2007 JC2 H2 Economics Preliminary Examinations

National Junior College

Economics Department

Preliminary Examination 2013

Answer Booklet

Senior High 2

H2 Economics

(Syllabus 9732)

Examiners’ Report for 2013 H2 Economics Prelims

Case Study Question 1

(a) Compare the change in prices of HDB Resale Residential property and Commercial Shop Space from 2006 to 2011. [2]
Similarity: Property prices of both HDB Resale Residential property and Commercial Shop Space show a general increasing trend. [1]
Difference: HDB Resale Residential property prices increased at a faster rate as compared to Commercial Shop Space property prices. [1]
(b) Using economic analysis, account for the trend in Private Residential property prices over the period 2006 to 2011. [4]
Residential property prices show an increasing rate of increase.

  • This is due to the increase in Residential property which could be attributed to the following factors:
  • Increasing household income with a “buoyant economy”
  • Availability of housing loans with “low interest rates”
  • Lifestyle changes
  • Speculators fuelling increase in investment demand
  • State and explain clearly a reason for an increase in demand. [2]

 

  • Interpret that the phrase “it takes time for supply to catch up with demand because of the period required for construction” meant that supply of housing is likely to be price-inelastic (make reference to Extract 2). [1] Thus any increase in demand would like to a sharper increase in prices. [1]
(c) With the aid of diagrams, explain how the change in the prices of Residential property could cause changes in the prices of Commercial property. [4]
  • There is a positive correlation between the prices of Residential property and Commercial property.
  • They are substitutes in production (or in competitive supply) as URA land parcels are “earmarked for competing uses such as for commercial, hotel and private residential developments” (Extract 2). Land resource is a common factor of production that can be used for development of commercial or private properties. [1]
  • Illustrate diagrams showing both markets of Residential and Commercial property. [1]

Canvas 316

  • Explain briefly the diagrams. As demand for residential property increases, the price of residential property increases. The quantity supplied of residential property increases from Q0 to Q1 in Figure (a), in accordance with law of supply. [1]
  • Thus, at each possible price, there is less land available for construction of commercial property. Thus causes a fall in supply from S0 to S1 of commercial property, leading to an increase in its prices, as seen in the increase in price from P0 to P1 in Figure (b). [1]
(d) Explain a possible cost advantage HDB has over developers of private housing projects. [2]
  • Public housing projects are able to enjoy internal economies of scale given the larger scale of production as compared to private housing projects (e.g. condominium projects). [1]
  • Any reasonable explanation of economies of scale applied to the housing market will be awarded the mark. An example could be marketing economies as public housing projects are able to obtain bulk discounts when procuring construction materials. [1]
(e) With reference to the data, evaluate the measures to address the increasing property prices in Singapore. [8]
Introduction

  • A number of measures had been implemented to curb increasing property prices, which include both demand-side and supply-side measures.

Body Elaborate on at least 2 of the following measures with clear links to the impact on the housing market.

  • Additional Stamp Duty ïƒ curbs speculator demand as it deters potential investors ïƒ fall in DD of housing ïƒ downward pressure on property prices

Evaluation:

  • This may be effective as speculative demand may be significant in a buoyant housing market. This measure allows the government to curb housing demand without hurting the genuine home buyers.
  • This may deter FDI from S’pore which would result in negative impact on our macroeconomy. A fall in FDI would result in a fall in injections to AD, thus via the multiplier effect, result in a more than proportionate fall in nominal National Income, compromising on actual economic growth and cyclical unemployment. Fall in FDI may also compromise on potential economic growth.

 

  • Housing Loan Limits ïƒ difficulty in obtaining housing loans ïƒ limits households ability to purchase housing ïƒ fall in DD of housing ïƒ downward pressure on property prices

Evaluation: However it is stated in Extract 3 that there are “low interest rates” and that “(m)any households have amassed cash reserves which can be put down as a deposit for a property” which limits the effectiveness of the above measure in reducing housing demand.
Evaluation for DD-side measures:

  • The mentioned measures do not necessarily target the other core reasons that drive up demand for housing. As mentioned in Extract 3, “healthy economy”, “shallow capital markets” and “lifestyle changes” are some factors causing an increase in demand for housing.
  • Largely effective though as Supply of housing is relatively price-inelastic. Thus any small changes in demand would lead to significant fall in prices (explain clearly with aid of diagram).

 

  • Increase supply of HDB flats/ Increase supply of land parcels for Private Residential projects ïƒ downward pressure on property prices

Evaluation for SS-side measures:

  • It takes time for housing projects to be completed and thus this is more of a LT measure and should be complemented with cooling demand-side measures.
  • Effectiveness is also dependent on PED for housing, which could differ depending on the type of housing.

Conclusion/ Evaluate

  • Candidates are to evaluate on the effectiveness of the above measures.
  • Both demand-side and supply-side measures are required to address the rising prices as the causes are multi-faceted.
  • Measures are not likely to be effective as data shows that housing prices are still rising (ref. to Table 1).
  • Whilst stamp duty and loan limits are effective ST measures, the government needs to consider LT measures to address the fundamental changes in the housing market.

 

L2 4-6 marks
  • Balanced consideration of both Demand-side and Supply-side measures.
  • Good scope of discussion with at least 2 measures explained.
  • Good rigour of elaboration (e.g. inclusion of market equilibrium diagram, application of elasticity concepts etc.)
  • Reference to case material in explanation (including the consideration of table of trend of housing prices).
L1 1-3 marks
  • Lack of balance in consideration of policies.
  • Limited scope of discussion with only 1 measure explained. Or mere listing of measures without clear explanation.
  • Weak rigour of elaboration
  • No or minimal reference to case material in explanation.

 

E2 2 marks Well-reasoned overall assessment of the measures supported by analysis.
E1 1 mark Some attempt at assessing the individual measures in addressing the rising housing prices.
(f) Discuss the view that government provision of public housing is necessary. [10]
Introduction

  • Identify the various sources of market failure in the housing market:
  • Income inequity
  • Merit good (for genuine home-buyers/ owner occupied housing)

Body Thesis: Government provision is necessary as it helps to solve the market failure present in the housing market.

  • Explain that there are positive externalities of public housing where the creation of “cohesive communities” help to “support national objectives such as maintaining racial harmony and stronger family ties” (Extract 4). As such public housing is deemed to be socially desirable and is a merit good. Public housing is likely to be under-consumed due to the presence of imperfect information whereby households are unaware of the full benefits of public housing.
  • Also, this allows the government to develop projects such as the “Green Neighbourhood” (Extract 4). As such, there are other external benefits of consumption of such public housing projects as compared to other private housing projects.
  • Explain clearly with the aid of the benefit-cost framework, how there would be an under-consumption of housing if to the private markets, and thus there is a need for the government to intervene to increase the consumption of housing.
  • In addition, public housing also help to address the income inequality in an economy as the government strives to provide public housing at affordable prices.

Anti-thesis (i): Government provision is not necessary as it may result in government failure.

  • There could be government failure where the government estimates incorrectly the housing demand and supply. Asymmetric information is present, and this has resulted in insufficient supply of HDB flats to cope with the increasing demand.
  • As the sole provider of HDB flats, and thus as one of the major players in the housing market, the government has significant market power. This may result in both productive inefficiency and X-inefficiency due to the lack of competition.

Evaluation: With a large scale of production, with the provision of public housing, the government is able to reap internal economies of scale and pass on these cost savings to potential home-owners in terms of lower prices for public housing.
Anti-thesis (i): Government provision is not necessary as there are other methods of intervention or private producers are able to adequately provide for the markets.

  • Instead of direct provision, government can consider subsidising private housing market projects instead. This would effectively lower the MPC so as to increase the consumption of housing (explain with the aid of benefit-cost diagram). Such private projects are likely to be of greater variety, for example, condominiums with various amenities such as pool, bbq pit etc.

Evaluation: Subsidies would likely result in a strain on the government budget.

  • Changes to government regulation to encourage consumption of housing by genuine home-buyers/ owner occupied housing. Government perhaps could reduce restrictions on genuine home-buyers so as to encourage consumption of housing. For example, banking regulation can help ease the availability of housing loans to such genuine home-buyers i.e. first-time home-buyers. Otherwise, direct subsidies can be given to genuine home-buyers.

Evaluation: It may be difficult to distinguish between demand from genuine home-buyers and speculative demand. Thus, the encouragement of demand of genuine home-buyers may fuel further increases in property prices, worsening the problem identified in part (e).
Conclusion

  • It depends on the characteristics of the economy. For a land-scarce economy such as Singapore, it is important to ensure that efficiency of land use is achieved. Given that Singapore economy is small, estimation errors are unlikely to be significant and thus government should provide for public housing to address market failure problems such as concerns of under-consumption as well as income inequality concerns.
  • Whilst government should step in to provide public housing, it should also regulate and allow the development of private housing developers so as to complement its efforts. This would keep the housing market contestable and ensure a variety of housing options for potential home-buyers.

 

L3 6-8 marks
  • Balanced essay in elaboration of thesis and anti-thesis.
  • Good rigour of elaboration (e.g. inclusion of +ve externalities diagram)
  • Good scope of discussion e.g. identification of more than 1 source of market failure in thesis or elaboration of at least 2 reasons for anti-thesis.
  • Show good recognition and elaboration of other methods of government intervention.
  • Excellent reference to case material in explanation.
L2 4-5 marks
  • Balanced essay in elaboration of thesis and anti-thesis.
  • Good rigour of elaboration (e.g. inclusion of +ve externalities diagram)
  • Good scope of discussion e.g. identification of more than 1 source of market failure in thesis or elaboration of at least 2 reasons for anti-thesis.
  • Show minimal recognition of other methods of government intervention
  • Some reference to case material in explanation.
L1 1-3 marks
  • Lack of balance in elaboration of thesis and anti-thesis.
  • Limited scope of discussion in both thesis and anti-thesis.
  • Weak rigour of elaboration
  • No or minimal reference to case material in explanation.

 

E2 2 marks Well-reasoned overall assessment of whether government provision in necessary.
E1 1 mark Some attempt at assessing the individual reasons for or against government provision.

C

ase Study Question 2

(a) (i) With reference to Figure 1, describe the trend in GDP growth of emerging and developing economies over the period 2007 to 2011. [2]
General trend: The GDP growth of emerging and developing economies generally declined over the period from 2007 to 2011. [1 mark]
Refinement: The emerging and developing economies went into recession with negative GDP growth in Q4 2008, but recovered to show positive GDP growth again by Q1 2009. [1 mark]
OR The GDP growth of emerging and developing economies showed the sharpest decline in 2008 but recovered sharply in 2009. [1 mark]
(ii) Suggest two possible reasons why the recovery of advanced economies and of emerging economies after the global economic slump of 2008 and 2009 ‘took divergent paths’. [4]
Possible reasons:

  • Advanced countries faced high government debt which caused greater financial instability and loss of confidence, resulting in a smaller increase in investment and consumption spending. The outlook for emerging economies was more positive as they did not suffer from high government debt, resulting in larger increases in C and I. The AD and hence NY rose faster for emerging economies.
  • Advanced countries were constrained from pursuing expansionary fiscal policy by their high government debt, whereas emerging economies were not. As such, emerging economies could rely on large fiscal stimulus to boost domestic demand and stimulate economic growth, thus recovering faster.
  • The negative outlook in advanced countries caused capital to flow out to emerging economies. The capital inflow leads to an increase in I and hence increase in AD in emerging economies which stimulates economic growth via the multiplier effect. This allows emerging economies to recover faster.
  • Advanced countries may be more integrated among themselves in terms of trade and financial flows, so their economic downturn affected one another more adversely. Since the fall in AD was larger, it took a longer time for them to recover. Emerging economies, on the other hand, were able to continue growing through trading among themselves, and were less affected by the recession in the advanced economies. Their AD did not fall as much and could increase more quickly due to the increase in (X-M) after the recession.
(b) (i) State the theoretical relationship between the government budget balance and the government debt. [1]
A deficit in the government budget balance would lead to an increase in the government debt. [1 mark]
(ii) Explain one reason why the above relationship might not be observed from the data in Table 2. [2]
From Table 2, all the countries showed a budget deficit throughout the period 2008 to 2011. We would expect their government debt to increase throughout the period. However, the Central Government Debt as a percentage of GDP for countries such as Greece, India and Italy declined in 2010 and 2011. [1 mark for stating the discrepancy between the data and the expected relationship] Possible reasons: [1 mark]

  • The economic recovery in 2010 and 2011 may cause the GDP to increase more than the rise in government debt.
  • There could be bailouts given by the EU or IMF which help to reduce the government debt
  • The creditors of the government debt may have decided to “forgive” or write-off some of the debts, thereby helping to reduce the government debt of these countries.
  • Falling interest rate may help to reduce the debt burden (which includes the interest payments). Hence the proportion of government debt is reduced.
Examiners’ Comments: >>
(c) Using a relevant diagram, analyse the effect of rising oil prices on economic growth of the US. [3]
Oil is used as a fuel for power generation and transportation such as in cars, trains and airplanes. A rise in price of oil will therefore result in an increase in cost of production for firms, causing a fall in the SRAS. [1 mark] The increase in cost of production means that firms will reduce their output at each given price level, resulting in a fall in the equilibrium level of national income. Hence it causes economic growth to decline and even become negative. [1 mark].
As shown in Fig 1, the fall in SRAS causes a fall in real output from Y0 to Y1, showing negative economic growth.
Fig 1
Straight Connector 2Group 7Group 8 Price Level
Straight Connector 12
Straight Connector 15
SRAS1
Straight Connector 14
SRAS0 AD
Straight Connector 3 Real Output Y0 Y1
(d) With reference to the data, assess the appropriate policy options for the US government to keep the economy growing amidst the threats it is facing. [8]
From Extract 1, the advanced countries, which include the US, are experiencing a slowdown in economic growth from 2010 to 2011, “with growth and interest rates remaining unusually low”. In addition, as mentioned in Extract 2, US is faced with rising oil prices which threaten its economic growth further with increasing costs of production. This coincides with an impending eurozone debt crisis which could threaten the financial stability of the world. The negative outlook causes a loss of confidence which results in an outflow of capital and fall in consumer spending. All these threats suggest the need for the US government to adopt appropriate policies to stimulate economic growth.
As the US government is itself suffering from high government debt (over 80% of GDP in 2011), expansionary fiscal policy would not be an appropriate option. In fact, the US government may be forced to cut its spending as mentioned in Extract 2 – “struggling state and local governments may dismiss more workers this year as many face their deepest shortfalls since the economic downturn began, and a Congressional stalemate over the country’s budget could even lead to a federal government shutdown”.
One appropriate policy option is monetary policy. The Fed can reduce interest rate to stimulate investment. The cut in interest rate reduces the cost of borrowing for firms, and hence increases the profitability of investments. This leads to an increase in investment.
As the interest rate is already “unusually low” as mentioned in Extract 1, it may not be possible to reduce interest rate much further, making Monetary Policy less appropriate. Instead, the US government can adopt exchange rate depreciation. According to the Marshall-Lerner condition, as long as the sum of elasticity of demand for exports and imports is greater than one, a depreciation of the exchange rate will lead to an improvement in the balance of trade. This means an increase in (X-M), which means an increase in AD, resulting in a multiplied increase in national income through the multiplier process.
Another option is to implement Supply-side policies to increase SRAS. As the economic slowdown is a current problem, the focus is on achieving actual growth rather than potential growth. Hence the appropriate policy is to increase SRAS rather than LRAS. Possible SS-side policies:

  • Subsidies to reduce cost of production (as above)
  • Reducing structural rigidities eg. wage guidelines to recommend flexible wages or wage cuts
  • Increasing labour force (eg. foreign labour or encouraging women to work) to reduce labour costs.

Conclusion (Overall assessment): Given the uncertainties of the external environment and the economic slowdown US is experiencing, the government will need to adopt expansionary demand management policies to boost its domestic demand. However, the high US government debt makes fiscal policy inappropriate, leaving the government with the choice of monetary policy or exchange rate policy. According to the Mundell-Fleming policy trilemma, US being a country with free capital mobility, will have to choose between adopting monetary policy and exchange rate policy. However, given that US interest rate is already very low, any increase in money supply will not reduce interest rate very much. Instead, it could cause capital outflow due to the surplus liquidity in the financial markets, leading to a fall in the US dollar exchange rate. However, as there are also supply side factors such as the rising oil prices, the government should complement the demand management policies with supply-side policies to reduce the costs of production and shift the SRAS. Such a combination of policies will help the US government to sustain economic growth in the face of the various threats mentioned in the case study.

L1 1-2 Largely irrelevant with some relevant points that are not clearly explained. Major conceptual errors may be found.
L2 3-4 Policies are appropriate but may not be well developed or explained. Only 1 policy that is well developed.
L3 5-6 At least 2 appropriate policies well explained with relevant diagrams. Assessment of the appropriateness of fiscal policy is included

 

E1 1 Some attempt at assessing the policies for achieving sustained economic growth
E2 2 Well-reasoned overall assessment of the policies supported by analysis.
(e) It is said that ‘Italy, the eurozone’s third largest economy, is not just “too big to fail”, but it may also be too big to bail’. Discuss the possible impact of an unsustainable Italian government debt on the economies of the UK and China. [10]
Introduction: With a high government debt amounting to over 110% of GDP and an economy in contraction, Italy finds it increasingly difficult to service or repay its government debt. As the Italian government debt becomes unsustainable, the financial and economic stability of the entire eurozone is threatened. Other countries that have economic or financial linkages with Italy or the eurozone will also not escape the adverse effects of the debt crisis.
Effects of the unsustainable government debt: As its debt becomes unsustainable, the Italian government will have to cut its spending and raise taxes in order to reduce its debt. This will have a contractionary effect on the economy, causing AD and hence national income to fall. Moreover, business and consumer confidence will also be affected, causing consumption and investment to fall, thus leading to further decline in AD and real output. The loss of confidence is likely to cause capital to flow out of Italy, as investors decide to withdraw their investments or shift their businesses to other countries.
As the third largest economy in the eurozone, Italy is “too big to fail”. In the event that the government defaults on its debt payment, it could cause a major financial crisis as the banks and other governments who own the debt (ie the creditors) will see much of their assets wiped off their balance sheets, and may even become insolvent as a result. This could lead to a collapse of the banking system and a credit crunch as liquidity dries up (ie loanable funds become in shortage).
Impact on UK: As mentioned in Extract 4, Britain is “on the frontline” of the eurozone debt crisis, due to its close connection with the eurozone countries. UK will likely be more adversely affected through its trade and capital flows with the eurozone. The economic contraction in Italy arising from the government budget tightening and loss of confidence will mean a fall in Italy’s demand for imports. Other countries in the eurozone may also experience an economic recession due to their close trade relations with Italy. This may cause the eurozone countries to reduce their demand for imports or even adopt protectionistic measures to restrict imports. This would mean a fall in UK’s exports, leading to a fall in AD and hence real output via the reverse multiplier effect.
Moreover, as mentioned in Extract 2, British banks may also own part of Italy’s government debt. If the Italian government defaults on its debt, the British banks “would not be spared”. This means that the British banks will also experience a loss of their assets in terms of loans to the Italian government. If the banks do not have sufficient reserves, they may face a shortage of liquidity and become insolvent. Any collapse of a bank will result in loss of wealth as the savings deposits of the people will be gone. This would cause a fall in consumption spending as well as fall in investment due to the negative outlook. In addition, the credit crunch, as loanable funds become in shortage, will also cause investment to fall. The effect is a further contraction of the economy, resulting in severe recession.
The loss of confidence in the UK arising from the economic downturn and banking crisis may cause capital to flow out to other countries. This not only results in a fall in investments, further aggravating the economic contraction, but also a worsening of the Capital and Financial Account of the balance of payments. To the extent that it causes an overall balance of payments deficit, it could lead to a depletion of the country’s official foreign exchange reserves or an increase in the foreign debt, which will add to the debt burden of future generations in UK.
However, as UK is not part of the eurozone and retains its own currency (the sterling pound), it is able to implement its own macroeconomic policies such as monetary policy or exchange rate policy independently of the eurozone. It is therefore able to counteract the economic contraction by introducing expansionary monetary policy. Moreover, the British pound may be perceived as a stronger currency, thus attracting short-term capital inflow as investors decide to put their funds into pound sterling deposits. This will help to improve the balance of payments, as well as provide much needed liquidity to the banking system.
Impact on China: Likewise, China could be adversely affected through its trade relations with Italy and the eurozone. A debt default by the Italian government can be likened to a major bankruptcy which can cause a severe recession in the eurozone, and the “consequences would be felt everywhere, including in the US and China”. As mentioned in Extract 4, “trade would go into freefall”, which means that China will also experience a decline in its exports, leading to a fall in AD, and hence decline in real output. Extract 3 also mentioned that “economists are expecting demand for Chinese exports to weaken in coming months, as the U.S. and European economies struggle to grow at even a modest pace”. This can lead to a recession in China, similar to what is seen in UK.
However, China could be less adversely affect compared to the UK, as it could benefit from capital inflow due to the more positive outlook of its economy. As mentioned in Extract 3, “China’s red hot economic growth… remains the envy of many western countries still struggling to recover from the global economic meltdown.” Extract 1 also mentioned that “China, Brazil and other fast-growing nations have struggled to contain inflation and control heavy inflows of investment money”. Such capital inflows result in an increase in investment in China, which leads to an increase in AD as well as productive capacity and LRAS, resulting in both actual and potential growth. Moreover, the inflow of capital also helps to improve the Capital and Financial Account of the balance of payments, which can contribute to further accumulation of foreign exchange reserves in China.
In addition, China is focusing on “promoting more domestic demand”, as mentioned in Extract 3. This may be done through the government’s expansionary fiscal policy. Hence, despite the potential fall in net exports, the AD may still increase due to other factors such as increased government spending on infrastructure or increased consumption due to transfer payments given by the government. Moreover, as the Chinese government is not constrained by high government debt, it is able to pursue expansionary fiscal policy to stimulate AD and increase economic growth.
Moreover, China may be less dependent on trade with the EU compared to UK, as it may have more trade relations with other Asian countries such as India, Singapore and Japan. Hence, the Chinese economy could still continue to grow as it expands its trade in the Asian region.
Conclusion and evaluation As the world becomes increasingly integrated, it is likely that a debt crisis in eurozone caused by the unsustainable Italian government debt would have adverse consequences on countries all over the world, including UK and China. Being in close proximity and hence closely linked to the EU, UK would likely bear the brunt of the eurozone debt crisis and could well fall into a deeper recession. While China could also be adversely affected via a decline in its exports, the negative impact may be mitigated by an increase in domestic demand as well as capital inflow from the advanced countries. Hence, the overall impact of the Italian government debt crisis on China is likely to be more muted.

L1 1-2 Largely irrelevant with some relevant points that are not clearly explained. Major conceptual errors may be found.
L2 3-5 Impact on only ONE country is fairly well developed (ie only impact on UK OR China) OR no differentiation between UK and China ie treating the impact as identical for both countries. Or there is discussion of impact on BOTH UK AND China, but may lack rigour in analysis. Discussion of the impact is one-sided (only positive or only negative effects) Lack of reference to case materials
L3 6-8 Excellent discussion of impact on BOTH UK AND China that is well developed with good rigour of analysis, supported by references to the case materials, including comparison or discussion of different extent of impact between UK and China. There should be some reference to the significance of the government debt. Discussion is 2-sided, covering both positive and negative effects on at least one of the countries.

 

E1 1 Some evaluation of the impact on UK and/or China that may not be well developed nor supported by analysis
E2 2 Excellent evaluation of the impact on UK AND China that is well developed and supported by analysis.

 

Essay Question 1
Sales of electronic cigarettes – battery powered slim metal tubes – have doubled, attracting new firms into the market. Smokers of electronic cigarettes inhale the vaporised nicotine without the chemical, tar and smell inherent with conventional cigarettes. The market for conventional cigarettes has been in steady decline in recent years, and is still facing tax hikes imposed by governments around the world. Adapted from theweek.com, 26 April 2013
Using demand elasticity concepts, discuss the likely effects of these changes on the revenue earned in the cigarette industry. [25]
Suggested Answer:
Introduction

  • State that revenue earned is determined by equilibrium price and quantity in the market for both electronic (e-cigarettes) and conventional cigarettes.
  • Recognize that e-cigarettes and conventional cigarettes are substitutes in consumption and therefore revenue in one market is also affected by changes in the price of the substitute good.

Body :
Conventional cigarette market

  • Explain that a continuing tax hike by governments around the world increases the cost of production for conventional cigarette firms, there resulting in a fall in supply for conventional cigarettes.

 

  • Explain that the demand for conventional cigarettes is likely to be price inelastic, i.e PED

With reference to figure 1, given the relatively price inelastic demand curve of conventional cigarettes, a leftward shift of the supply curve from S0 to S1 results in a less than proportionate fall in quantity demanded from Q0 to Q1 to the increase in its price from P0 to P1, ceteris paribus. Revenue earned in the conventional cigarettes market increases as the rise in revenue (area A) due to the increase in price is greater than the fall in revenue (area B) due to the fall in quantity demanded.
Group 189
Line 1098
E-Cigarette Market

  • Explain that the effect of changes in the e-cigarette market on its revenue is dependent on the values of PED and XED.

PED

  • Explain that the demand for e-cigarettes is likely to be price elastic, i.e. PED > 1.

Smokers are likely to consider conventional cigarettes as a good substitute to electronic cigarettes. In addition e-cigarettes to social smokers, i.e. smokers who smoke only for leisure as part of a social group, is but one of many means / tools of socialising for them and therefore the degree of necessity is low in terms of consumption.
With reference to figure 2, as more new firms are attracted to the e-cigarettes market the supply of e-cigarettes producing firms will increase. Given the relatively more price elastic demand curve D0 , a rightward shift of the supply curve from S0 to S1 will see a more than proportionate rise in quantity demanded from Q0 to Q1 to the fall in price from P0 to P1 , ceteris paribus.
Revenue earned in the e-cigarettes market will increase as the fall in revenue (area A) due to the fall in price is less than proportionate to the increase in revenue (area B) due to the increase in quantity demanded, ceteris paribus.
Figure 2 – Market for e-cigarettes Group 1074
AutoShape 1071A
B
XED > 0 (substitute in consumption)

  • Explain that both conventional and e- cigarettes are substitutes in consumption. This means that an increase in the price of conventional cigarettes will lead to an increase in demand for electronic cigarettes. However the extent of the increase in demand for e-cigarette is dependent on the value of XED.
  • Explain that the cross elasticities of e-cigarettes with respect to conventional cigarettes is likely to be high and positive, i.e. XED > 1.

E-cigarettes and conventional cigarettes are strong / close substitutes for smokers addicted to nicotine, and therefore have high positive cross elasticities. A high and positive value of XED means that for a given increase in the price of conventional cigarettes this will lead to a significant increase in the demand for e-cigarettes, ceteris paribus.
With reference to figure 3, as the price of conventional cigarettes increases, quantity demanded will decrease. According to the Law of Demand, there is an inverse relationship between price and quantity demanded, ceteris paribus. And as the quantity demanded for conventional cigarettes decreases, the quantity demanded for e-cigarettes will increase at every price levels given that they are substitutes in consumption. And if XED > 1, this results in a significant increase in the demand for e-cigarettes as illustrated by a rightward shift of the demand curve for e-cigarettes from D0 to D2.Group 131
Line 1172 Price of conventional cigarettes
P1
P0
AutoShape 486
Q1
Evaluation :
Not all smokers addicted to nicotine consider e-cigarettes and conventional cigarettes to be strong / close substitutes in consumption. To these smokers, the experience of smoking from a metal tube (e-cigarettes) is unlike smoking the real thing (conventional cigarettes). To these smokers the overall experience of smoking a conventional cigarette is irreplaceable, from having to tap the conventional cigarette stick thereby packing in the tobacco to being able to taste the tobacco as they put that cigarette stick to their lips. As such, e-cigarettes and conventional cigarettes are weak substitutes with positive cross elasticities values ranging between zero and one, i.e. 0
With 0 demand for e-cigarettes is to a relatively smaller extent as compared to the increase in price of conventional cigarettes.

  • Explain the importance of considering the values of PED and XED, and the rightward shift in supply due to the increase in the number of new firms in order to analyse the effect on revenue earned in the market for e- cigarettes.

 

  • Explain that the overall effect on revenue earned in the e-cigarettes market is dependent on the extent of the shifts its demand and supply curves. Thus, this gives rise to a resultant equilibrium price that is uncertain although the quantity transacted of e-cigarettes will increase.

(note : candidates are not required to draw the many different permutations of the differing extent of shifts in demand and supply curves to illustrate the effect of changes on revenue earned in the e-cigarette market. A well reasoned explanation(s) with at least one diagram to illustrate understanding is sufficient.)

  • Explain that it is likely that demand for e-cigarettes is price elastic and that the cross elasticities of e-cigarettes with respect to conventional cigarettes is high and positive, i.e PED > 1, XED > 1. The extent of the shift in demand is likely to be more than the extent of the shift in supply in the market for e-cigarettes for “sales of e-cigarettes have doubled which attracted new firms into the market”.

Figure 4 : Markets for e-cigarettes and conventional cigarettes
Price of e-cigarette Line 1190S0
Line 319Line 1169Price of conventional cigarettes S1
S2 Line 178Line 181S0 Line 1155Line 204
Line 1191
E2 P2
P1
Line 1196Line 176Line 182Line 1157Line 1158AutoShape 187AutoShape 188
Line 1193Line 179 P0
D2 Line 1176P0
Line 1175
D0
D0
Q0 Q1Q1 Line 11700
Q2Line 169Qty of e-cigarette Q0
Qty of conventional cigarettes
AutoShape 427AutoShape 1153
With reference to figure 4, as the price of conventional cigarettes increases, demand for e-cigarettes increases significantly since XED > 1. The extent of the shift in demand is more than the shift in supply in the market for e-cigarettes, thereby giving rise to the resulting equilibrium price of P2 and equilibrium quantity at Q2. Revenue earned in the e-cigarettes market increases and is given by the area OP2E2Q2.
Conclusion / Evaluation

  • The effect of changes on revenue in the markets for conventional and e-cigarettes depends on the values of PED and XED, as well as the relative extent of the shifts in demand and supply in the e-cigarettes market.

Knowledge of elasticity values in the respective markets allows cigarette manufacturers an opportunity to implement strategies aimed at increasing the revenue earned for their respective firms in the relevant market.

Mark Scheme
Level Descriptors
Level 3 18 – 21
15 – 17
  • Answer shows excellent knowledge of demand and supply forces, and how revenue expenditure earned may be affected
  • Excellent consideration of elasticity concepts (must include BOTH PED AND XED) and its relevance in influencing revenue.
  • Excellent analysis of other possible scenarios where the overall total revenue may increase/decrease i.e. Analysis of different extents of shifts, demand and supply changes in the market for conventional cigarettes)
  • Excellent rigour in economic analysis and development.
  • Excellent use of diagrams that is adequately explained.

Excellent attempts at contextualisation.

  • Good consideration of elasticity concept (must include BOTH PED AND XED) and its relevance in influencing total revenue.
  • Good rigour in economic analysis and development.
  • Good use of diagrams that are adequately explained.
  • Some attempts at contextualisation with some relevant examples.
Level 2
12 – 14
10 – 12
  • Answer shows good knowledge of demand and supply forces and how revenue may be affected.
  • Good consideration of elasticity concepts and its relevance in influencing market equilibrium.
  • Good rigour in economic analysis and development.
  • Relevant diagrams drawn with clear explanation.
  • Some contextualisation.
  • Some recognition that the extent of the shifts in demand and supply curves has an effect on price and hence overall revenue earned.
  • Answer shows adequate knowledge of demand and supply forces and how revenue may be affected.
  • Consideration of elasticity concepts and its relevance in influencing revenue (i.e. at least one elasticity concept).
  • Some rigour in economic analysis and development.
  • Relevant diagrams drawn but not well explained or clear explanation in absence of diagrammatical analysis.
  • Minimal or no contextualisation.
  • Possibly only 1 market analysed well and incomplete analysis for the other market (for example, the changes in demand and supply in the conventional cigarette market may be well explained but the changes in demand in the e-cigarettes market was not well analysed or vice-versa)
Level 1 6 – 9
1-5
  • Answer shows some knowledge of demand and supply forces and how equilibrium price &/or equilibrium quantity may be affected in one markets.
  • Errors and inconsistencies occur in the explanation, showing lack of understanding of the economic concepts. (For example, if the changes in demand and supply in both markets may not be identified correctly or not explained correctly)
  • Answer lacks balance in consideration of demand and supply forces.
  • Lack of economic analysis and development
  • Minimal or no contextualisation.
  • Max 9m if analysis considers only equilibrium price and quantity with no reference to revenue earned.
  • Answer is mostly irrelevant.
  • Only few valid points which do not clearly address the question.
Evaluation
E1 (1-2) For a mainly unexplained judgment on the likely effects on revenue in both markets.
E2 (3-4) For well-reasoned judgment on the likely effects on revenue in both markets.
Essay Question 2
Singapore Post Limited (SingPost) has been steadily expanding beyond Singapore. It will continue to diversify its business and tap the overseas markets. Its online shopping platforms, vPOST and Clout Shoppe, will accelerate its expansion in the e-commerce business.
Discuss how SingPost’s growth strategies might impact SingPost, consumers and other firms in Singapore. [25]
Suggested Answer:
Introduction:
Identify SingPost’s growth strategies as diversifying its business, expanding in the e-commerce business and tapping overseas markets, which can be seen as a form of vertical integration and horizontal integration. These growth strategies will diversify SingPost’s goods and services as well as increase the level of competition in the e-commerce, international mail and delivery services industries, and have varied effects on consumers and other firms in Singapore.
SingPost’s expansion in the e-commerce business and diversifying its business is a form of vertical integration, which is an acquisition of the firm at different stages of production in the same industry. E-commerce is a type of industry where buying and selling of a product or service is conducted over the Internet. After consumers make online purchases, they will likely depend on postal services to deliver the products they have ordered. As for SingPost’s entry in the overseas market, it can be seen as a form of horizontal integration which increases SingPost’s scale of production in the postage and delivery services, as well as increases the level of competition in the mail and delivery industry.
Body:
Positive impacts:
SingPost

  • Reap internal EOS (Any well explained sources of internal EOS)

SingPost’s growth will increase its scale of production and enable it to reap substantial internal EOS and gain cost advantages. These cost savings can also be passed down to consumers in terms of lower prices.

  • Increase total revenue (Any well explained reason)

Increase no of consumers By expanding in the e-commerce business, SingPost is able to diversify its business and capture a greater consumer base. SingPost’s online shopping platforms, vPOST and Clout Shoppe provide consumers with more convenience and choices when they shop online.
Increase Diversification Expanding in the e-commerce business allows SingPost to diversify its business and increase sales volume from new products and new markets. Product diversification involves addition of new products to existing products.

  • Dynamic efficiency

SingPost is able to sustain its supernormal profit in the long run from its dominant position in the mail and delivery industry. Coupled with the probability of earning higher profit from diversifying its business and expanding in the e-commerce industry, SingPost is able to attain dynamic efficiency as it develops a more efficient production technique to produce goods and services, lowering its LRAC.
Consumers

  • Increase consumer choice and welfare

SingPost’s expansion in the e-commerce industry will increase the level of competition in the industry, and hence provide a greater variety of choices for the consumers to choose from i.e. a more competitive online shopping platform where consumers are able to gain access to more products and brands online.

  • Lower price, higher output and increase consumer surplus

With the increased competition, demand for e-commerce services will become more price elastic due to the availability of more close substitutes. As such, firms in the e-commerce industry will have less market power to set price above marginal cost and restrict output sold, resulting in a higher consumer surplus.
Other firms

  • Less likely to suffer from X-inefficiency

SingPost’s entry in the overseas market will increase the level of competition in the mail and delivery industry. Dominant firms like United Parcel Service of America (UPS) and Deutsche Post DHL will face a stronger competition and a reduction of their supernormal profits earned in the long run. This will have less incentive to lax about cost controls and less likely to suffer from X-inefficiency.

  • Dynamic efficiency

With the increase in the level of competition, dominant firms like United Parcel Service of America (UPS) and Deutsche Post DHL, including SingPost have more incentive to make use of their supernormal profits earned in the long run to engage in R&D and develop a more efficient method to produce goods and services. As such, they are able to attain dynamic efficiency as more goods can now be produced from any given amount of resources. Costs are lowered and lower prices are charged to consumers.
Negative impacts:
SingPost

  • X-inefficiency

As SingPost diversifies its business, expands in e-commerce and overseas market, and earns greater supernormal profits in the long run, it could lax in cost controls and suffer from X-inefficiency. For instance, SingPost could pay large amount of rents to locate their offices in prestigious locations in overseas or not use the most updated and efficient production methods. Such higher costs may be passed on to the consumers in terms of prices.
Other firms

  • Unable to reap internal EOS

Smaller firms in the e-commerce industry will be left with less market share when SingPost enters the industry. They will not be able to reap substantial internal EOS to compete with SingPost and offer lower prices to consumers; hence they will need to rely on non-price strategies to compete, i.e. offering personalised services to consumers.

  • Decrease in total revenue

With the increase in competition from SingPost, smaller firms in the e-commerce industry are likely to experience a fall in demand of their goods and services as consumers turn to SingPost’s online platforms i.e. vPOST and Clout Shoppe which provide more attractive offers.
Likewise, firms like United Parcel Service of America (UPS) and Deutsche Post DHL will now face a fall in the demand of their mail and delivery services, as SingPost diversifies its business and enters the e-commerce and overseas market.
With an increase in total cost and a reduction in total revenue, profits of other firms will fall.

  • Forced to leave the industry

The increase in competition when SingPost enters the e-commerce industry will result in smaller share of profits earned by the smaller firms. As such, they have no ability to devote their profits to Research & Development (R&D) efforts, which is essential in the e-commerce industry to provide consumers with better quality of goods & services. Examples of better quality and high technology services include domestic and international payment systems, efficient automated online assistants and order tracking.
In the long run, these smaller firms will find themselves losing their consumers to SingPost and may not be able to remain in the industry. This is especially so as SingPost’s dominant position in the mail and delivery industry will enable it to use its supernormal profits earned to innovate in high technology e-commerce services for its consumers, for instance providing both advanced data security and high frequency of page loads to increase the sales conversions and the number of shoppers checking out their online stores. This will affect the smaller producers, which do not have the relevant resources to engage in such non-price strategy, product differentiation and innovation to compete with SingPost and might be forced to leave the industry.
Consumers

  • Higher price

If SingPost lax in cost control and suffer from X-inefficiency, these higher costs may be passed on to the consumers in terms of higher prices, such as higher postage and delivery fees or e-commerce sales charges. Likewise, firms in the e-commerce industry as well as mail and delivery services industry who now produce at a lower scale due to the fiercer competition faced from SingPost, may no longer be able to reap substantial internal EOS and enjoy the cost savings. Hence they have no choice but to charge the consumers at higher prices.

  • Decrease consumer choice and consumer surplus

If the smaller firms in the e-commerce industry are able to compete with SingPost and are forced to leave the industry in the long run, consumers will be left with limited choice and access to products and brands online. On the extreme end, if SingPost capture a significant market share in the e-commerce industry, it might over exploit the consumers by charging them at high prices and restricting the output, decreases the consumer surplus.
Evaluative Conclusion:
SingPost’s growth strategies will allow SingPost to diversify its goods and services, as well as increase the level of competition in both the e-commerce industry and international mail delivery industry. The increase in level of competition will benefit the consumers in terms of greater consumer’s surplus and welfare as they face lowered prices, greater availability of choices and quality goods in the markets.
However, the impact on producers will vary for SingPost and its competitors in the e-commerce industry and international mail delivery industry. In the e-commerce industry where a large number of smaller firms are present, the entry of a dominant firm like SingPost in the industry will have an adverse effect on these smaller firms in terms of their revenue and profits earned. They are unlikely to compete with SingPost which has the resources to engage in product innovation and differentiation to capture a greater market share, and get rid of its competitors. As such, these smaller firms will not be able to survive in the e-commerce industry in the long run, which might lead SingPost to over exploit the consumers, if it is left with significant market power in the e-commerce industry to do so.
SingPost’s strategies to diversify its business, expand in the e-commerce and overseas market will serve as threats to the dominant firms i.e. United Parcel Service of America (UPS) and Deutsche Post DHL in the international mail delivery industry. It will provide them with more incentive to be cost efficient and engage in product innovation to keep their market share, which will ultimately benefit consumers in terms of lowered prices and higher quality products.

Mark Scheme
Level Descriptors
Level 3 (18-21)
(15-17)
  • Answer shows excellent knowledge on the impacts of SingPost’s various growth strategies
  • Excellent elaboration on the positive AND negative impacts on consumers, SingPost AND other firms.
  • Excellent explanation on the impacts on consumer welfare AND SingPost’s AND other firms’ revenue AND cost advantages and their performances
  • Excellent rigour of analysis and minimal/no errors in elaboration.
  • Excellent use of diagrams to support elaboration.
  • Excellent contextual examples given.
  • Answer shows excellent knowledge on the impacts of SingPost’s various growth strategies
  • Excellent elaboration on the positive AND negative impacts on consumers, SingPost AND other firms.
  • Excellent explanation on the impacts on consumer welfare AND SingPost’s AND/OR other firms’ revenue AND/OR cost advantages and their performances
  • Excellent rigour of analysis and minimal/no errors in elaboration.
  • Excellent use of diagrams to support elaboration.
  • Excellent contextual examples given.
Level 2 (12-14)
(10-11)
  • Answer shows good knowledge on the impacts of SingPost’s growth strategies
  • Good elaboration on the positive AND negative impacts on consumers, SingPost AND/OR other firms.
  • Good explanation on the impacts on consumer welfare AND SingPost’s AND/OR other firms’ revenue AND/OR cost advantages and their performances
  • Good rigour of analysis and minor errors in elaboration.
  • Good use of diagrams used to support elaboration but diagram analysis is weak.
  • Good contextual examples given.
  • Answer shows good knowledge on the impacts of SingPost’s growth strategies
  • Good elaboration on the positive AND/OR negative impacts on consumers, SingPost AND/OR other firms.
  • Good explanation on the impacts on consumer welfare AND/OR SingPost’s AND/OR other firms’ revenue AND/OR cost advantages and their performance
  • Some rigour of analysis and minor errors in elaboration.
  • Some attempt to use diagrams to support elaboration but diagram analysis is weak.
  • Some attempt to provide contextual examples.
Level 1 (6-9)
(1-5)
  • Answer shows some knowledge on the impacts of SingPost’s growth strategies
  • Some elaboration on the positive AND/OR negative impacts on consumers, SingPost AND/OR other firms.
  • Some rigour of analysis and minor errors in elaboration.
  • Minimal or no diagrams used to support elaboration.
  • Minimal or weak contextual examples given.
  • Answer is mostly irrelevant
  • Answer shows some knowledge on the impacts of SingPost’s growth strategies but little or no elaboration.
E2 (3-4) Judgement made with economic justification
E1 (1-2) Judgment without economic justification.
Essay Question 3
(a) Explain how market dominance and immobility of factors of production in a country can lead to market failure. [10]
(b) Discuss the extent to which globalisation has reduced the problems associated with these sources of market failure. [15]
(a) Suggested Answer: Introduction

  • Explain that market failure refers to a situation in which markets produce undesirable outcomes. Resources are not allocated efficiently and/or optimally (i.e. equitably).
  • Explain market dominance
    Due to high barriers to entry, imperfect information or unique products, firms may have high market power which allows them to dominate markets, influencing prices, rather than having prices determined by market forces. Monopolies and oligopolies tend to have such market dominance.
  • Explain immobility of factors of production
    Factor immobility refers to the inability of a factor of production to shift from one use to another, even in response to large changes in remuneration.

Body

  • Explain why the presence of market dominance (and immobility of factors of production) can lead to market failure
  • The presence of market dominance may lead to firms enjoying monopoly power and hence there is imperfect competition and the presence of firms such as monopolies and oligopolies may result in the ‘wrong’ quantity being produced at too high a price, and the market outcome being allocatively inefficient.
  • The immobility of factors of production may also create barriers to entry resulting in firms enjoying monopoly power and hence leading to imperfect competition
  • Socially optimum level of output is at QPC where total welfare to society is maximised.
  • In an imperfect market, assuming that the monopolist seeks to maximise profits (where MR=MC), it has the incentive to restrict production at output QM and charge price PM.
  • By under-producing output QMQPC, the potential social benefits lost (area QMABQPC) is greater than the potential social cost incurred (area QMCBQPC), leading to a fall in the net benefit to society (area ABC). This is also known as the deadweight loss to society due to an allocatively inefficient level of production.

 

  • Explain why immobility of factors of production can lead to market failure
  • Factor immobility may be due to Occupational Immobility
    Factor immobility may be due to Geographical Immobility
  • Factor immobility prevents the switch to the production of new goods and services most valued by society, in the quantity required, thereby resulting in allocative inefficiency while the unemployment of immobile factors results in productive inefficiency.
Mark Scheme
Level Descriptors
Level 3 (9-10)
  • Answer shows excellent knowledge about the market failure arising from market dominance AND immobility of factors of production
  • Excellent rigour of analysis which includes
  • an excellent use of diagram to explain the market failure arising from market dominance
  • an explanation of how immobility of factors of production causes structural unemployment and productive/allocative inefficiency
  • a discussion of different types of inefficiencies
  • a recognition of income inequality
  • There are no errors in explanation
  • Good use of examples
(7-8)
  • Answer shows good knowledge about the market failure arising from market dominance AND immobility of factors of production
  • Good rigour of analysis which includes
  • a well-explained diagram to explain the market failure arising from market dominance
  • a recognition of different types of inefficiencies OR income inequity
  • There are no major errors in explanation
Level 2 (5-6)
  • Answer shows some knowledge about the market failure arising from market dominance AND/OR immobility of factors of production
  • Some rigour of analysis which may include
  • a diagram to explain the market failure arising from market dominance although it may not be particularly well explained
Level 1 (1-4)
  • Answer is mostly irrelevant.
  • Answer may only list points about market dominance and/or factor immobility.
  • Answer may have multiple concept errors.
(b) Suggested Answer:
Introduction:

  • Globalisation refers to the increasing integration of national economies in terms of financial flows, trade, movement of factors of production, ideas, and changes in information and technology.
  • As explained in (a), market dominance and immobility of factors of production lead to market failure. Problems associated with market dominance include high prices, low output, allocative inefficiency, lack of dynamic inefficiency and inequity. Problems associated with immobility of factors of production include structural unemployment.

Thesis: Globalisation has reduced the problems associated with market dominance and immobility of factors of production Effect on Market Dominance

  • With falling trade barriers, there is increasing competition in many markets because of the increase in imports. Cheaper imports from developing countries may enter the markets in developed countries, resulting in more competition.
  • There may be a change in market structure from a monopoly to oligopoly or from oligopoly to monopolistic competition as market concentration ratios of top firms fall.
  • The increasing competition also increases the incentive for firms to differentiate their products through innovation and R&D. This may reduce inequality problems to some extent as firms may have to channel their supernormal profits previously gained from their market dominance, to improving their products instead. Consumers also benefit from enjoying a greater variety of products (both because of a wide range of imports as well as R&D efforts of domestic firms) as well as possibly higher quality of products. If the R&D efforts are successful, there may be dynamic efficiency which results in lower costs for firms. These costs savings may also be shared with consumers in the form of lower prices in the long run.
  • With greater flows of ideas and technology brought about by globalisation, there may be greater sharing of technology which smaller firms can tap, in order to compete more effectively. This could also result in a greater variety and higher quality of products for consumers to enjoy.
  • If domestic firms were facing problems of X-inefficiency due to market dominance which resulted in their complacency, increasing competition would also force them to produce on the LRAC and be productively efficient.
  • Consumer welfare increases and the associated problems of high prices, little variety and high allocative inefficiency are reduced.

Effect on immobility of factors of production

  • With globalisation, there are increasing flows of labour between countries as transport costs are lowered and there are less restrictions on labour flows between countries
  • Industries may hire foreign workers if their skills match their needs. Similarly, if workers are unable to find jobs which require their skill set, they can move to other countries with a demand for their labour.
  • With more outsourcing and offshoring, labour may also not have to move overseas as foreign firms might choose to set up factories overseas instead. This helps to solve the problem of geographical immobility where workers were unemployed because of their reluctance to leave their homes.
  • Thus globalisation reduces the problem of unemployment and thus productive inefficiency to some extent. For industries that had problems hiring sufficient and appropriate workers, their problems are also reduced to some extent.

Antithesis: Globalisation has not reduced (but has increased) the problems associated with market dominance and immobility of factors of production Effect on market dominance

  • While globalisation may lead to increasing competition and therefore a fall in the problems associated with market dominance, it may also lead to other problems.
  • If competition is too intense, domestic firms may not be able to compete and may be forced to leave the industry.
  • Also, in industries with very high barriers to entry, a local monopoly may become a global monopoly, thereby increasing its market power and dominance.
  • These problems may also lead to income inequality issues. Globalisation tends to benefit firms with comparative advantage but tends to hurt firms without comparative advantage. This results in a widening income gap within countries which may result in social problems.
  • Increasing competition also may result in an erosion of supernormal profits of firms. Firms have less ability to do substantial R&D which may not be beneficial to consumers. Thus globalisation may not necessarily have only reduced the problems associated with market dominance but it may have reduced the benefits that come with market dominance as well.

Effect on immobility of factors of production

  • While globalisation may lead to greater mobility of factors of production across countries and therefore a fall in problems associated with labour immobility, it may also create other problems.
  • Immobility of factors of production within a country may still be large unresolved. For example, occupational immobility occurs due to a lack of ability to switch between jobs in different industries. This could be due to a mismatch of skills. For example, in developed countries, as low skilled jobs are lost to outsourcing, there is structural unemployment amongst low skilled workers. These workers may not be able to find a job because the jobs in supply are those which require high skills. Thus structural unemployment worsens in developed countries if these workers cannot relocate to regions which require their skills.
  • Due to structural shifts in an economy as countries specialise and trade according to comparative advantage, export oriented industries with comparative advantage would see an increase in demand for labour. However industries without comparative advantage would see a fall in demand for their goods and therefore a loss of jobs, resulting in greater structural unemployment.
  • With increasing specialization as countries focus on their comparative advantage to reap the benefits of specialization and trade, workers may also have increasingly specialized skills. If there are changes in world demand, industries which face a fall in demand might suffer and workers in these industries may not be able to switch jobs if they lack the necessary skills.
  • All of these worsen the problems associated with occupational immobility.

Synthesis: Whether or not globalisation has reduced the problems associated with market dominance and immobility of factors of production depends on

  • The type of industry
    In some industries, due to the large number of imports, market dominance has greatly reduced, improving consumer welfare. For example, clothes and shoes made in China, India and Vietnam are being exported to many developed countries, bringing down prices and increasing output and variety. Firms in developed countries are forced to innovate to remain competitive.
  • The MES of the industry
    For industries with large MES, global dominance may lead to greater fall in average costs which would not have been achieved if output was produced only for one domestic market. This may lead to lower prices and greater consumer welfare and may not necessarily cause problems.
  • The government policies in place to manage globalization

For example, many developed countries have anti-competitive laws which punish firms that abuse their market power. If firms are found engaging in anti-competitive behaviour, they may face harsh penalties such as hefty fines. This prevents the likelihood of large MNCs abusing their market power and exploiting their consumers or workers. However, if governments impose protectionist policies to protect domestic firms, then these firms may still have high market power and the associated problems that come along with their market dominance may still remain.
Similarly, if there are policies in place to help workers upgrade their skills, the problems associated with factor immobility may not be so severe. If workers are able to upgrade their skills and find jobs, structural unemployment may not be a severe problem even with globalisation.

Mark Scheme
Level Descriptors
Level 3
9-11
  • Answer shows excellent knowledge of the effect of globalisation on market dominance AND immobility of factors of production.
  • Well-balanced answer to show how problems may or may not be reduced.
  • Excellent development and rigour in economic analysis throughout.
  • Good use of real world examples.
Level 2 7-8
6
  • Answer shows good knowledge of the effect of globalisation on market dominance AND immobility of factors of production.
  • Some evidence of a balanced answer to show how problems may or may not be reduced.
  • Good development and rigour in economic analysis.

OR

  • Answer shows good knowledge of the effect of globalisation on market dominance OR immobility of factors of production.
  • Well-balanced answer to show how problems may or may not be reduced.
  • Good development and rigour in economic analysis.
  • Answer shows fair knowledge of the effect of globalisation on market dominance AND/OR immobility of factors of production.
  • Some evidence of a balanced answer to show how problems may or may not be reduced.
  • Some development and rigour in economic analysis.

OR

  • Answer shows fair knowledge of the effect of globalisation on market dominance AND immobility of factors of production.
  • May not be a balanced answer to show how problems may or may not be reduced.
  • Some development and rigour in economic analysis.
Level 1 4 – 5
  • Answer shows some knowledge of the effect of globalisation on market dominance AND/OR immobility of factors of production.
  • May not be a balanced answer to show how problems may or may not be reduced.
  • Little development and rigour in economic analysis.
  • Answer may be a mere listing of points.
1 – 3
  • Answer is mostly irrelevant.
  • Only a few valid points incidentally in an irrelevant context.
  • For example, answer may focus on the effects of globalisation on macroeconomic aims rather than on market failure.
Evaluation
E1 (3-4) For a well-reasoned judgment on whether or not globalisation has reduced problems associated with market dominance and immobility of factors of production.
E2 (1-2) For a mainly unexplained judgment on whether or not globalisation has reduced problems associated with market dominance and immobility of factors of production.
Essay Question 4
Singapore’s inflation unexpectedly accelerated to the fastest pace since 2008, with rising housing prices as one of the key drivers, renewing calls for a switch from a regime of managing exchange rates to managing interest rates to control for inflation. Adapted from Bloomberg, 23rd Sept 2011
Discuss the validity of this view. [25]
Suggested Answer:
Introduction :

  • State that Singapore’s characteristics of a small open import-reliant export-led economy expose her vulnerability to external shocks. As such imported inflation is a main cause of inflation in Singapore.
  • However there are other domestic factors contributing to Singapore’s rising inflation rate.

Body: Thesis : A switch from a regime of managing exchange rates to a regime of managing interest rates to control for inflation is valid.

  • Explain that domestic causes of inflation have been significant contributors to rising inflation rate in recent years as a result of higher cost of housing. (an explanation of either domestic cause will be sufficient)
  • For example, consumer expenditure on the housing has increased in recent years. This is due to the rapid increase in demand of housing. The demand for (private) housing is mainly by speculative foreign buyers and citizens, while the demand for public housing is in general by genuine home owners. An increase in autonomous consumer expenditure on housing will lead to an increase in AD resulting in demand pull inflation.
  • A switch to a regime of managing interest rates will mean managing the cost of borrowing for buyers and hence consumer expenditure on housing. A rise in interest rates increases the cost of borrowing which can lead to a fall in demand for housing. The fall in consumer expenditure on housing reduces demand pull inflationary pressures as AD falls since C is a component of AD.

Anti-Thesis: A switch to a regime of managing interest rates to control for inflation is not valid.

  • Explain why imported inflation is the main external cause of inflation in Singapore.

Singapore is small in size and lacking in scarce natural resources. This means that we are dependent on imports for basic necessities, and raw materials & intermediate goods necessary for the production of goods.
Imports make up 40% of domestic consumption. Domestically produced goods, which are also exported, have high import content. This means that our domestic prices are very much dependent on foreign prices and hence are affected by changes in external prices. Given Singapore’s small size, she is a price taker in world markets. Any increase in foreign price will lead to higher domestic prices resulting in imported inflation.

  • Explain the importance of maintaining a regime in managing exchange rate to control for imported inflation.

Singapore’s total volume of trade (exports and imports) is about 400% of GDP. The importance of imports in the Singapore economy means that exchange rate has an important influence on domestic cost of production, which also has an impact on export competitiveness. A regime of managing exchange rates will ensure that key factor inputs, which are essential for survival and in the production of exports, will be at prices that will not result in Singaporeans facing excessively high general price levels or that will result in our exports losing competitiveness.For example, to mitigate the negative effects of imported inflation caused by a rise in world price of oil, the Monetary Authority of Singapore (MAS) allows an appreciation of the S$.

  • Explain that Singapore’s small size openness to capital flows makes it difficult to target interest rates to control for inflation.
  • Singapore’s small capital market underscores the importance of attracting capital from abroad to supplement small domestic capital market. In addition, Singapore’s role as an international financial centre means that the economy is very open to capital flows. Small changes in relative interest rates would lead to large and quick movements of “hot money” making it hard to target money supply. Domestic interest rates are determined interest rates of other larger economies and expectations of how the S$ will change.
  • If MAS decides to increase the domestic interest rate by reducing money supply through an open market sale, domestic interest rates would rise above world interest rate and this would lead to short term capital inflows (‘hot money’) due to higher returns on Singapore assets. As a result, there would be an increase in liquidity in Singapore’s financial markets and hence an increase in domestic money supply. This would lead to a fall in interest rate until it becomes on par with the world interest rate again. Hence, Singapore government has no control over domestic money supply and interest rate. (it is also acceptable if the given explanation is based on impossible trinity)
  • Explain that there are causes of inflation which cannot be controlled by managing a regime of interest rates. For example, the increase in structural rigidities leading to higher general price level as a result of the Singapore’s government policy on foreign manpower. From 2010, there has been a gradual increase in foreign workers levy particularly for low skilled foreign workers across all sectors in the Singapore economy. The change in foreign manpower policy aimed to reduce the rapid growth and reliance on foreign workers . The higher levy imposed increases firms’ higher cost of production and if the higher cost is passed on as higher prices for these firms’ output , the is leads to a rise in the general price level and higher cost of living for Singaporeans.
  • To mitigate the negative effects of this government induced policy on foreign manpower, supply side policies can be implemented to help firms’ rising cost of production through

(1) subsidies to firms and employees to encourage retraining participation rate under the Continuing and Education Training scheme (CET) -> increase the labour productivity retraining to equip them with the necessary knowledge and skills (2) subsidies / tax incentives to firms to encourage invest in capital so to increase capital productivity eg. tapping government funded schemes – Productivity and Innovation Credit scheme introduced in 2010 -> improvement in quantity and quality of both labour and capital resources -> increase productive capacity of the economy -> potential economic growth.
Conclusion/ Evaluation :

  • Singapore’s characteristics of a small economy with a lack of scarce resources and openness to trade and capital flows underscores the importance in maintain a regime of managing exchange rate so as to influence the prices of imports and exports and hence control of imported inflation, the main cause of inflation in Singapore.
  • Although arguably a regime of managing interest rates can control for inflation caused in recent years by domestic factors, its impact is limited for the rise in housing prices is driven by the demand from speculative buyers. These speculative buyers are unlikely to be affected by changes in interest rates for they are ready buyers with access to cash.
  • There are other domestic causes contributing to the rising inflation rate in which a regime in managing interest rates has little impact. Instead other alternative policies will be more appropriate to address the root cause of these domestic factors.
  • The view to switch from a regime of managing exchange rates to a regime of managing interest rates is therefore not valid. Singapore must continue maintaining with the regime of managing exchange rates to control for imported inflation, adapting and complementing with alternative appropriate policies to control for other causes of inflation.

Mark Scheme

Level Descriptors
Level 3 18-21
  • Answer shows excellent knowledge of why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Good attempt distinguishing between external and domestic causes of inflation.
  • Excellent attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapore’s inability to deviate from world’s interest rates.
  • Excellent development and rigour in explaining how both regimes work.
  • Excellent contextualisation: sound understanding of how characteristics of Singapore’s economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.
  • A recognition of effects of interest rates on housing market.
15-17
  • Answer shows excellent knowledge why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Some attempt at distinguishing between external and domestic causes of inflation.
  • There may be some attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapore’s inability to deviate from world’s interest rates.
  • Good development and rigour in explaining how both regimes work.
  • Good contextualisation: sound understanding of how characteristics of Singapore’s economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.
Level 2 12-14
  • An answer which shows a good discussion of why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Some attempt at distinguishing between external and domestic causes of inflation.
  • There should be some attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapore’s inability to deviate from world’s interest rates.
  • Some development and rigour in explaining how both regimes work.
  • Some contextualisation: sound understanding of how characteristics of Singapore’s economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.
10-11
  • Answer shows good knowledge of why exchange rate policy AND/OR interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. There may be no or some attempt to explain why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapore’s inability to deviate from world’s interest rates.
  • Answer may lack / limited development in economic analysis.
  • Some contextualisation: some attempt at making use of the characteristics of Singapore’s economy to help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.
Level 1 6-9
  • Answer shows some knowledge of why exchange rate policy OR interest rates (monetary policy) can be used as a measure for Singapore to manage inflation.
  • There may be some conceptual errors in the explanation, showing a lack of understanding of economic concepts.
  • Limited contextualisation: Theoretical explanation lacking in application to the Singapore context.
1-4
  • Answer is mostly irrelevant.
  • A few valid points made incidentally in an irrelevant context.
  • Major conceptual errors.
Evaluation
E1 (1-2)
  • For an unexplained judgement whether there should be switch from a regime of managing exchange rate to a regime of managing interest rates.
  • OR evaluation on the use of exchange rate policy AND/OR use of interest rates (monetary policy) to control for inflation.
E2 (3-4)
  • For a well-reasoned explained judgement whether there should be switch from a regime of managing exchange rate to a regime of managing interest rates.
  • AND evaluation on the use of exchange rate policy AND/OR use of interest rates (monetary policy) to control for inflation.
Essay Question 5
Labour force numbers went up as more Singapore residents joined the workforce. Labour force participation rates in 2012 also reached a record high as older residents and working-age women joined the workforce.
(a) Explain the possible conflicts in a government’s macroeconomic objectives. [12]
(b) Discuss the extent to which the initiative of encouraging older residents and working-age women to join the labour force is effective in helping Singapore achieve its macroeconomic objectives. [13]
(a) Suggested Answer:
Introduction:

  • Government aims to achieve the following 4 macroeconomic goals: High and sustainable economic growth, low inflation (price stability), low unemployment and healthy balance of payments.
  • Possible conflicts may arise in achieving the 4 macroeconomic aims.

Body:

  • Low inflation vs actual growth/low unemployment
  • An increase in AD will lead to a multiple increase in real national income by the full multiplier process if the real national income increases at the Keynesian range where there is a lot of spare capacity. However, if the economy is nearing full employment, real national income may not increase by the full multiplier, as there is an increase in general price level. Nevertheless, an increase in real national income indicates that there is an increase in actual growth in the economy.
  • Conflict arises when the economy aims to achieve low inflation and actual growth/unemployment. As AD increase close to full employment, real national income increases, achieving actual growth and low unemployment, and yet the trade off is that general price level increases as AD increases close to full employment level, causing demand pull inflation. Demand pull inflation occurs due to the existence of bottlenecks as the economy moves closer to the full employment as those sectors experiencing near-full capacity will find their unit costs rising, and therefore prices charged for their commodities will rise. GPL will therefore increase as real output increases. Hence, this explains for the conflict in achieving low inflation and actual growth/low unemployment.

2. Economic growth vs low structural unemployment

  • Economic growth involves changes in production both in terms of the goods produced, and techniques used and the skills required. Hence the more rapid the rate of growth, the more rapid the rate of change in production techniques. People may then find their skills are no longer relevant or their jobs may be replaced by machines. Workers may thus find themselves unemployed as their skills do not match the available jobs. For instance, when the economy engages in new technology such as invention of new techniques of production, these new machines increases the productive capacity and LRAS of the economy, achieving economic growth. Yet at the same time, workers may not have the relevant skills to operate these new machines and technology, resulting in them being unemployed. Thus there is a mismatch of skills and opportunities as economic growth brings about a change in the structure of the economy, causing the conflict in achieving economic growth and low unemployment.

 

  • Economic growth vs healthy balance of payments
  • Economic growth may cause a BOP current account deficit, if the investment undertaken to achieve growth involves purchasing imported machinery. Furthermore, the rising incomes due to economic growth may lead to increased purchases by households on imported consumer goods, given a relatively high marginal propensity to import. This will worsen the BOT and current account, hence BOP worsens.

 

  • Low inflation vs healthy balance of payments
  • The use of exchange rate policy i.e. currency depreciation to improve balance of trade (if Marshall-Lerner condition holds) can lead to demand-pull inflation and cost-push inflation. Depreciation decreases the price of exports in foreign currency and increases the price of imports in home currency. Given Marshall-Learner condition holds, |PEDx + PEDm| > 1, depreciation will increase net exports and improve BOT. The increase in net export can lead to demand-pull inflation if AD increases close to or at full employment level. Also, if the economy is open and import-reliant, depreciation will increase the cost of imported raw materials and decrease SRAS, resulting in cost-push inflation.
  • This explains for the possible conflict in achieving low inflation and healthy BOP.

Conclusion: In aiming to achieve the 4 macroeconomic objectives, government is likely to face the possible conflicts: low inflation vs actual growth/low unemployment, economic growth vs low structural unemployment, economic growth vs healthy BOP and low inflation vs healthy BOP. Hence, there is a need for government to implement the relevant macroeconomic policies to help achieve the macroeconomic objectives.

Mark Scheme
Level Descriptors
Level 3 (9-12)
  • Answer shows excellent knowledge of at least 3 possible conflicts in a government’s macroeconomic objectives
  • Excellent analysis in considering all 4 macroeconomic objectives
  • Excellent economic rigour of elaboration
  • Excellent use of diagrams
Level 2 (7-8)
(5-6)
  • Answer shows good knowledge of at least 2 possible conflicts in a government’s macroeconomic objectives
  • Good economic rigour in explanation
  • Good use of diagrams
  • Answer shows good knowledge of at least 2 possible conflicts in a government’s macroeconomic objectives
  • Some economic rigour in explanation
  • May not have attempted to use diagram or diagram is not well explained
Level 1 (1-4)
  • Answer is mostly irrelevant with no evidence of understanding the possible conflicts in achieving low unemployment, low inflation, economic growth and healthy BOP.
  • Answer shows weak attempt to explain possible conflicts in a government’s macroeconomic objectives
(b) Suggested Answer: Introduction:

  • Identify the following 4 macroeconomic objectives: High and sustainable economic growth, low inflation (price stability), low unemployment and healthy balance of payments
  • The initiative of encouraging older residents and working-age women to join the labour force increases the quantity of labour in Singapore which is an aggregate supply management policy to increase the aggregate supply in the short run and long run, through reducing production cost and increasing productive capacity of the economy.

Body: Thesis: The initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives
Explain how increase in quantity of labour will achieve macroeconomic objectives in Singapore.

  • Economic growth, low unemployment and low inflation
  • The long run aggregate supply is determined by the quantity and productivity of factor inputs including labour. Given the initiative of encouraging older residents and working-age women to join the labour force, quantity of labour will increase, leading to an increase in the long run aggregate supply of Singapore and full employment output. Hence potential growth increases.
  • The increase in labour supply will also bring about a fall in wage costs, decreasing the cost of production in producing every unit of output. Hence aggregate supply curve shifts downwards and to the right. Real output increase, achieving actual growth and lower cyclical unemployment rate. In addition, general price level decreases, curbing cost-push inflation in the economy.

 

  • Healthy BOP
  • Increase in the labour supply leads to a fall in cost of production and increases export competitiveness since exports will be relatively cheaper than imports. This leads to a rise in the quantity demanded for exports and a fall in the demand for imports, this is especially so if demand of exports is relatively price-elastic (e.g. countries such as Korea produce close substitutes for Singapore’s exports of consumer electronics), as such a more than proportionate increase in quantity demanded of exports leads to an increase in export revenue. Hence Singapore’s balance of trade and the balance of payments improves.
  • At the same time, the increase in labour supply and lower wage costs can attract more foreign direct investment to Singapore, improving the financial and capital account and hence BOP improves.

Anti-Thesis: The initiative of encouraging older residents and working-age women to join the labour force is not effective to help Singapore achieve its macroeconomic objectives Explain how increase in quantity of labour may not achieve macroeconomic objectives in Singapore.

  • Economic growth

Actual growth:

  • Although the increase in quantity of labour can increase LRAS and potential growth of the economy, actual growth may not occur since achieving full employment level of national income requires that AD is sufficiently high to buy the potential output. However, the level of AD depends on many factors, including business and consumer confidence. A policy focusing on increasing quantity of labour cannot effectively counter such fluctuations in AD because such a policy is a long term supply-side policy aimed primarily at shifting the AS.
  • Evaluation (Alternative way): The government needs to adopt additional stimulus to boost AD i.e. expansionary fiscal policy and depreciation of domestic currency.

Potential growth:

  • While increasing quantity of labour is a desirable and necessary growth direction for Singapore in view of intensified global competition, there are many problems in increasing quantity of labour force. Singapore being a developed country with mainly highly skilled labour and capital intensive industries will demand more highly skilled labour to work in the high-technology industries such as biomedical, pharmaceutical and aerospace. As such, encouraging older residents and working-age women to join the labour force may not be effective in allowing them to work efficiently in the capital intensive and high-technology industries, since they may lack the set of relevant skills required in these industries. As a result, AS may not increase as much since quantity of labour is not the sole factor in determining AS, rather quality of labour is important to increase productive capacity. If the older residents and working-age women are not equipped with the relevant skills, they will still be underemployed.
  • Evaluation (Alternative way): In order to increase potential growth in Singapore, it is important to increase the skills of the labour force. Singapore government can provide the older residents and working-age women with training so that they acquire the essential skills to work in these expanding industries. Nevertheless, training takes time and it is also a costly investment and a heavy drain on government finances. The outcome is uncertain depending not only on the workers’ receptiveness but also the quality of training.

 

  • Low unemployment
  • Although the increase in quantity of labour can increase LRAS and potential growth of the economy, actual growth may not occur since achieving full employment level of national income requires that AD is sufficiently high to buy the potential output (mentioned under the anti-thesis point on economic growth). If growth of AD does not keep pace with potential growth, cyclical unemployment rate will rise.
  • Furthermore, there is a possibility of a mismatch of skills between the old residents/ working-age women and the jobs available (i.e. jobs that demand skills to work in the high-technology industries such as biomedical, pharmaceutical and aerospace) in the market, giving rise to structural unemployment. Structural unemployment is evident as Singapore undergoes changes in the structure of the economy.
  • As Singapore moves from a labour intensive industry to a capital intensive industry, industrial innovations and new techniques to produce goods and services are emphasized, hence hiring surplus workers raise costs and can hasten the decline of an industry that is threatened by competitive products. An industry that is declining due to economic changes becomes an increasingly large burden to the government which may find itself withdrawing its support to encourage old residents and working-age women to join the labour force.

 

  • Low inflation

Demand-pull inflation

  • If Singapore is currently experiencing demand pull inflation, the initiative of encouraging old residents/working-age women to join the workforce may not be sufficient to improve the situation if the increase in AS is not quick enough to counter the effect of an increase in GPL brought about by the increase in AD close to or at full employment. For instance, world economic recovery can lead to an increase investment due to investors’ optimism on the economy, resulting in an increase in AD and cause Singapore to experience demand-pull inflation. Given this situation, an increase in labour supply will not be appropriate in curbing demand-pull inflation, and help Singapore achieve low inflation rate.
  • Evaluation (Alternative way): Hence, there is a need to use contractionary AD management policies to tackle demand pull inflation to achieve low inflation.

Cost Push Inflation

  • Encouraging old residents and working-age women to join the workforce increases the labour supply and decreases the wage costs. Curbing cost-push inflation is appropriate in the given economic conditions in Singapore as there are cost-push inflationary pressures. However, the cause of Singapore’s cost-push inflation is mainly due to import price-push inflation, given that a large proportion of Singapore’s imports are raw materials since Singapore’s resources are scarce. An increase in the cost of imported inputs due to inflation in foreign countries leads to a fall in Singapore’s SRAS and an increase in the general price level. Hence, decreasing wage costs via increasing labour supply will not tackle the root cause of Singapore’ cost-push inflation problem.
  • Evaluation (Alternative way): As such, it is important for Singapore to appreciate its domestic currency so that imported necessities become cheaper in terms of domestic currency, this would also lower GPL as price of final goods & services are lower, leading to lower imported inflation.
Mark Scheme
Level Descriptors
Level 3 (7-9)
  • Answer shows an excellent explanation of the effectiveness AND ineffectiveness of encouraging older residents and working-age women to join the labour force to help Singapore achieve its macroeconomic objectives.
  • Answer shows an excellent explanation on the impact on at least 3 macro goals with an excellent theoretical framework, showing a balanced analysis with scope & depth.
  • Answer makes excellent reference to real world examples
Level 2 (5-6)
  • Answer shows a good explanation of the effectiveness AND/OR ineffectiveness of encouraging older residents and working-age women to join the labour force to help Singapore achieve its macroeconomic objectives.
  • Answer shows a good explanation on the impact on at least 2 macro goals with a good theoretical framework, showing a balanced analysis.
  • Answer makes good reference to some real world examples.
Level 1 (1-4)
  • Answer is mostly irrelevant
  • General remarks on the impact of the initiative with or without reference to the macro goals
  • Only few points made in with little reference to the question and with no economic basis
  • No evidence of theoretical framework
Evaluation
E2 (3-4) Well explained judgment on whether the initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives.
E1 (1-2) Mainly unexplained judgment on whether the initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives
Essay Question 6
The North-American Free Trade Area (NAFTA) agreement, linking trade and facilitating investment between the United States, Canada and Mexico, was considered a major accomplishment by President Bill Clinton in 1994. However, many Americans now blame the agreement for the loss of thousands of U.S. manufacturing jobs.
(a) Explain how Free Trade Agreements such as NAFTA might lead to unemployment and income inequality within a country. [10]
(b) Discuss whether protectionism is the best solution for tackling unemployment and income inequality in a developed country like the USA. [15]
(a) Suggested Answer: Introduction

  • Define Free Trade Agreements: A Free Trade Agreement is a legally binding agreement between 2 or more countries that agree to remove some trade barriers between the signatories.
  • Provide example/s of Free Trade Agreements (NAFTA, ASEAN)
  • Define unemployment and income inequality
  • Unemployment refers to the number of people of the legal age who are willing to and are able to work but are unable to find suitable employment.
  • Income Inequality: Differences in terms of income distribution within the population

Body Explain the effects of signings of FTAs

  • FTAs will affect trade patterns of a country, allowing trade volumes to increase where the country will now specialise in the production of goods which it has a comparative advantage in.
  • Define and Explain the Theory of Comparative Advantage: A country has a comparative advantage over another country in the production of a good if it can produce it at a lower opportunity cost, i.e. it has to forgo less of other goods in order to produce it.
  • For developed countries such as the USA, they tend to be relatively well-endowed with capital and thus have a comparative advantage in capital-intensive industries and will specialise in these industries (e.g. car manufacturing).
  • FTAs increase the pace of specialisation and globalisation and may result in the collapse of domestic industries that might not be able to compete with the influx of imports, in industries where the country does not have a comparative advantage in. On the other hand, exports might not rise compared to the rise in imports due to the lower level of national income in other signatories, such as Mexico that are developing countries.
  • Net exports may fall as a result of the influx of imports being greater than the increase in exports ïƒ lead to deficiency of effective demand (fall in aggregate demand).
  • FTAs (with lower tariffs and removal of restrictions on FDI) will foster an increase in overseas FDI and offshoring, which will result in hollowing out of domestic industries, especially manufacturing and in industries that the country does not have a comparative advantage in (e.g. clothes industry).

Effects on unemployment Cyclical unemployment

  • Due to deficiency of effective demand (with a fall in AD), there will be a fall in national income. Since labour is a factor of production and is a derived demand for goods and services, there will be an increase in unemployed labour.

Structural unemployment

  • Possibility of collapse of domestic industries that might not be able to compete with the influx of imports, especially in industries (senile industries) where the country does not have a comparative advantage in.
  • Structural unemployment as workers does not have the necessary skills to transit to new industries. (Mismatch of industries and skills of workers). This is especially so with the transfer of knowledge and skills between countries that might easily render workers’ existing skills easily obsolete and make it difficult for the workers to find new employment.
  • For example, with the signing of NAFTA, the US lost many manufacturing jobs (esp. textile) to Mexico, which has a relative comparative advantage in labour-intensive industries.

Effects on Income Inequality

  • Income inequality might be exacerbated within a country as workers and factor owners of industries with comparative advantage (e.g. capital-intensive industries) in the country will be able to increase their factor incomes at the expense of workers and factor owners of industries (e.g. labour-intensive industries) that do not have the comparative advantage.
  • This is especially so if workers in the disadvantaged industries are not able to transit into new industries and suffer from structural unemployment as a result. This is especially difficult for workers in developed countries, especially as the new emerging industries (sunrise industries) tend to be capital and knowledge-intensive, which will be difficult for the workers to make the transition.

Conclusion The signing of FTAs, such as NAFTA, which increases the pace of globalisation, will have detrimental effects on unemployment, cyclical and structural unemployment, as well as on income inequality that are difficult to eradicate.

Mark Scheme
Level Description Marks
L3 For an answer that demonstrates excellent development of analysis for effects of FTAs on unemployment (both cyclical and structural) AND income inequality Answer demonstrates excellent examples of relevant FTA/s for illustration 7-10
L2 For an answer that is accurate with excellent development of analysis for effects of FTAs on unemployment (either cyclical or structural) AND income inequality Answer demonstrates good examples of relevant FTA/s for illustration 5-6
L1 For an answer that shows limited knowledge on the effects of FTAs on unemployment OR income inequality Answer demonstrates a lack of or limited use of examples of illustration There are conceptual errors and/or inconsistencies in explanation. 1-4
(b) Suggested Answer:
Introduction
Define Protectionism: enacting of trade barriers to restrict trade between countries Examine the context of developed countries like the USA where unemployment, especially structural unemployment and income inequality have been prevalent due to the effects of specialisation (based on comparative advantage) and offshoring which have increased the gap between the different segments of the population, especially between the low-skilled and high-skilled workers.
Body Thesis: Protectionism is the best solution for tackling unemployment and income inequality
Explain how protectionism deals with unemployment and income inequality

  • Protectionism, through the enactment of barriers to free trade will reduce the amount of imports that a country imports
  • This can be carried out through measures such as the use of tariffs and import quotas.
  • For example, tariffs, a tax levied on imports will increase the price of imports and reduce the quantity demanded for imports.
  • Illustrate using a diagram
  • This will result in a net increase in net exports (X-M) and thus increasing AD and national output and reduces cyclical unemployment
  • Protectionism, with the protection of domestic industries (senile industries) will also reduce the extent of structural unemployment that may happen as a result of the signing of FTAs, through the slowing of adoption of new technologies and the reduction in foreign competition in the domestic market.
  • This will also reduce the extent of income inequality that is a result of income losses from factor owners and workers from comparatively disadvantaged industries (though at the expense of slower/negative income growth for the industries with comparative advantage).
  • Protectionism can be particularly useful for a developed country who has a huge domestic market and do not have a comparative advantage in labour-intensive industries (which hires a lot of labour), where protectionism may prevent a huge fall in employment (especially structural unemployment) and a subsequent rise in income inequality.

Anti-Thesis: Protectionism is not the best solution for tackling unemployment and income inequality
Examine limitations of Protectionism

  • Problem of inefficiency on society
  • Protectionism is a beggar-thy-neighbour policy that benefits the home country at the expense of the trading partners becoming worse off. If incomes of trading partners fall because of a fall in their export revenue, then they in turn would import less, affecting the first country which erected trade barriers.
  • Developed countries generally have more FTAs signed and it is difficult to pursue protectionism without breaking the provisions in the FTAs and this may also invite possible retaliation by trading partners.
  • Protectionism is a temporary solution that does not deal with the underlying root causes of unemployment and income inequality arising from factors such as loss of export competitiveness due to increasing pace of globalisation.
  • The problem of unemployment may also worsen with the fall in export competitiveness of our exports due to the lack of competition and incentives to innovate will also lead to the eventual fall in exports (X) and a fall in investor confidence (I), leading to a fall in net export revenue and investment that will reduce actual economic growth and cause an increase in cyclical unemployment as a result of the fall in demand for factors of production.
  • The decrease in income inequality will be achieved but at the expense of making everyone poorer through a fall in actual economic growth.
  • This is in contrast with the use of trade liberalisation policies to encourage free trade and make the country a more popular place for investment, where this will result in economic growth, albeit at the expense of income inequality.

Other policies that tackle unemployment and income inequality
Examine the policy options available to a developed country (Examine any 2 from below)

  • Exchange Rate Policy
  • Fiscal Policy/Monetary Policy
  • Supply-Side Policy
  • Income Redistribution Policy
  • Synthesis/Conclusion Possible synthesis: Given the severity of unemployment and income inequality, a policy mix is needed. Comparing between the policies, it is unlikely that protectionism is the best policy considering the inability of the policy to deal with the underlying root causes of unemployment and income inequality brought about by globalisation and increasing competition from trading partners. Protectionism and the use of income redistribution policies offers only a temporary “breathing space” for other policies such as supply-side policy to be implemented, which are better able to deal with the root causes. Synthesis should consider the nature of developed countries when evaluating the different policies and coming to a stand on the best policy to be adopted.
Mark Scheme
Level Description Marks
L3
  • For an answer that shows excellent knowledge in explaining how protectionism deals with the problem of unemployment and income inequality
  • Excellent explanation of other policies that deals with both unemployment and income inequality with excellent discussion of the adoption of the policies in the context of developed countries.
  • At least 2 other policies should be discussed in-depth with clear reference to context of developed countries (supported by examples of policies)
  • Excellent development and rigour in economic analysis.
9-11
L2
  • For an answer that shows some knowledge in explaining how protectionism deals with the problem of unemployment and income inequality
  • Limited explanation of other policies that deals with both unemployment and income inequality with some/limited discussion of the adoption of the policies in the context of developed countries.
  • Some conceptual errors in the explanation of policies
5-8
L1
  • For an answer is mostly irrelevant with discussion of policies that do not deal with the problems of unemployment and income inequality
1-4

 

Evaluation Marks
E2 For a well-reasoned judgment on the best choice of policy in dealing with the problems of unemployment and income inequality 3-4
E1 For a mainly unexplained judgment 1-2

2

National Junior College
Humanities Department (Economics)