2015 Case Study Question 1

a) Extract 3 (Paragraph 1) states that the demand for better food in highly-populated emerging markets like China, India and Brazil was increasing. As potash is a fertilizer containing potassium which can be used to improve soil for farming, an increase in the demand for better food will lead to an increase in the demand for potash which will lead to a rise in the price.

b) Extract 1 (Paragraph 2) states that most of the potash from the new mine in North Yorkshire would be exported. Therefore, the opening of the new potash mine would create jobs in the shipping industry. Furthermore, when workers who would be employed in the new potash mine receive income for their supply of labour, they would increase demand for goods and services which would create jobs in the industries and this spillover effect is commonly known as the multiplier effect.

c) Extract 2 (Paragraph 2) states that the other cartel member Belaruskali was operating outside the cartel which means that it was charging a lower price and/or producing a higher output level, a claim made by Uralkali. As such actions would hurt the profit of Uralkali, it decided to leave the potash cartel so that it would able to protect its profit. It is also stated in the paragraph that Uralkali wanted to increase the ‘demand’, or more precisely quantity demanded, of its product through lower its price with the objective of increasing its market share, sale revenue or profit. That might be possible as Uralkali might have a large amount of excess production capacity. Extract 3 (Paragraph 1) states that there was over-capacity in potash production.

d) Extract 2 (Paragraph 3) states that with the collapse of the potash cartel, potential customers will delay buying in anticipation of plunging prices. Extract 2 (Paragraph 2) states that Canada is an exporter of potash. Therefore, the collapse of the potash cartel will lead to a decrease in the external demand for potash in Canada. When this happens, the demand for Canadian dollars in the foreign exchange market will fall which will lead to a fall in the exchange rate.

e) Students can discuss expansionary fiscal policy, expansionary monetary policy and education and training to reduce unemployment.

f)There are several factors that are likely to influence whether the proposed new potash mining project in North Yorkshire should go ahead.

Projection of the cost

Extract 1 (Paragraph 1) states that potash is refined from ore dug from mines. Therefore, an increase in the wages of miners will lead to an increase in the cost of production of potash which will lead to a decrease in the profit. As Sirius Minerals is a profit-oriented private firm, this will reduce its incentive to build the new potash mine.

Projection of the revenue

Extract 3 (Paragraph 1) states that the demand for better food in highly-populated emerging markets has been rising. If the trend continues, the demand for potash will increase which will lead to an increase in the price and the quantity resulting in an increase in the revenue and hence the profit. This will increase Sirius Minerals’ incentive to build the new potash mine.

However, the same paragraph states that there existed over-capacity in potash production and farmers’ willingness to find other methods to fertilise their crops and these factors will lead to a fall in the price of potash. The collapse of the potash cartel will also lower the price of potash due to increased competition which is stated in Extract 4 (Paragraph 1). Furthermore, Extract 4 (Paragraph 2) states that if BHP Billiton Ltd builds what would be the world’s largest potash mine, the price of potash may fall further. If the demand for potash is price inelastic, a fall in the price will lead to a smaller proportionate increase in the quantity demanded resulting in a fall in the revenue and hence the profit. Furthermore, as stated in Extract 2 (Paragraph 2), the collapse of the potash cartel will lead to a fall in the demand resulting in a fall in the revenue and hence the profit as potential customers delay buying in anticipation of plunging prices. This will reduce Sirius Minerals’ incentive to build the new potash mine. Extract 3 (Paragraph 4) states that the cartel’s break-up and the expected drop in price could halt several large potash projects around the world, including Sirius Mineral’s plan to dig in Yorkshire.

Government Intervention

The production of potash produces external costs such as air pollution as potash is refined from ore dug from mines which is stated in Extract 1 (Paragraph 1). Extract 3 (Paragraph 2) states opponents to the new potash mining project have claimed that the environmental costs will be very high. Therefore, in the absence of government intervention, potash will be over-produced resulting in a loss of social welfare. Students can draw a diagram to show the deadweight loss which is the net social welfare loss. It follows that Sirius Minerals may not get approval from the government to build the new potash mine, in which case, the mine will not be built.

However, the government may approve the project due to the beneficial macroeconomic effects. Extract 1 (Paragraph 2) states that the project will lead to an increase in exports of potash to China and, at full production, could reduce the UK’s balance of payments deficit by 10% by 2022. The construction of the new potash mine will lead to an increase in investment. This, together with the increase in exports, will lead to an increase in aggregate demand resulting in an increase in national output. When this happens, the demand for labour in the economy will rise which will lead to a fall in unemployment. Extract 3 (Paragraph 3) states the new potash mine is expected to create about 3000 jobs during construction. Furthermore, as stated in the same paragraph, the opening of the new potash mine will directly create jobs in the mining industry and the multiplier effect will indirectly create jobs in other industries. Due to the beneficial macroeconomic effects, the government may approve the new potash mining project in spite of the negative externalities in production, in which case, the mine may be built.

Evaluation: The government should grant approval to Sirius Minerals to build the new potash mine. According to the extracts, the new potash mine will create thousands of jobs, increase national output and reduce the balance of payments deficit by billions of pounds. These macroeconomic benefits are especially great in view of the sluggish UK economy since the 2008-2009 Global Financial Crisis. Therefore, the macroeconomic benefits are likely to outweigh the microeconomic costs. Nevertheless, the government should not neglect the microeconomic costs of the negative externalities that will be caused by the new potash mine. To do this, it can impose a tax equal to the marginal external cost to eliminate the loss of social welfare caused by the negative externalities. The extra tax revenue generated will also reduce the budget deficit of the UK government.

A more elaborate answer to 2015 Case Study Question 1 will be provided in economics tuition.

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