Jurong Junior College

PRELIMINARY EXAMINATION 2009

ECONOMICS 9732/01

Higher 2 27 August 2009

2 hour 15 minutes Additional Materials: Answer Paper

READ THESE INSTRUCTIONS FIRST Write your name and class on all the work you hand in. Write in dark blue or black pen on both sides of the paper. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters or glue. Answer all questions. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question.

This document consists of 8 printed pages.

JJ Economics [Turn over

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Answer all questions.

Question 1 Issues in aviation industry

Extract 1: Airfare war on Singapore-Kuala Lumpur route Two weeks before all barriers are lifted on the Singapore-Kuala Lumpur (KL) route to allow low-cost airlines free access, the big boys are slashing fares by up to 60 per cent to retain market share. Malaysia Airlines fired the first salvo yesterday with its offer of $172 nett for a round-trip fare - $89 out of Singapore and RM199 (S$83) out of KL. Singapore Airlines will release tickets at $293 the following week. Their new fares add to several other promotions and deals offered by budget airlines Singapores Tiger Airways and Jetstar Asia, as well as Malaysias AirAsia. The low-cost airlines entered the Singapore-KL market in February with restrictions on the number of flights they can operate, but are boosting capacity from Dec 1. Their return Singapore-KL fares range from as low as $60 to more than $150, depending on time of travel and availability.

Source: The Straits Times, 15 November 2008 Extract 2: Will you need to pay an emissions tax for your flight? Airport tax, security tax, insurance and a fuel levy these all add to the total fare an air traveller pays before even boarding his flight. Pretty soon, one more could be added to the list an emissions charge. The European Union (EU) has declared that from 2012, Singapore Airlines, Malaysia Airlines, Emirates and all other carriers that fly to Europe will have to keep to a stipulated amount of carbon emissions, or pay extra. This is expected to cost the industry about US$3.4 billion (S$4.9 billion) when the scheme takes off. Etihad Airways and Delta Air Lines-Northwest Airlines both said that in a competitive industry, it will be tough to pass the costs on to travellers. Singapore Airlines said its fares are based on market demand, while a spokesman for Malaysia Airlines said that in the end, it will be up to travellers to decide if the total cost of travel is reasonable. Other countries such as Australia and the United States are also considering carbon emissions and trading schemes. The President of the 190-member grouping International Civil Aviation Organisation (Icao) said, The EU plan is not the way to go. Emissions is a global problem that requires a global solution. Others have pointed out other flaws in the proposal, It is a seemingly unfair situation for long-haul carriers especially. If you fly from Singapore for example, you are not in the EUs airspace for the entire flight, yet you have to be accountable to the EU for the full 12 or 13 hours. Despite the industry turbulence, Icao understands that there is significant public pressure on the EU, as well as other governments and organisations, to take action to manage climate change. Meanwhile, International Air Transport Association will continue to work with the civil aviation and air navigation communities, and aircraft makers, to push for more fuel efficiency and lower consumption. New planes like the Airbus A-380 superjumbo are over 20 per cent more efficient than aircraft that came before them. Alternative fuel is another important area. Tests have shown that existing jet fuel and aviation biofuel can be mixed with no impact on operations or safety. Biofuel, which could emit up to 80 per cent less carbon, should find its way into aircraft fuel tanks by 2012 or 2013. Even as airlines and Icao work towards lower emissions, aviation accounts for just 2 per cent of global man-made carbon dioxide emissions.

Source: The Straits Times, 11 August 2009

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Extract 3: Budget carriers thriving As travellers pinch pennies and opt for cheaper alternatives, AirAsia, Europes Ryanair and other low-cost carriers are adding routes and buying new planes to grab a larger slice of global aviation at the expense of their more established rivals. Major players such as British Airways and Hong Kongs Cathay Pacific Airways have reported full year losses for the first time in years despite cutting costs and flights to cope with a downturn in premium air travel. Full-service carriers, which once completely dominated the skies, are banking on an economic recovery to restore their fortunes but they may find it tough to return to the growth levels they enjoyed before the crisis. To be sure, all airlines have struggled as oil prices soared in the last two years. Oil prices have since tumbled and despite a rally early this year, are still half the level of a year earlier. But major industrialised economies continue to contract and economic conditions are likely to remain tough even when a recovery is under way. The International Air Travel Association in June predicted airline losses worldwide to swell to US$9 billion (S$12.9 billion) this year, nearly double its previous forecast. Full-service carriers are the worst hit as the downturn has hammered business and first-class travel, which make up a small percentage of seats but account for up to 40 per cent of their revenues. Their smaller, no-frills rivals are weathering the recession better with a low-cost model that relies on high passenger volumes, stripping out costs through strategies such as taking the cheapest land slots at airports and turning full service features like meals and check-in baggage into profit-making extras. In Asia, budget aviation has seen exponential growth since the start of the decade and now has a 16 per cent market share. The market share of low-cost carriers could cross the 20 percent mark in the next one to two years, as they open up new routes across the region and give travellers an option to fly at a fraction of the cost charged by full-service airlines.

Source: The Associated Press, 5 August 2009

Table 1: Singapore Visitor Arrivals by Air

Area of Residence 2003 2004 2005 2006 2007 2008

Americas 265 417 354 952 396 132 424 983 430 959 415 909Asia 2 770 075 3 815 515 4 191 445 4 544 152 4 806 597 4 787 076Europe 727 734 894 986 949 781 1 005 866 1 053 728 1 111 547Oceania 417 130 599 150 658 580 704 909 784 556 842 970Africa 51 540 63 607 70 921 77 702 83 095 75 856Unknown 133 81 72 97 12 723 76Total 4 232 029 5 728 291 6 266 931 6 757 709 7 171 658 7 233 434Note: Americas includes Canada & USA

Oceania includes Australia and New Zealand Source: Singapore Tourism Board

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Questions (a) (i) Compare the changes in Singapore visitor arrivals by air from the Americas with those

from the Oceania over the period 2003 to 2008. [2]

(ii) Explain one possible reason for these changes. [2] (b) Identify two items, other than tourism, which affect the invisibles account of a country. [2] (c) With reference to the data, explain why the market for air tickets on the Singapore-Kuala

Lumpur route is oligopolistic. [6] (d) Explain why carbon emissions in the aviation industry cause market failure and discuss the

effectiveness of using emissions tax to manage the problem of climate change. [8] (e) Discuss whether the thriving market of budget airlines disproves the cost advantages of full-

service carriers. [10]

[Total: 30]

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Question 2 The Weakening Global Economy

Extract 4: Bank of England holds interest rates steady at record 0.5% low

The Bank of England is expanding its programme of buying up assets to boost the money supply, and holding interest rates steady at a record low of 0.5 per cent indicating that the British central bank remains cautious about recent signs of an economic recovery.

A statement from the bank's nine-member monetary policy committee noted the recent conflicting data on the economy. On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling, the statement said. On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending. The committee added that while the British recession appeared to have been deeper than previously thought, the pace of contraction has moderated and business surveys suggest that the trough in output is close at hand.

The conflicting data had left economists divided ahead of yesterday's announcement about whether the bank would expand the quantitative easing programme. Halting the asset buying programme too early could prolong Britain's worst recession in decades, but pumping too much money into the economy raises the risk of an inflation headache down the road.

Source: Adapted from the Business Times, 7 Aug 2009

Extract 5: Globalisation stalled

The long-standing trend of improving global business environments-as a result of robust growth, liberalisation and infrastructure improvements-will be halted and even partially reversed in some areas over the next five years.

For the first time since the Economist Intelligence Unit's Business Environment Rankings (BER) were introduced in 1996, the average business environment score for the 82 countries covered by the model is lower for the five-year forecast period (now 2009-13) than for the historical period (2004-08). Indeed, more than half the countries (44 in all) are expected to have a worse overall business environment in 2009-13 than they had in the past five years.

The current crisis will have a significant impact on business environments. The global business landscape will be characterised by lower cross-border capital flows, tighter regulation and less risk-taking. As measured by the BER, the deterioration in the global business environment reflects worsening market opportunities, increased macroeconomic and political risk, and problems in financial systems.

The severe weakening of the global economy has led to a rise in protectionist sentiment and some protectionist policies are already being pushed through. The potential damage to the global business environment and to longer-term economic growth prospects cannot be underestimated, should there be a descent into significant and sustained protectionism, says Robin Bew, Editorial Director and Chief Economist at the EIU.

Source: Adapted from The Economist Intelligence Unit, 20 May 2009

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Extract 6: Chinas strong domestic demand

The strong rebound in Chinas economy in the second quarterpushing GDP 7.9% higher than a year agocame entirely from domestic demand. Thanks to the biggest fiscal stimulus and loosening of credit of any large economy, Chinas real domestic demand is likely to grow by at least 10% this year. This sucked in more imports, while exports continued to slump. Chinas merchandise trade surplus narrowed to $35 billion in the same quarter, 40% down on a year earlier.

In fact, the popular perception that China has always relied on export-led growth is rather misleading. Its current-account surplus did soar from 2005 onwards but until then was rather modest. And over the past ten years net exports accounted, on average, for only one-tenth of its growth.

The problem is more that the mix of domestic demand between consumption and investment is unbalanced, and becoming even more so. In 2008 private consumption accounted for only 35% of GDP, down from 49% in 1990. By contrast, investment had risen from 35% to 44% of GDP. This year the bulk of the governments stimulus is going into infrastructure, further swelling investments share. Chinese capital spending could exceed that in America for the first time, while its consumer spending will be only one-sixth as large. This is Chinas most glaring economic imbalance.

Source: Adapted from The Economist, 30 Jul 2009

Figure 1: Euro-Sterling Exchange Rates

Price per

Euro

Source: Reuters EcoWin

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Figure 2: Bank of Englands Base Rates

Source: Bank of England

Table 2: Macroeconomic Indicators: UK 2004 2005 2006 2007 2008 2009* Real GDP Growth (%) 2.8 2.1 2.8 3.0 0.7 -4.4 Unemployment Rates (%) 4.7 4.8 5.4 5.3 5.6 7.5 Inflation Rates (%) 1.3 2.0 2.3 2.3 3.6 1.9 Current Account Balance (US$ billion)

-43.2 -58.1 -80.7 -75.5 -45.9 -

Current Account Balance (% of GDP)

-1.6 -2.5 -3.2 -2.7 -1.7 -1.5

Government Budget Balance (% of GDP)

-3.3 -3.5 -4.5 -4.1 -5.5 -14.4

[*Projections] Source: Organisation for Economic Co-Operation and Development

Table 3: Macroeconomic Indicators: China

2004 2005 2006 2007 2008 2009* Real GDP Growth (%) 10.1 10.4 11.1 11.4 9.0 8.0 Unemployment Rates (%) 4.2 4.2 4.1 4.0 4.1 4.4 Inflation Rates (%) 3.9 1.8 1.5 4.8 5.9 -0.6 Current Account Balance (US$ billion)

68.7 161 253 372 426 -

Current Account Balance (% of GDP)

3.6 7.2 9.0 10.5 9.8 9.5

Government Budget Balance (% of GDP)

-2.1 -1.4 -0.7 0.9 -0.3 -4.3

[*Projections] Source: Organisation for Economic Co-Operation and Development

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Questions (a) (i) Compare the trend of UK exchange rates and interest rates from Sep 06 to Dec 08. [2] (ii) Explain the link between exchange rates and interest rates. [4] (b) Using Table 2, comment on the implications of changes in the current account balance on UK unemployment rate from 2004 to 2008. [6] (c) Discuss whether the Bank of England (BOE) should continue to implement the expansionary monetary policy. [8] (d) With the help of the data provided, discuss and compare the likely impact of the weakening global economy on the UK and China economies. [10]

[Total: 30]