Answer

Data response on zinc (1 hour)

Zinc is the fourth most widely used metal, after iron, aluminium and copper. Zinc is used in a variety of ways, including the production of alloys used in the motor and construction industries. It is also used in the production of chemicals, some of which are used to galvanise steel, which stops it rusting. Because of the global downturn, it is estimated that global production in 2009 will be 2.65m metric tonnes, compared with demand of 2.41m metric tonnes. The USA is the world’s largest consumer, but China is catching up rapidly. Back in 2007, when the world economy was growing strongly, zinc prices on the London Metal Exchange, averaged $4,200 per tonne, but by 2009 this price had fallen to $1,400 per tonne. Despite this fall in price, supply onto the market was slow to adjust, with over production continuing.  In an attempt to help stabilise prices, the Chinese government announced in 2009 plans to control supply by buying up stocks.

Zinc production and use creates a number of harmful by-products, including sulphur dioxide from zinc smelting, and hazardous waste which must be safely disposed of. Zinc production is also heavily reliant on energy from fossil fuels, which contributes to carbon emissions. Subsidies may encourage zinc producers to switch to low energy technology. Other strategies that could help encourage the reduction of carbon emissions include carbon offsetting, a carbon tax, and carbon trading, such as the European Carbon trading scheme. A tax on hazardous waste could also provide an incentive to find alternative ways to extract zinc from the earth.

Carbon trading is often described as a ‘cap and trade’ system. Emission limits (caps) are set for producers, and if these limits are exceeded, the polluter must buy permits to pollute in the carbon market. Other producers that emit below their limit can sell their surplus permits on the carbon market.  Hence, an incentive is created to reduce carbon emissions.

The world’s largest zinc producing firm, the London-based Belgian-owned company Nyrstar, has mining operations around the world, including the USA and Australia.  A representative of Nyrstar told Fox News recently that any type of carbon tax could not be passed on to consumers, and that the company would have to bear the cost itself.  Nyrstar are also worried that tough anti-pollution policy by the Australian government would cost the company many jobs, which would go to China, where pollution control is a low priority.

(Sources: Fox News; ILZSG; Metalspace.com; Basemetals.com; Reuters International)
  1. Calculate the % fall in the price of zinc from 2007 to 2009. (2)
  2. Using a diagram, explain why zinc prices fell between 2007 and 2009. (5)
  3. With reference to the data, comment on the price elasticity of supply of zinc. (7)
  4. Analyse the impact of falling zinc price on producers and consumers. (6)
  5. Evaluate the Chinese government’s plans to control supply by buying up stocks. (8)
  6. Use a diagram to explain how a subsidy on low energy technology might encourage its use. (5)
  7. Use a diagram to illustrate the effect of pollution on the social costs of zinc production. (5)
  8. Evaluate the use of carbon taxes and carbon trading as a means of reducing the external cost of zinc production. (12)

50 marks

Student answer

  1. Calculate the % fall in the price of zinc from 2007 to 2009. (2)

The price fell from $4,200 to $1,400, i.e. – $2,800, which is: – 2,800/4,200 x 100 = – 67%

  1. Using a diagram, explain why zinc prices fell between 2007 and 2009. (5)

Zinc prices fell for two main reasons. Firstly, the global downturn, which means that global incomes are falling, and this suggests that demand around the world is also falling. As incomes fall, demand for normal goods fall given that income elasticity of demand (YED) for normal goods is positive. In contrast, demand for inferior goods will rise as YED for inferior goods is negative. Zinc is used to make cars and other products, which are normal goods, so demand will fall, and the demand curve will shift to the left, from D to D1, as shown below:

 Falling price of zinc

In addition, the article states that production has increased, which means that supply is also likely to have increased, meaning that the supply curve shifts to the right. The effect of this is to reduce supply to S1.

The combined effect is that the price of zinc will fall significantly, from P to P2.

  1. With reference to the data, comment on the price elasticity of supply of zinc. (7)

Price elasticity of supply (PES) indicates the responsiveness of producer’s supply to a change in price, and is calculated using the following equation:

% change in quantity supplied

% change in price

The data says that, despite the fall in price, supply onto the market was slow to adjust. This implies that PES is < 1 and inelastic. This is probably because, in the short run, it is difficult for zinc producers to increase or decrease their production.

However, if stocks exist, then PES will be more elastic. Also, in the long run PES will also be more elastic.

  1. Analyse the impact of falling zinc price on producers and consumers. (6)

Producers are likely to suffer from the fall in zinc prices, as this will reduce their revenue, which is P x Q. This can be seen below.

It also means that producer surplus will fall. Producer surplus is the extra benefit gained by a producer when the price in the market is greater than they would be prepared to supply at. Producer surplus falls from P,A,B to P1,C,B.

If production costs do not fall, then this also means that profits will fall.

On the other hand, consumers of zinc – e.g.  car producers and chemical producers, will gain from falling prices. Firstly, it means that their costs of production fall, so they may be able to make more profits. Secondly, their consumer surplus, which is extra benefit to consumers when the price is below what they would be prepared to pay. Car producers may be prepared to pay a lot for zinc because they need it in production, so a falling price will increase their consumer surplus, as shown below:

Consumer surplus increases from A,B,P to A,C,P1

  1. Evaluate the Chinese government’s plans to control supply by buying up stocks. (8)

The Chinese government is buying up stocks of zinc, presumably to put them in a buffer stock, to help stabilise the market price. The price of zinc is falling due to over production, so buying up stocks will help raise the price, as shown below:

In evaluating this we can say that there may be information failure – how much stock must they buy to achieve a particular price? They may get it wrong.

Secondly, buffer stocks cost a lot in terms of the cost of buying up the stock, and the cost of running the scheme. This money could be spent on other things, hence there is an opportunity cost.

Thirdly, buying up the stock may not affect the price all that much because other factors could make it fall again, such as a fall in global demand.

  1. Use a diagram to explain how a subsidy on low energy technology might encourage its use. (5)

Low energy technology may be very expensive for zinc producers to buy, so a subsidy might make it cheaper. A subsidy is a grant given by the government to help reduce price and encourage use.

A subsidy will shift the supply curve to the right, and reduce price, as shown below:

Zinc producers can now afford to purchase more of it at the lower price.

  1. Use a diagram to illustrate the effect of pollution on the social costs of zinc production. (5)

The marginal private cost of zinc production is shown by the MPC curve. Social costs of production mean private costs + external costs, like carbon emissions and hazardous waste. The addition of external costs raises the social costs curve to marginal social cost (MSC), as shown below:

 

If we add the marginal benefit curve (marginal social benefit, MSB), the optimum output is Q1 rather than Q. Hence, when external costs are added, output should be reduced to achieve the socially optimum (efficient) output.

  1. Evaluate the use of carbon taxes and carbon trading as a means of reducing the external cost of zinc production. (12)

Carbon taxes are taxes on firms that produce carbon emissions. There are different types of tax, but most taxes operate like an extra cost to firms, so the supply curve rises by the amount of the tax, as shown below:

 

The effect of the tax is to raise price, and demand contracts so that less is consumed and produced.

In evaluating carbon taxes we can say that the effect of the tax depends upon PED. For example, a tax on zinc producers may raise price, but users of zinc (car producers) carry on buying it because there is no alternative.

Secondly, the zinc producer might not pass on any of the tax rise at all, so demand continues at the higher rate.

However, taxes can also raise revenue for the government, and this can help subsidise ‘greener’ technology.

Carbon trading is a scheme which involve ‘cap and trade’ – the government sets a cap (a limit) on pollution, and then if polluters exceed this limit they must buy extra permits to pollute. Low polluters can sell their surplus permits in the carbon market. The incentive is to reduce pollution.

In evaluating carbon trading we can say that it exploits the power of the price mechanism to send out signals to producers to change their behaviour, and provides incentives to become less polluting. In this way they work automatically.

Secondly, they force the polluter to include the ‘external cost’ as an ‘internal’ (private) cost of production. There is an incentive to reduce costs.

However, they are complicated schemes to set up, and firms may carry on polluting and pass the extra cost on to consumers, who may also carry on polluting.