 Case Study Q30

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Q30: Case StudyThe Market for Tea and Coffee

(a) (i) Calculate the percentage change in the priceof coffee and the percentage change in the price oftea between 1995 and March 2004. [2]

The price of coffee was 54.7% lower (or fell by). (1 m)

The price of tea was 16.8% higher (or rose by). (1 m)

Percentage change in price of coffee = 45.3 - 100

100x 100 = - 54.7

Percentage change in price of tea = 116.8 - 100

100x 100 = 16.8


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(ii) Compare the trend in the price index ofallbeverages with that ofteabetween 1999 and 2004. [2]

In general, the price indexes of all beverages and teaboth fell before rising. (1 m)

The price of all beverages continued to rise at end ofthe period, whereas the price of tea fell. (1 m) ORThe price of all beverages fell almost twice as fastthan that of the price of tea. (1 m)


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(a) (iii) Explain whether the data shown in Table 2 is

always consistent with the changes in the price of coffee

shown in Table 1. [2]

What data does Table 2 show?

What does theory suggest? (the relationship between the

changes in price of coffee and the data in Table 2) Is the data always consistent?



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(a) (iii) Explain whether the data shown in Table 2 is

always consistent with the changes in the price of coffee

shown in Table 1. [2]

Economic theory suggests that when production exceedsconsumption (surplus), a downward pressure on prices isexpected. Similarly, when consumption exceeds production

(shortage), it suggests an upward pressure on prices. (1 m)However between the years 2001 to 2003, prices of coffeerose despite the coffee surplus indicated in Table 2. (1 m)



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(b) (i) Suggest and explain any two reasons why Indian

exporters are finding it difficult to compete with other

exporters in the world market for tea. [4] How do exporters stay competitive in the world market?

What are the possible reasons for their (otherexporters)competitiveness?


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exporters in the world market for tea. [4]From the case material, cheap imports from countries such asNepal, Vietnam and Indonesia suggests that rivals in the globaltea market may have lower costs of production (1 m) due tocheaper factor endowments available in these economies. (1 m)

Strong support from the countries respective governments in theform of production/export subsidies (1 m) enable foreigncompetitors to sell ordump their tea at artificially lower prices in

the world markets. (1 m)


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exporters in the world market for tea. [4]Indias exchange rate is overvalued i.e. too strong, (1 m)causing Indias exports to be uncompetitive in world markets.(1 m)



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Exchange Rate

1 SGD = 45 Rupees

1 SGD = 30 Rupees

Stronger currency DD

of exports likely to fall,ceteris paribus.


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(b) (ii) Use demand and supply curvesto explain the

changes in the market fortea in India. [6]

How did the demand for tea in India change?

How did the supply for tea in India change?

How did the above influence the market for tea in India?

[support with evidence from extract]



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(b) (ii) Use demand and supply curvesto explain the changes in the

market fortea in India. [6]

Given market DD curve D1 and SS curve S1, equilibrium price and quantity

are P1

and Q1

respectively.

DD side change

in DD for tea caused by a change in the taste and preferences in favourof coffee, colas and sodas, ceteris paribus.

As mentioned in Extract 2, Coca-Cola and Pepsi are drawing away Indian

tea drinkers and coffee was promoted into fashionable drink status.

Hence, the demand curve shifts leftwards from D1 to D2.



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(b) (ii) Use demand and supply curvesto explain the changes in

the market fortea in India. [6]

Supply side change

SS for tea , ceteris paribus, due to the in cheap tea imports as a result ofthe removal of quantitative restrictions on imports in 2001. This would shift the

SS curve rightwards from S1 to S2.

Final Outcome

Equilibrium price would from P1 to P2 but the change in equilibrium quantityis uncertain, depending on the relative changes in DD and SS.

The in DD is likely to be greater than the in SS as imports constitute asmall proportion of SS.Equilibrium quantity will from Q1 to Q2.



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Correct diagram (2m)

Figure 1: Market for tea in India

D2

P2

S1

P1

Q1

D1

S2

0Quantity of tea(million kg)

Price of tea

($)

Q2

(b) (ii) Use demand and supply curvesto explain the

changes in the market fortea in India. [6]


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(b) (iii) Discuss whether government action to fix a minimumprice for tea sold in India would be an effective way to solve theproblems experienced by Indian tea producers. [6]

Describe the problem

Explain the suggested policy

What is minimum price?

How does it address the problem?

Evaluate the suggested policy (If more marks are allocated) Suggest alternative solutions



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Problems faced by Indian tea producers

Increasing costs

Falling revenues due to:

DD side

Falling tea exports between 2000 and 2004 by 18.4% due toincreasing number of foreign competitors

Waning DD in Indian tea market due to substitutes (Coca-Cola,Pepsi, coffee) declining sales of 1.5% per annum between 1999and 2003

Cheap tea imports due to removal of quantitative restrictions in 2001

SS side

Large accumulation of excess tea stocks

Total production expected to stagnate between 2003 and 2004 (860million kg)


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(b) (iii) Discuss whether government action to fix a minimum

price for tea sold in India would be an effective way to solve the

problems experienced by Indian tea producers. [6]

1.Describe the problem

2. Explain the suggested policy What is minimum price?

How does it address the problem?

3. Evaluate the suggested policy



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A BSurplus

QEQD QS

PE

PF

D

Quantity of tea(million kg)

Price of tea($)

Minimum Price

S

2. Explain the Suggested Policy


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(b) (iii) Discuss whether government action to fix a minimumprice for tea sold in India would be an effective way to solve theproblems experienced by Indian tea producers. [6]

The Indian tea producers encountered the problems ofincreasing

costs and declining revenues over many years.

The Indian govt could intervene by fixing a minimum price for teasold in India and help the tea producers cover the rising costs.

Definition: Price of tea sold in India is not allowed to fall below theminimum price level set by the Indian govt. (Or it is illegal for anyseller to sell tea below the minimum price.)

To be effective, the minimum price has to be set above theequilibrium price PE as shown in the figure below.

1. Describing the Problem2. Explain the Suggested Policy


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(b) (iii) Discuss whether government action to fix a minimum

price for tea sold in India would be an effective way to solve theproblems experienced by Indian tea producers. [6]

QS > QD The surplus (QD-QS) created would pose some problems:

W/o minimum price law, producers already face excess SS. Added surplusstock from the minimum price law will the incentive for producers to findways to evade the price control and prices defeats the purpose of minimum price control

If the price control is strictly enforced, producers cannot sell their surpluses

and will suffer even greater losses than what they are currently incurring. Only way for price control to work is for the govt to buy up the surplus.

It then stores the surplus, destroys it or sells it abroad govt funding is needed andtherefore requires higher taxes. But taxation is not w/o its own costs.

3. Evaluate the Suggested Policy


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(b) (iii) Discuss whether government action to fix a minimumprice for tea sold in India would be an effective way to solve the

problems experienced by Indian tea producers. [6]

QS > QD The surplus (QD QS) created would pose some problems:

Promise of high tea prices stalls the drive for greater efficiency andcost-cutting measures May encourage greater complacency intea producers.

Could be detrimental for Indian tea producers in the world marketwhere its competitors such as Indonesia and Vietnam are able toproduce tea at much lower costs.

3. Evaluate the Suggested Policy


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(b) (iii) Discuss whether government action to fix a minimum price for tea

sold in India would be an effective way to solve the problems experienced

by Indian tea producers. [6]

In conclusion:

The minimum price may help the tea producers cover the rising costs.

Tea producers who are able to sell at the minimum price are better

offwhereas those who are willing to sell their tea at a lower price

but not able to do so are worse off. Higher tea prices will serve as an added incentive for consumers to

switch towards alternative, more fashionable drink substitutes.

Hence total tea consumption in India is predicted to fall.

The same legislation may hinder Indias competitiveness in the exportmarket.

However, the problem of cheap tea imports may be minimized as the

limited demand created through the price floor will indirectly restricted the

imports.

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Case Study Q30