AS Data Response 1

DATA RESPONSE
Course: AS - Year: 2020 - Serie: October/November - Version: 2
(a)
(i) From 2004 to 2009, the price of vanillin, "a synthetic substitute to natural vanilla" has
decreased, leading to a "falling demand for natural vanilla" because "some of the world’s
largest producers of ice cream replaced natural vanilla with vanillin". As a result, the
equilibrium price of natural vanilla has decreased from 250 US$ per Kg to 30 $US per Kg.
This is depicted in Figure 1 below.
Figure 1: The market for natural vanilla from 2004 to 2009
(ii) From 2015 to 2018, the price of natural vanilla has surged from 130 $US per Kg to
600 $US per Kg. This is because "poor harvests have reduced the country’s vanilla
production by more than 20%". This negative supply shock was exacerbated in 2017
"when a cyclone hit Madagascar, which accounts for 75% of global production". This is
depicted in Figure 2 below.

Figure 2: The market for natural vanilla from 2015 to 2018
(b)
(i) An economist would use the Cross-Price Elasticity of Demand (XED) to measure the
responsiveness of the demand for natural vanilla to a change in the price of vanillin.
(ii) The XED is equal to the percentage change of the quantity demanded of Good X
divided by the percentage change in the price of Good Y. Vanillin and natural vanilla are
substitutes in consumption (i.e. in competitive demand so one can be replaced by the
other). Therefore, if the price of vanillin increases, then its quantity demanded will fall due
to the law of demand, leading buyers to purchase more natural vanilla instead. In other
words, an increase in the price of vanillin (i.e. positive denominator) will lead to an
increase in the quantity demanded for natural vanilla (i.e. positive numerator) so overall,
the XED will be positive. It should be noted that the "more positive" the value of the XED,
the easier it is to replace one good by the other (i.e. the closer or more perfect the
substitutes).
(c) The Price Elasticity of Supply (PES) measures the proportionate response of quantity
supplied to a proportionate change in the price of the good or service. It is calculated as
the percentage change in the quantity supplied divided by the percentage change in
price.
Supply is said to be price-elastic if the PES is larger than 1 (i.e. a given percentage
change in price will bring about a larger percentage change in quantity supplied), and it
is said to be price-inelastic if it is smaller than one (i.e. a given percentage change in
price will bring about a smaller percentage change in quantity supplied).
The supply of ice creams made with natural vanilla can be expected to be less
price-elastic than that of ice creams made with vanillin because vanillin is an input that
is more readily available than natural vanilla. Indeed, as indicated in the extract, "it takes
three years for the plant to start producing" natural vanilla. Therefore, if the price of ice
creams made with natural vanilla increases, ice cream producers may be unable to
significantly increase their output in the short-run (i.e. price-inelastic supply). In particular,
this will be the case if natural vanilla producers are already operating at, or close to full
capacity, a situation which seems likely because many farmers "ceased growing natural
vanilla" in response to the fall in the price of natural vanilla. On the contrary, vanillin "is
made from more reliable sources of plentiful raw materials, such as wood pulp and
petroleum ". Therefore, if the price of ice creams made with vanillin increases, ice cream
producers will have no difficulties in purchasing more vanillin in order to increase their
production (i.e. price-elastic supply).
(d) On the hand, the recent rise in the price of natural vanilla can be expected to have a
positive impact upon Madagascar’s economy. Indeed, given that natural vanilla accounts
for a significant share of its exports, the rise in the price of natural vanilla will lead to a
favourable movement in Madagascar’s terms of trade (i.e. one unit of exports can
purchase more units of imports). Besides, assuming the demand for natural vanilla is
relatively price-inelastic (likely to be the case if the demand for ice-cream is price-
inelastic or if there is a low substitutability between natural vanilla and vanillin),
Madagascar’s export revenue will increase and its current account balance will improve.
Moreover, the higher price of natural vanilla will encourage existing farms to increase
their output and it will attract new firms into the market (assuming the barriers to entry
are sufficiently low). This increase in economic activity will create more employment
opportunities for the Malagasy population, and ultimately improve their standard of
living.
However, the recent rise in the price of natural vanilla can also have a negative
impact on Madagascar’s economy. This is likely to be the case if the demand for natural
vanilla is relatively price-elastic so export revenue will fall. Besides, as farms are
encouraged to increase their production of natural vanilla (profit incentive), more
environmental damage may occur. In particular, forests might be cleared in order to
provide extra farmland. Alternatively, more of the existing farmland can be used to
produce natural vanilla but this will generate an opportunity cost because the Malagasy
economy will experience a decrease in the production of other agricultural commodities
which can be essential for the population. Also, the increase in production can be
expected to lead to a decrease in the price of natural vanilla, jeopardizing the long-run
profitability of natural vanilla farms. Similarly, it will increase the vulnerability of
Madagascar’s economy because of an exacerbated dependence on natural vanilla. Finally,
the additional income generated by the higher price of natural vanilla may only be
captured by a small minority of the Malagasy population (i.e. the landowners). In that
case, and assuming no trickle-down economics, income inequality will worsen and most
Malagasy residents will be left behind with very low living standards.
Overall, the recent rise in the price of natural vanilla will benefit Madagascar’s
economy if the demand for natural vanilla is relatively price-inelastic, if new employment
opportunities are created, if the induced environmental damage and opportunity costs
remain limited, and if the resulting increase in national income effectively improves the
standard of living of the average Malagasy resident.

AS Data Response 1

Uploaded by

Copyright:

Available Formats

AS Data Response 1

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

AS Data Response 1

Uploaded by

Copyright:

Available Formats

DATA RESPONSE

Course: AS - Year: 2020 - Serie: October/November - Version: 2

This is depicted in Figure 1 below.

Figure 1: The market for natural vanilla from 2004 to 2009

depicted in Figure 2 below.

substitutes in consumption (i.e. in competitive demand so one can be replaced by the

supplied to a proportionate change in the price of the good or service. It is calculated as

is said to be price-inelastic if it is smaller than one (i.e. a given percentage change in

price will bring about a smaller percentage change in quantity supplied).

production (i.e. price-elastic supply).

encouraged to increase their production of natural vanilla (profit incentive), more

environmental damage may occur. In particular, forests might be cleared in order to

economy will experience a decrease in the production of other agricultural commodities

profitability of natural vanilla farms. Similarly, it will increase the vulnerability of

Madagascar’s economy because of an exacerbated dependence on natural vanilla. Finally,

standard of living of the average Malagasy resident.

You might also like