2022 PU1 H2 June Holiday Revision Package – Suggested Answer for Q2

a. Explain what might cause price elasticity of demand and price elasticity of supply to be
different for different products. [10]
b. Using the above elasticity concepts, assess the impact of a rise in the price of bubble tea
on the market for soft drinks. [15]

Question Requirement:
For (a): Explain the factors which determine the value of price elasticity of demand and price
elasticity of supply, giving relevant examples.
For (b): Explain how a rise in the price of bubble tea will affect, in terms of direction and
extent, the price and quantity of soft drinks. Soft drinks should be regarded as a substitute
for bubble tea.
Command word ➔ Assess
Concept ➔ Impact (direction and extent) of price of bubble tea on the market of its
substitute, soft drinks, using PES
Context ➔ Bubble tea and soft drinks

Part (a) Suggested Answer

Requirement Suggested Answer

Introduction: Price elasticity of demand (PED) measures the responsiveness of quantity

demanded of a good to a change in the price of the good itself, ceteris paribus
Define PED
while price elasticity of supply (PES) measures the degree of responsiveness
and PES.
of quantity supplied of a good to a change in the price of the good itself,
ceteris paribus.

Body 1: The numerical sign of the PED value is always negative as there is an inverse
relationship between the price and quantity demanded of the good according
Explain, max,
to the law of demand, i.e. price and quantity demanded change in the
2 factors opposite direction.
determining
the value of The factors determining the value of PED include: proportion of income
Price spent, availability of Substitutes, need for the good, time period of analysis,
Elasticity of addiction, and definition of the good.
Demand,
showing how For instance, the demand for car in Singapore tends to be highly elastic as
the quantity there are substitutes available and the proportion of income spent to buy a
demanded car is fairly substantial. If price of cars increases, consumers can switch to
will be alternative mode of transport (substitutes) such as public buses, MRT/rail
responsive or service, taxis or private ride-hail services.
not, to a While the demand for toilet paper tends to be inelastic, not just because there
change in the is a lack of substitute, but also the strong need for this good as necessity in
price of the daily lives.
good
Hence due to the relevant PED factors explained above, the PED (absolute)
+ values for cars and toilet paper are different. The PED (absolute) value for
Egs

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 cars is greater than 1, while the PED (absolute) value for toilet paper is close
to 0/less than 1.

Body 2: The numerical sign of the PES value is always positive as there is a direct
relationship between the price and quantity supplied of the good according
Explain, max,
to the law of supply, i.e. price and quantity supplied change in the same
2 factors
direction.
determining
the value of The factors determining the value of PES include: availability of spare
Price capacity, level and durability of stocks, availability and mobility of factors of
Elasticity of production (fop), length and complexity of the production process, and time
Supply, period of analysis.
showing how
the quantity For example, the supply for agricultural products/fresh produce such as
supplied will vegetables tends to be inelastic as farmers may not have ‘spare capacity’
be responsive (available spare land space) to increase production. Moreover, such goods
or not, to a cannot be stored for long in the warehouse (limited level and durability of
change in the stock). Also, with limited labour and land space to mobilise for increase
price of the production (unavailability and immobility of factor inputs), the increase in
good quantity supplied for agricultural products/fresh produce when price
increases is highly limited.
+
Whereas, the supply for soft drinks tends to be elastic. This is because the
Egs factor inputs (water, sugar, plastic bottles etc) needed for soft drink
production are more readily available. In addition, if the machines used in the
production are not fully utilised (on a 24-hour basis), there may be spare
capacity available to step up production. Besides, the production process is
relatively short and non-complex (compared to other forms of production that
are extended with time and complex/sophisticated in nature).

Thus, considering the various factors affecting PES, we can deduce that the
supply for agricultural products/fresh produce is price inelastic, with a PES
value less than 1. While the supply for soft drinks tends to be price elastic,
with a PES value more than 1.
Conclusion: It is important to note that PED/PES values are, at best, estimates because
of the ceteris paribus assumption. Nonetheless, they are important/useful
concepts that help to refine the analysis further in-depth. Economists and
governments can use PED and PES to understand the impact of changes in
market equilibrium (Pe and Qe) and how firms/households are affected by
changes in market forces.

Level Descriptors Marks

L3 A well-developed and rigorous explanation showing clearly the factors 8-10
accounting for different values of PED and PES for different products.
Relevant examples were cited and explained in the answer.
L2 An underdeveloped explanation of the factors causing the PED and PES 5-7
to be different for different products

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 L1 For an answer which shows some knowledge on what is PED and PES. 1-4
Answer contains errors and inaccuracies in their definition/factors
affecting the value of PED and PES.

b) Using the above elasticity concepts, assess the impact of a rise in the price of
bubble tea on the market for soft drinks. [15]
Part (b) Suggested Answer
Requirement Suggested Answer

Introduction: Bubble tea and soft drinks can be substitutes as both are sweetened drinks.
Hence any change in the price of bubble tea (price of substitute) will have
Identify the an impact on the market for soft drinks.
relationship
between
bubble tea and
soft drinks

Body 1: When price of substitute (in this case bubble tea) increases, consumers
would look for cheaper alternatives. One alternative or substitute is to
Non-price
consume soft drinks instead. Thus the rise in price of bubble tea could
factor (price of
increase the demand for soft drinks, ceteris paribus. This would be reflected
related good/
as a shift of the demand curve for soft drinks to the right, which results in an
substitute) →
increase in equilibrium price and quantity.
Shift in DD
With reference to the diagram (Fig. 1) below, at the original price P0, a
shortage (Q1Q2) is created when demand for soft drinks rises. This would
Note – the cause an upward pressure in price to remove the excess demand. As price
inclusion of rises, quantity demanded would fall while quantity supplied would rise. The
adjustment price would continue to rise until the new equilibrium (E1) is reached where
process is not the shortage would be removed with a higher equilibrium price (P1) and
always higher equilibrium quantity (Q1)
necessary.
Depending on Fig 1: Market for soft drinks
the question’s Price
requirement, S0
here it is E1
included to P1
ensure that the E0
discussion for P0
part (b) – 15m shortage
is not too
short/ under- D0 D1
developed.
Quantity
Q0 Q1 Q2

To further analyse the extent of the rise in equilibrium price and quantity,
PES needs to be considered.

Body 2: If the supply of soft drinks can be considered price inelastic (PES <1), for eg,
Explain how due to the lack of spare capacity faced by soft drinks manufacturer as in the

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the value of supply curve, S1 in Fig 2 (below), an increase in demand for soft drinks, given
PES will a rise in the price of bubble tea will lead to an increase in the market price
impact the from OP0 to OP1, and a rise in the quantity sold from OQ0 to OQ1.
market for soft
However, if the supply of soft drinks is considered to be price elastic
drinks, given a
(PES>1), for eg because of the availability of stocks, then an increase in
rise in the
demand for soft drinks will lead to an increase in the market price from OP0
price of bubble
to OP2, and the rise in the quantity sold from OQ0 to OQ2.
tea.
As can be seen in the diagram (Fig 2) below, the increase in demand will
bring about a greater increase in price when the supply is price inelastic,
compared to when the supply is elastic. On the other hand, there is greater
increase in quantity when the supply is price elastic, compared to when the
supply is inelastic

Fig 2: Impact of a rise in demand for soft drinks, with different PES
(Students need explain only one scenario (i.e., supply being price elastic OR
price inelastic). However, the factors used to justify the PES must be
applicable to soft drinks.)
Thus, an increase in the price of bubble tea will increase both the equilibrium
price and quantity in the market of its substitute, soft drinks, ceteris paribus.
Whether price increases more than quantity depends on the value of the
price elasticity of supply. An inelastic supply of soft drinks will bring about a
greater rise in price whereas an elastic supply will bring about a greater
increase in quantity in the soft drinks market.

Conclusion: The impact on the market for soft drinks may be different should the
comment on assumption of ceteris paribus be relaxed. In addition, soft drinks are
assumptions assumed to be a substitute of bubble tea. Yet how close a substitute
that can affect consumers perceive soft drinks is for bubble tea, affects the extent of the
the conclusion shift of the demand for soft drinks. For bubble tea ‘fans’, soft drinks may not
on the final be a close or good substitute, then the rise in DD for soft drinks could be
change in limited or insignificant.
market (Pe,

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Qe) for soft Moreover, the impact on the market for soft drinks also depends on whether
drinks the rise in price of bubble tea is temporary (short-run) or sustained (long-
run). If the increase in price of bubble tea is temporary, it may not affect the
soft drinks market substantially as consumers also require time to adjust
their consumption pattern (from bubble tea to soft drinks).
Besides, PES for soft drinks is affected by factors as explained in (a).
Unexpected changes in supply shock (ie unavailability of factor inputs) could
make supply less elastic, especially in the short run. Alternatively, an
improvement in production process may make the supply more elastic.
Nonetheless, taking into account all these considerations and assumptions
can allow economic agents (in this case, the consumers and producers) to
understand the changes in the market better and formulate better strategies
to cope with these changes.

Level Description Marks

L3 Answer uses accurate economic analysis to explain how the rise in the 7-10
price of bubble tea will result in an increase in equilibrium price and
quantity in the market for soft drinks. Economic analysis also shows
accurate application of the price elasticity of supply.
L2 Answer explains how the increase in price of bubble tea will impact the 5-6
market for soft drinks in terms of the change in equilibrium price and
quantity. Analysis however, did not consider the price elasticity of supply.

OR

Answer explains how an increase in the price of bubble tea will result in
an increase in equilibrium price and quantity in the market for soft drinks
and applies PES. However, there are errors/gaps in the application of PES
in the economic analysis.

Only completed demand and supply analysis without application of PES:

Max 5m
L1 Answer shows recognition of the relationship between bubble tea and soft 1-4
drinks. Lacks economic analysis to explain how specifically the rise in the
price of bubble tea will impact the market of soft drinks.
E3 Answer shows a reasoned conclusion. Recognises unstated 4-5
assumptions.
E2 Answer shows some attempt at a reasoned conclusion and is supported 2-3
with gaps in analysis.
E1 Answer shows an attempt at a reasoned conclusion, but the conclusion is 1
unsupported.

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