Price Changes

Source material: Kenya’s flower industry (Source Material 1)

Kenya fact file 2015

population 47 million
labour force 18 million
unemployment rate 10%
GDP per head $3200

Kenya has a growing global reputation for high quality flowers and is the world’s third largest producer
of flowers. Production of flowers contributes to employment and to Kenya’s gross domestic product
(GDP) which increased in 2015. Most of the flowers are grown in an area that has the right conditions
for growing flowers. It has a ready supply of water, fertile soil, warm days and cool nights, and is close
to the capital’s airport in Nairobi. Kenya’s exports of flowers increased significantly between 1990 and
2015, and flowers are now the country’s second biggest export earner after tea. Many of Kenya’s
flowers are sold to the UK, US and Russia for special occasions including Mother’s Day, Thanksgiving
and Women’s Day. On these days, demand not only increases but also becomes more price-inelastic.

Kenya’s flower industry faces a number of challenges. A change in temperature can slow down
production so that producers can fail to deliver their flowers on time, for example to Russia in time for
Women’s Day. This can result in demand exceeding supply and shortages occurring. At other times
there is a surplus of supply with some flowers remaining unsold. Kenyan producers are also affected
by changes in the foreign exchange rate and the country’s interest rate.

In 2015, the value of the Kenyan shilling (KES) depreciated from KES88 to KES98 = US$1. The
country’s interest rate rose to 16.5% in the same year. The country faces fierce competition in the
flower industry from several countries.

As well as challenges, the industry also has a number of strengths. Many people would like to work
in the industry as the wages are higher than in most other Kenyan agricultural jobs. Productivity has
increased each year since 2000, in part, because of improved educational standards. Fig. 1 shows
the relationship between real GDP per head and the adult literacy rate in a number of African
countries.

Fig. 1 The relationship between real GDP per head and the adult literacy rate
in selected African countries

90
80 Uganda Kenya
Tanzania
70
60 Senegal
50
Adult literacy 40 Benin
rate 30
20 Niger
10
0
0
500 1000 1500 2000 2500 3000 3500

Real GDP per head (US$)

 Indicative Contents for Price Changes

Factors that may increase demand --- increase in demand ---- price rises (with more Q)

Factors that may decrease demand --- decrease in demand --- price falls (with less Q)

Factors that may increase supply --- increase in supply ---- price falls (with more Q)

Factors that may decrease supply --- decrease in supply --- price rises (with less Q)

Question 1

Explain two reasons why the price of Kenyan flowers may have fallen in the US in 2015.
Refer to the source material 1 in your answers.

Indicative Contents
 Fall in wage costs → lower production costs → lower prices (exports from Kenya)
 Very fertile soil → surplus of flowers → lower prices in US (exports from Kenya)

The price of Kenyan flowers may have fallen in the US in 2015 as a rise in productivity (1)
could have reduced costs of production which were passed onto the consumer (1). Secondly,
growing in the area with very fertile soil in the right conditions for flowers (1)would increase
supply, which in turn make them cheaper(1)

Question 2
The price elasticity of demand (PED) for sugar in most countries is less than 1. In 2017, the
price of sugar fell. However, the price of specialised, higher quality sugar grown in countries
such as Mauritius fell by less than the average global price. Efficient producers, such as some
farmers in Brazil that have a low fixed cost of production, were also less affected by the fall
in price.

Explain two reasons why the price of sugar may fall

Indicative content
 A change in tastes will lower demand → sugar less appealing
 Concern about health will lower demand → consumers switch to other foods
 A rise in the price of a complement → e.g. tea

One reason why the price of sugar may fall is that a fall in income will lower demand (1) as
consumers have less purchasing power to buy goods (1) Secondly, a fall in the population
size will also lower demand (1), as there will be fewer consumers to buy sugar (1)
Russia’s struggle for economic recovery (Source Material 2)

Shortly after the 2014 Winter Olympic Games in Sochi, Russia, the value of the
Russian currency, the rouble, depreciated significantly against the US$. Russian
Gross Domestic Product (GDP) growth rates also became negative. Political and
economic instability in the region contributed to these changes.

To avoid further outflows of financial capital from the Russian economy and further
falls in the value of the Russian rouble, the central bank of Russia increased the
official interest rate to 17%. By 2016, the rouble fell even more and the central bank
considered selling its foreign reserves to raise the exchange rate against the US$.

Overall, things did not look good for the Russian economy in 2016. Export values fell
and foreign investors lacked confidence in the Russian economy. This not only had a
negative impact on unemployment rates and economic growth but also had an impact
on poverty rates which were expected to return to pre-2007 levels. Demographic
trends did not help as Russia’s population declined due to high death rate, low fertility
rate, and a high level of emigration.

Domestic consumption and investment, however, showed some positive signs.

Consumers bought more domestic products and domestic investment increased.
However, inflation rose and the central bank introduced policy measures to avoid a
rapid increase in prices.

As an oil producer, Russia’s economy was affected by falling international oil prices.
Saudi Arabia, the world’s second largest oil producer, continued to increase oil
production despite pressures by other producers to cut production. In addition, global
demand for oil was weak. Table 1 shows the price of oil between 2010 and 2016.

Table 1 Price of Oil

2010–16 (US$)

Price of Oil
Year
(US$ per barrel)
2010 82
2011 92
2012 103
2013 93
2014 95
2015 53
2016 37

In 2016, domestic Russian oil producers struggled to make a profit due to economic
uncertainty and competition from renewable energy. They were also concerned that it
may become even more difficult for them to make a profit in the future. This was
because the government wanted to increase tax on oil producers to raise more
revenue. The government believed that such an extra tax would not actually hurt the
large oil producers.
Question 3

Explain, using information from the extract, two reasons for falling oil prices. Refer to the
source material 2 in your answers.

Indicative Content

 Global demand weak → global economic uncertainty/price reduced to attract

consumers

One reason for falling oil prices from the extract is Saudi Arabia’s output of oil is
growing (1), which has increased supply causing the price level to drop (1). Secondly,
global demand for oil is decreasing (1) due to global economic competition from renewable
energy as a substitute to oil (1)

Question 4
In October 2015, the Chinese government switched from its one child policy to a two
child policy partly because of the challenges caused by an ageing population. The birth
rate was falling anyway due to rising female participation in the labour force,
improvements in education, later marriages and the rapidly rising price of housing.

Explain why the price of housing may increase.

Indicative Content

 Increase in demand→ rise in population

 Decrease in supply→ increase in raw materials/wage costs

he price of housing may increase due to an increase in demand (1) caused by an increase
in consumer income (1). Secondly, a decrease in supply may increase house
prices (1) due to a rise in costs of production (1)
Question 5
Explain, using information from the extract, two reasons why a rise in the price of vanilla
might not cause an increase in the price of ice cream.

Indicative content

 Rise in productivity of workers → fall in labour costs

 Fall in another cost identified in the pie chart → may offset a rise in the price of
vanilla

Ice cream is a luxury product and has substitutes. Therefore, it has relatively elastic demand
(1). Hence producers will be concerned that a rise in price could cause a fall in revenue (1).
A fall in labour costs and fall in another cost identified in the pie chart may offset a rise in
the price of vanilla. Therefore , a rise in the price of vanilla might not cause an increase in
the price of icecream.
Rubber production in Liberia (Source Material 3)

Liberia is a west African country that has faced a number of serious problems in
recent years. These have included a civil war and in 2014 the outbreak of the Ebola
epidemic. There have also been improvements. The unemployment rate was 85% in
2004 but had fallen to 4% in 2016. This reduction has influenced both emigration and
wages. Workers have received higher wages although some economists think that
the higher wages have increased the country’s inflation rate
which in 2016 was 8%.
The country has a good supply of drinking water and a climate favourable to
agriculture. More than 70% of the country’s labour force is currently employed in
agriculture. The country’s main exports are rubber, iron ore, timber and gold.

A US multinational company (MNC) runs the world’s largest single natural

rubber farming operation in Liberia. The price of rubber fell by 75% between 2011
and 2016. The global supply of rubber had exceeded demand as a number of
countries imposed import restrictions on rubber. In
response to the lower price the US MNC cut its production, but still made a loss. The
MNC does not want to go out of business and is trying to survive by cutting its costs.
In the long run it hopes to maximise profits. When some of its 7000 workers retire,
they will not be replaced. The MNC has introduced new production techniques and
diversified into growing cocoa and coffee.

The Liberian government is providing subsidies to local rubber farmers to help them
buy new equipment and introduce new farming methods. Despite the challenging
situation, a number of local Liberian rubber farmers are increasing the size of their
operations by buying up more land. Some others are diversifying by using wood from
the rubber trees to make furniture.

While helping its rubber farmers, the Liberian government is also encouraging the
expansion of the secondary and tertiary sectors. Between 2014 and 2016 it increased
its expenditure on healthcare but this was at the expense of a number of public sector
investment projects. Table 1 compares the infant mortality rate and healthcare
expenditure per head in selected countries in 2015.

Table 1 Infant mortality rate and

healthcare expenditure per head in
selected countries in 2015

Infant mortality rate Healthcare expenditure

Country (deaths per 1000 per head
live births) (US$)
Cuba 4.5 459
Hungary 5.0 2 096
India 41.5 248
Liberia 67.5 90
Turkey 18.8 1 148
UK 4.4 3 749
Question 6
Explain, using information from the extract, two reasons why the price of
rubber fell between 2011 and 2016. Refer to the source material 3 in your
answers.
One reason why the price of rubber fell between 2011 and 2016 is supply exceeding
demand (1) which led to the existence of unsold rubber, encouraging rubber producers to
lower their prices (1). Secondly, improved production methods (1) could lower the costs of
production therefore increasing the supply of rubber (1)