Outlines to a Level Economics Paper 2008 and 2009

Advice: <3 MsEWong Dearest students from 10A01F, 10S06C, 10S06P, 10S07B, the outlines for 2009 A level essay questions and 2008 case study are meant as a guide. Please improve upon them. Let‟s revise your basics once again. For every essay question, do

Saturday, October 23, 2010 1:24 PM 1

- Clarify ambiguity in key terms/phrases

- Decide on the economic framework o Must use diagrams in explanation (unless not appropriate) o Must use economic theory in explanation o Must use economic terminology in explanation

- Decide on the structure by obeying the command word

o If it is “Explain” type of questions, there is no need for flip-side or counter-arguments to the argument

o If it is “Discuss” type of questions, you must always provide a balanced approach. What is meant by a “balanced” approach? A balanced approach can refer to either providing a flip-side/counter-argument/anti-thesis to the thesis of the question OR providing sufficient scope of coverage. Whether you provide a flip-side or counter-arguments depends on the way the question is phrased. Two examples of a similar type of question is provided for you below. Note that while the content might be the same, the linking sentences are modified to address each question directly.

E.g. 1: Questions like “Discuss if interest rate is the only factor that

determines the level of investment” will require a flip-side or counter-argument

Argument/Thesis: Explain how and why interest rate determines the level of investment

Counter-argument/Anti-thesis: However, interest rate is not the only factor that determines the level of investment.

o Identify two other non-interest rate factors like „expectations of future business climate‟ and „political stability‟ and explain how and why they determine the level of investment

Evaluate by weighing the relative importance of the factors and decide which is the most important factor determining the level of investment

Conclude by making a stand that interest rate is not the only factor but a combination of factors play a role in determining the level of investment and provide additional insight on which is the most important factor and whether which is the most important factor depends on the state of the economy

E.g. 2: On the other hand, questions like “Discuss the factors that determine

the level of investment” will not require a flip-side or counter-argument because there is none. Rather you have to provide scope of coverage in terms of the factors (in this case, provide factors that lead to both a movement as well as shift in MEI curve).

Interest rate is one factor that determines the level of investment. Changes in interest rates lead to a movement along the marginal efficiency of investment curve. Explain how and why interest rate determines the level of investment

Another factor is expectations of future business climate. Changes in expectations will lead to a shift in the MEI curve.

Provide at least one or two more factors that shift the MEI curve

Evaluate by weighing the relative importance of the factors and decide which is the most important factor determining the level of investment

Conclude by making a stand that a combination of factors play a role in determining the level of investment and provide additional insight on which is the most important factor and whether which is the most important factor depends on the state of the economy

- Note the mark allocation too. The marks awarded will give you an indication of how much to

write and whether to exhibit higher-order skills -



A level Economics Paper 2 2009

1. Governments around the world protect consumers against market failure due to market dominance. (a) Analyse, with supporting examples, how market dominance might lead to market

failure. [10]

Clarify what is meant by “market failure”

Clarify what is meant by “market dominance” – ability of the firm to control price and exclude competition

o Monopoly – sole firm in the industry o Oligopoly – a few dominant firms in the industry; a few firms each having a

large market power (e.g. 3 firm concentration ratio) (Whether an industry can be classified a monopoly is not always clear. It depends on how narrowly the industry is defined. A monopoly may have a monopoly over a certain drug, but there are alternative drugs for treating a particular illness.)

Explain concept of allocative efficiency o Use diagram to illustrate how market dominance leads to market failure o Economic framework: firm‟s level of analysis (oligopoly/monopoly)/market

structure o Diagram must be explained – explain why the profit-max monopoly produces

where MC=MR and MC curve cuts MR curve from below and hence the profit-max output level is allocatively inefficient (explain why P>MC is allocatively inefficient)

Include explanation on why market dominance also usually leads to productive inefficiency and x-inefficiency to secure good L3 marks

May want to include inequity (market failure)

Examples of market which are highly concentrated. Must use real life examples to support your analysis and explain your examples Here are some examples of market dominant products:

Adobe Flash[4][5]

Adobe Photoshop[citation needed]

Apple iPod portable media players

Microsoft Windows[7][8][9]

, Microsoft Office[citation needed]

Intel personal computer processors[10]

Google Internet search

Dolby audio technologies

L'Oréal Group - the world's largest cosmetics and beauty company A recent example of a monopoly would be that of the pharmaceutical giant

Pfizer over the drug Viagra®, which at the time of its release had no substitutes or competitors. It was the inventor of the product for which there is high demand but no preexisting supply.

Other monopolies occur when consolidation across industries results in a single supplier. This was the case with the company Standard Oil, which had to be broken up by the government in 1911.

Oligopolies include petrol retail industry in Singapore, Banking industry in Singapore

http://en.wikipedia.org/wiki/Adobe_Flash

http://en.wikipedia.org/wiki/Adobe_Flash

http://en.wikipedia.org/wiki/Dominance_(economics)#cite_note-Flash_Player_Statistics-4

http://en.wikipedia.org/wiki/Adobe_Photoshop

http://en.wikipedia.org/wiki/Wikipedia:Citation_needed

http://en.wikipedia.org/wiki/Apple_Inc.

http://en.wikipedia.org/wiki/IPod

http://en.wikipedia.org/wiki/Microsoft_Windows

http://en.wikipedia.org/wiki/Microsoft_Windows

http://en.wikipedia.org/wiki/Dominance_(economics)#cite_note-7


http://en.wikipedia.org/wiki/Microsoft_Office

http://en.wikipedia.org/wiki/Wikipedia:Citation_needed

http://en.wikipedia.org/wiki/Intel


http://en.wikipedia.org/wiki/Google

http://en.wikipedia.org/wiki/Dolby

http://en.wikipedia.org/wiki/L%27Or%C3%A9al



(b) Assess the extent to which market dominance, rather than any other potential market failure, is the major cause of government intervention in the markets for goods and services within Singapore. [15]

Clarify o Objective of government intervention in the markets for goods and services

To achieve the two microeconomic aims – greater efficiency (which includes allocative and productive efficiency) and equity

o Sources of market failure

Thesis o Explain that market dominance is one of the major causes of government intervention

in the markets for goods and services within Singapore Provide real life examples

Singapore Competition Act: legislation anti-competitive laws Explain why the need for intervention

Increase the level of competition (Market structure becomes less monopolistic. Note that it does not become perfectly competitive so cannot use the PC industry vs monopoly industry framework)

o Economic framework: Firm‟s level of analysis: Diagrammatically, demand curve and marginal revenue curve of existing firm will shift leftwards and become more price elastic with increased number of competitors/substitutes leading to falling price of product which benefits the consumers (assume ceteris paribus, AC and MC curves do not change); consumers also benefit from increased choices

o When the demand curve shift leftwards and become more price elastic, allocative efficiency increases as the difference between price and marginal costs narrows

o With greater competition, firms will have more incentive to innovate to produce better quality products or to engage in research and development to search for more cost efficient methods of production so as to lower price to maintain their share of the market or gain a greater share of the market

Explain how the government intervenes in these markets

Anti-thesis o Explain that there are alternative reasons that led to the Singapore government

intervening in the markets and provide real life examples for each of the alternative reasons (Note to explain a few alternative reasons, not just one alternative reason)

Other sources of market failure (provide depth of analysis/theoretical framework and provide real life examples by placing your responses within the Singapore context)

Externalities – MSB=MSC framework o E.g. Positive externalities in consumption: Education

Subsidy o E.g. Negative externalities in car usage

Tax

Public goods – characteristics of public goods o E.g. National Service

Conscription Act o E.g Streetlights

Direct provision

Merit and demerit goods – externalities approach and/or personal well-being approach

Immobility of factors of production

Imperfect information



Conclusion o Make a stand regarding whether market dominance or any other potential market

failure is the major cause of government intervention in the markets for goods and services in Singapore

Possible evaluation

As Singapore is an open economy, Singapore‟s firms would be exposed to international competition rendering control of market domination less important for Singapore. Hence there is little need or reason for the government to intervene in this area.

The firms are also likely to be competing in contestable markets. This, together with the need to stimulate FDI, would provide a strong reason for the state to avoid intervention.

The large firms in Singapore are either MNCs or GLCs. The MNCs sell abroad and are governed and regulated by clear rules and regulation regarding production and employment. The government-linked firms may not profit maximize, especially in the short-run and market dominance is also not an issue. Thus, the main reason for government intervention in Singapore is most unlikely to be market dominance.

Consider the extent to which alternative sources of market failure, rather than market dominance is the main reason for government intervention in Singapore

o E.g. Labour is Singapore‟s only resource and Singapore is developing comparative advantages in high technology manufacturing and knowledge intensive service industries. In addition, car usage is on the rise with greater affluence hence externalities is a greater problem and is the major cause of government intervention in the markets for goods and services within Singapore.



2. A very popular band is due to play one concert at a 5000 capacity venue. The plan is to charge different prices according to the area which the seat is located. (a) Explain whether this pricing policy could be considered to be an example of price

discrimination. [10]

Clarify terminology by defining price discrimination (PD) and state the conditions for PD o Economic framework: Firm‟s level of analysis; PD o What is price discrimination?

Define what is price discrimination o State the 3 degrees of price discrimination. o Explain the necessary conditions for 3

rd degree price discrimination to be practiced

Degree of monopoly power No resale of goods Segmented markets with differing price elasticities of demand

Thesis (must place response within the popular concert and seating arrangement context) o Explain that this pricing policy may be considered to be an example of price

discrimination because it fulfils some or all of the conditions of price discrimination Identify that the pricing policy is an example of third degree price

discrimination

Define third degree price discrimination and explain why this pricing policy is an example of third degree price discrimination

o Charging the same product (in this case, to watch the concert) at different prices to different consumers for reasons not associated with cost differences

o Same product – watch the concert o Loyal fans will be willing to pay a higher price for the tickets

and will have a more price inelastic demand than non-fans. Fans who prefer to have a close up view of the pop idol(s) will have a more price inelastic demand than non-fans. Hence firm can charge fans who demand for a seat closer to the stage or a more centralised seat a higher price than non-fans who are not particular about their seats. Hence firm can charge a higher price for seats that are closer or more centralised to the stage than those further away from the stage or at the rear

Explain why the conditions of PD are fulfilled in the given context o Differences in price not due to cost differences

Yes. Cost of producing the seats, of renting the venue, of hiring the band, of logistics and administrative costs are the same regardless of whether they are front seats or back seats, centralised seats or rear seats. Cost of providing the differently priced seats is similar

o The firm must have monopoly power. The greater the monopoly power, the greater the ability to practice price discrimination

Yes. The promoter has a degree of monopoly power. Few substitutes to the band as the preamble mentions that the band is a very popular band and it is holding only one concert

o The firm must be able to segment the markets and the markets must have different price elasticity of demand

Yes. Fans are likely to have a more price inelastic demand and hence, willingness and ability to pay a higher price for the tickets. the concert goers can be segmented according to their differing price elasticities of demand. Those very keen to see their favourite singer will be willing to pay higher prices for seats nearer to their idol.



o No resale of tickets Yes. It is one seat per ticket. The date and time and

the exact location of the seats can be printed on the ticket. There is also no resale

Use good diagrams or verbal explanation to support your choice

Anti-thesis (must place response within the popular concert and seating arrangement context) o However, this pricing policy may not be considered to be an example of price

discrimination (PD) because it does not fulfil some/ all of the conditions of PD Consider the possibility that seats near the front of the stage may be viewed

as a different product to those at the rear. Seats nearer the stage provide a better view of the band members on state and is highly desired. These seats can be viewed to be a different good as they can command a different price.

Possibility of resale of tickets

Tickets can be re-sold to others because the names of the audience usually not printed on the ticket. In general, it is easy to resell concert tickets, especially since marketing them is so easy now that cyberspace has sites like ebay that can reach many people.

Conclusion (must place response within the popular concert and seating arrangement context)

o It all depends on how one views the seats near the front of the stage as compared to those further back. If one is of the view that seats near the front of the stage were a different product to those at the rear, then this is not price discrimination according to the strict textbook definition. However, if one is of the view that the seats are the same regardless of their location, then this pricing policy is an example of price discrimination.

(b) Discuss the problems that are likely to be faced in determining the prices to be

charged for the seats. [15]

Clarify that the traditional objective of the firm is to maximise profits by producing an output level where MC=MR and MC curve cuts MR curve from below. Price is determined on the demand curve at the profit-maximising output level.

o Economic framework: Apply firm‟s level of analysis framework given question and context in part (2a)

Thesis: Identify the likely problems faced in determining the different prices to be charged for different seats

o Difficulty in determining not only the demand curve for this concert but also the differing price elasticities of demand if the market was segmented to allow for price discrimination

The level of demand determines the price. Demand is determined by taste or preference, income level, the size of the population, price of related goods and many other non-price factors. If demand is high, then price will be high and vice versa.

However, it is very difficult to collect such information. It is very difficult for the promoter to know exactly the level of demand. He can estimate the willingness and ability to pay of people who are fans of the band but estimates are frequently based on past figures which might be out of date. E.g. if new bands come along and fans of this band diminished.

If the promoter practices price discrimination, he must also know the differing elasticities of demand of the different sub-markets and how to segment the whole market into these sub markets. PED is even more difficult to estimate as the concept has many restrictive assumptions.



o Difficulty in obtaining figures on marginal costs Difficulty in collecting information on MC

Possible antithesis: However, difficulty in obtaining figures on marginal costs might not be a problem in the case of concert tickets. This is because the total cost of producing the concert comprises primarily of fixed cost

o Identify the fixed costs of producing the concert and the variable costs of setting up the concert (if any). Consider if the variable cost of producing the concert is negligible.

Fixed cost is cost that does not vary with the level of output

E.g the cost of producing the concert will be the same because cost of hiring the band, advertising and publicity cost, venue charges, air con and lights charges will be the same whether you have 3000 people or 5000 people in the venue air con and lights still have to be switched on; the same band will still be playing

o If total cost of production comprises only of fixed cost, then marginal cost of production will be zero. Then profit-maximising firm will produce an output level where MR=MC of production equal zero. When MR equals zero, total revenue is maximised. In other words, in this case, by maximising total revenue, total profits will be maximised Hence, the firm maybe able to overcome the problem of MC by setting a price at the level that maximises total revenue (this will occur where MR=0)

Evaluation: o Yet in the case of a live concert, the output is pre-determined by the number of seats

in the venue which is fixed and in this case, fixed at 5000. Hence in this case, there is no need to decide on what is the profit maximising output level since the output level has already been determined by the maximum number of seats in the concert venue. In other words, the maximum number of seats for any live performance is fixed in advance by the choice of the venue unlike the sales potential of a record which is in theory almost unlimited. Hence the traditional method of determining the profit-maximising output level and determining price may not apply in this context

o Pricing also depends on the objective of the firm: A promoter may not want to maximise revenue or profits if they want to maintain goodwill and keep fans happy.

o If the promoter is able to get sponsors who use the band to advertise its products, then ticket prices need not be priced high too. More mileage can be obtained from headline news of how people are willing to queue for 48 hours to get rock bottom tickets for certain concerts sponsored by certain firms.

Conclusion/Evaluation (must place response within the popular concert and seating arrangement context)

o Which is the most pressing problem? Difficulty in obtaining information on MR o Can these problems be overcome? o Most concert promoters will have to estimate the level of demand for the band they

are promoting. They can look to pricing of tickets for similar bands that has just taken price in their own economy. Alternatively, they can look at the price of tickets charged by other promoters for the particular group they are bringing when they perform in other countries. Ultimately, a concert promoter takes the risk of bringing in a band. With higher risk, profits should be higher according to economic theory. In this case, it may not be so.



Alternative approach if the question is rephrased as “Using demand and supply analysis, discuss the problems that are likely to be faced in determining the prices to be charged for the seats.”

o An alternative method of determining price for concert tickets at a venue with a fixed number of seats can be determined using the basic demand-supply framework. That is, the firm can determine the different prices for different seats by considering the interaction between demand and supply for seats in each category. Hence the price of seats in each category will depend on:

Demand factors: The Band‟s track record and the profile of the audience which affects the willingness and ability of the audience to pay for each ticket

Supply factors: The size of the venue

Note that the maximum number of seats for any live performance is fixed in advance by the choice of the venue unlike the sales potential of a record which is in theory almost unlimited

Supply of seats is fixed at 5000 supply of seats is perfectly price inelastic

o Problems associated with Determining the demand curve and the supply curve for each category Setting the price too low

Shortages and a black market; artiste and recording company will struggle to make a profit

Setting the price too high Surpluses (band will play to empty seats); promoter will find it difficult to sell the tickets

Conclusion/Evaluation (must place response within the popular concert and seating arrangement context)

o Which is the most pressing problem? o Can these problems be overcome? o Most concert promoters will have to estimate the level of demand for the band they

are promoting. They can look to pricing of tickets for similar bands that has just taken price in their own economy. Alternatively, they can look at the price of tickets charged by other promoters for the particular group they are bringing when they perform in other countries. Ultimately, a concert promoter takes the risk of bringing in a band. With higher risk, profits should be higher according to economic theory. In this case, it may not be so.



3. There have been large changes in the price of crude oil over the past few years. Discuss what determines whether consumers or producers are more likely to bear the cost of these oil price changes. [25]

Clarify that the large changes in the price of crude oil over the past few years have affected the

o Crude oil market (producers/exporters and consumers/importers of crude oil) Clarify the reasons behind the rise in the price of crude oil

Due to an increase in demand for crude oil (e.g. rapid industrialisation of developing countries)

o Hence PES of crude oil will determine who is more likely to bear the cost of these oil price changes

PES of crude oil is determined by the capacity at which crude oil can be pumped out of the oil wells which in turn depends on the time frame – Supply of crude oil is more price inelastic in the short run than in the long run

For a given increase in demand (rightward shift of the demand curve), the more price inelastic the supply of crude oil, the greater the extent of increase in price and hence the greater the burden on consumers, vice versa

Fall in supply of crude oil (e.g. natural disasters; oil wells drying up) o Hence PED for crude oil will determine who is more likely to

bear the cost of these oil price changes PED for crude oil depends on the resource

endowment of countries, their dependency on crude oil as a factor of production and time frame

For example, countries that do not have oil wells will be more price inelastic in demand for crude oil

For example, countries that lack substitutes of crude oil will be more price inelastic in demand for crude oil

For example, the shorter the time period, the more price inelastic the demand for crude oil

For a given fall in supply of crude oil (leftward shift of supply curve of crude oil), the more price inelastic the demand for crude oil, the greater the extent of increase in price and hence the greater the burden on consumers, vice versa

Clarify that oil is also used as a factor of production in the production of final goods and services

o When price of crude oil increases increase in the cost of producing final goods and services fall in supply of final goods and services (upward shift of supply curve)

PED for the final good will determine who is more likely to bear the cost of these oil price changes

o Explain the factors that determine the PED for the final good Availability of close substitutes Proportion of income spent on the good Time frame

o Examples of goods that are relatively price elastic in demand include high value added manufactured goods

o Examples of goods that are price inelastic in demand include necessities like petrol

o For a given fall in the supply of a final good due to the increase cost of producing the final good as a result of the



rise in the price of crude oil (a factor input), the more price inelastic the demand for the final product, the greater the extent of increase in price and the greater the burden on consumers, vice versa

o Is this point relevant? Oil is an important factor of production (usually in the case of

manufactured goods) vs. Oil is of relative less importance as a factor of production (usually in the case of service industry as compared to manufactured goods)

Affect the extent of upward shift in the supply curve: The more important oil is as a factor of production, the greater the upward shift in the supply curve for the final good the greater the extent of increase in price of the final good

Conclusion: Make a stand on which is the more or most important factor(s) determining whether consumers or producers are more likely to bear the cost of these oil price changes

Alternative approach: There have been large changes in the price of crude oil over the past few years. Discuss what determines whether consumers or producers are more likely to bear the cost of these oil price changes. [25]

Introduction: What is price? Explain how the price of crude oil is determined using demand-supply economic framework. Explain the price adjustment process (how shortages and shortages and eliminated via price changes)

Analyse why equilibrium prices change when demand or supply changes in recent years using context of the crude oil market.

o Large rise in demand due to rapid industrialization and economic growth seen in large countries like India and China but supply is constant.

Supply of crude oil is relatively inelastic since oil firms have limited capacity to keep stocks of crude oil (and it is also expensive to store large quantity of refined oil). It takes a long time for oil firms to look for new sources of crude oil deposits and transform the crude oil into refined oil for use as fuel. It is thus not possible for oil firms to response much to changes in the price of crude oil or refined oil in the short run other than running down stocks.

With PES<1 and an increase in demand for oil, price will increase relatively more than if PES >1. Over the longer term, more exploration and thus discovery of oil deposits will be made. Only then will PES>1 and the price of oil will not be so high compared to the short run scenario. Diagram to illustrate that consumers will bear the brunt of the market price of oil shooting up from 0P0 to 0P1 in the short run. Oil producers will have a huge increase in their TR. However, prices will stabilise and fall back to 0P2 in the longer term when PES is relatively more elastic.

o Large fall in supply due to oil wells drying up but demand is constant. Demand for crude oil is relatively inelastic oil refinery would have invested a lot in machinery and equipment to refine the oil and it is not possible to change these fixed capital to other uses or refine other fuels in the short run. Thus, if PED<1 and a fall in supply happens, then price of crude oil will rise a lot compared to if PED > 1. Figure 2 shows that if demand is relatively more inelastic (Dinelastic), the price will rise from OP3 to OP4 rather than OP5 in the case of a relatively more elastic demand.

Analyse why equilibrium prices change when demand or supply changes in recent years using context of the markets that use crude oil as a factor of production.

o Crude oil (commonly known as petroleum in modern usage) is refined and separated into a large number of consumer products such petrol, kerosene and even chemicals to make plastics and pharmaceuticals. Petrol is a fuel used as a factor of production in the production of final goods and services by all firms since all firms need to transport their goods and their capital equipment need energy to move. The price of energy (electricity) will depend mainly on the market price of petrol since petrol is its main input used in most power stations to generate electricity.



o When price of crude oil increases, this will lead to an increase in the cost of producing all final goods and services. This fall in supply of final goods is depicted by an leftward shift of supply curve. The price of the final goods will then rise. The extent of the rise the market price of a final good depends on the extent of the increase in cost of production to the firms in the particular industry and also the relative strengths of PED versus PES of a particular good.

o For industries like the energy industry and chemical industries that use crude oil as a main input, the increase in cost of production will be high and thus supply falls to a large extent. This will mean, compared to other industries that do not use crude oil as a main input, a huge increase in market price for chemicals and energy.

o For other industries that use petrol for transport and need energy to move its machinery, the extent of the rise in its cost of production is smaller. The market price will rise but the extent of the rise in market price will depend largely on the relative strength of the PED compared to the PES for its good. Market price will rise relatively more if demand is relatively more inelastic than supply. As seen in Figure 2, a given fall in supply will lead to a larger increase in the market price of a good if demand is relatively more inelastic compared to supply. Examples of goods whose demand is relatively more price inelastic include necessities like foodstuff and transport for consumers. This implies that the firms producing goods like foodstuffs and transport could pass on the rise in price of fuel to its customers but not firms providing services like hairdressing and massages.

The PED for the final good depends on: o Availability of close substitutes o Proportion of income spent on the good o Time frame

The PES of a final good depends on: o Time period. o Factor mobility o Number of firms o Stocks and spare capacity o Length of production period

Conclusion: Make a stand on which is the more or most important factor(s) determining whether consumers or producers are more likely to bear the cost of these oil price changes



4. The relative importance of the components of the circular flow of income for a small and open economy, such as Singapore, is likely to be different from a large and less open economy, such as the USA. (a) Explain this statement. [10]

Content ideas to include:

Approach 1: o Draw the circular flow diagram and use it as an analytical tool to explain the relative

importance of the components that make up the circular flow of income Requires a comparison of the components of circular flow of national income

by analysing each component as a percentage of national income and not in absolute figures.

A well-developed explanation regarding the importance of (X-M) in Singapore and consumption in the USA

OR Approach 2: o Provide an analysis on the different sizes of the components of circular flow of

income as a proportion of national income

Or Approach 3: o Provide an analysis on the marginal propensity to withdraw combined with an

explanation of injections Note that the term „injections‟ is defined as additions to the circular flow of

income. Injections are independent of the country‟s current level of national income. Injections refer to autonomous spending. Hence, injections include only investment, government expenditure and exports. Note that consumption and imports are not classified as injections because both consumption and imports include a component that is dependent on the current level of national income – Consumption not only includes autonomous consumption but also induced consumption. Imports not only include autonomous imports but also induced imports. Induced consumption and induced imports vary directly with the level of national income and hence are not considered as injections.)

(b) Assess whether a change in the external value of its currency is more likely to have a larger impact on Singapore or the USA.

Content ideas

Clarify what is meant by „external value of its currency‟ – price of a domestic currency in terms of another foreign currency or a basket of foreign currencies

Explain why and how a change in the external value of its currency will have an impact on the four macroeconomic goals of both Singapore and the USA

o E.g. When the domestic currency of the USA depreciates, the price of exports in terms of foreign currencies fall and quantity demanded of exports will increase. On the other hand, the price of imports in terms of domestic currency increase and quantity demanded for imports will fall. According to the Marshall-Lerner‟s condition, so long as the sum of PEDx and PEDm is greater than one, even though individually PEDx <1 and PEDm<1, a depreciation of the US currency will improve balance of trade (which is the value of net exports). Improvement in the balance of trade will improve the current account which will in turn improve the balance of payments of the USA, ceteris paribus. Currently, USA is experiencing a trade deficit, hence the trade deficit will become smaller with a depreciation of the US dollar.

o When value of net exports increase, aggregate demand in USA will increase and in turn, national income will increase more than proportionately via the multiplier process, ceteris paribus. Elaborate

o As the demand for labour is a derived demand, unemployment will fall. o When the US dollar depreciates, the price of imported raw materials in terms of

domestic currency (US$) will increase. This will increase the cost of producing goods and services in the USA which will lead to an upward shift of the aggregate supply curve and result in cost push inflation accompanied by a dampening of actual growth



o The above effects are also experienced in Singapore when the Singapore dollar depreciates. The extent of the impact on Singapore may differ given that Singapore and the USA possess different characteristics.

Responses placed in context of Singapore and USA o Consider the unique characteristics of the Singapore situation and USA situation in

the analysis. E.g. Differences in dependency on external trade - Exports as a percentage of

GDP Differences in dependency on imported raw materials – lack of versus

relative abundance of natural resources Differences in size of multiplier

Provide sufficient depth of analysis and comparison between the two countries

Possible evaluation o Consider that there are other factors that affect (X-M) besides changes in the external

value of its currency.



5. Economic measures of the Singapore economy for 2007 indicate that GDP was S$243 billion. The current account on the balance of payments was S$59 billion in surplus. (a) Explain how you might use GDP and balance of payments data to measure the

performance of any economy. [12] Content ideas to include:

Clarify what is meant by “performance” of an economy o Production concept o How well the economy is doing in terms of the level of production of final goods and

services o How well the internal sector of the economy is doing in terms of production level o How well the external sector of the economy is doing in terms of production level

Explain how to use these measures o E.g. Explain how to use GDP to measure how well the economy is doing

GDP refers to the total value of final goods and services that is produced within the geographical boundaries of a country at a given time period

A rise in GDP may be due to increase in autonomous consumption, investment, government expenditure and exports or a fall in autonomous imports

If the rise in GDP is due to a fall in autonomous imports this does not necessarily indicate that the economy is doing well as the residents could be reducing its autonomous imports due to fear of retrenchment or greater uncertainty; A fall in imports in machinery could also affect future performance in terms of slowing down of potential growth

If the rise in GDP is due to increase in investment and government expenditure on infrastructure and research and development this not only indicates that the economy is performing well currently but that the economy has the ability to perform well in the future too, increased ability to produce more final goods and services in the future

o E.g. Explain how to use BOP data to measure how well the economy is doing Define BOP An improvement in the BOP could be due to an improvement in the current

account or the financial account If the improvement in the BOP is due to an improvement in the current

account as a result of an increase in exports, then the economy is doing well If the worsening of the BOP is due to a worsening of the current account as a

result of an increase in imports, it might also be an indication that the economy is doing well as higher levels of national income enables a country‟s residents to have greater ability to buy imports, resulting in a worsening of the current account and in turn, balance of payments account

If the worsening of the BOP is due to increase in imports on machinery, not only can this imply a good domestic performance which results in a greater ability to buy imports, it also implies better future performance since machinery enables a country to produce more goods and services in the future

Consider whether there are other measures of economic performance o Economic growth o Unemployment o Inflation



(b) Assess whether these economic indicators are the best measures of economic performance and standard of living in Singapore. [13]


Distinguish between “economic performance” and “SOL” o Economic performance refers to the production level of a country while SOL refers to

the ability to consume by the average resident of a country in a given time period o Production vs consumption concept

Clarify the economic performance in Singapore using the preamble o Assess whether GDP and BOP data are the best measures of economic performance

in Singapore o Assess whether there are better economic indicators to measure economic

performance in Singapore Economic growth Unemployment rates Inflation Income inequality

Clarify what is meant by “SOL” and set response in the context of Singapore by considering unique characteristics of Singapore in the analysis

o Assess whether GDP and BOP data are the best measures of material and non-material SOL

o Assess whether there are better economic indicators to measure material and non-material SOL

Material SOL

Composition of GDP: Consumption levels

Income distribution – Gini coefficient Non-material SOL

Literacy rates

Life expectancy rates

Leisure – number of hours worked per week Holistic indicators

Human development indicators

ISEW

Conclusion – make a judgment on which is the best indicator to measure economic performance and SOL (if any)



6. An economist stated ‘The trend towards globalisation leaves no room for protectionism’. (a) Account for the trend towards globalisation. [10]


Globalisation includes greater mobility of goods and services, FDI and labour between countries

Reasons behind globalisation o Theory of comparative advantage o Better transport links o Improvements in communication (e.g. internet)

Discuss whether you agree with the economist’s view. [15]


Thesis: o Provide an economic framework/arguing in favour a totally free flow of products and

productive factors between countries in the long run For the importing country, include a diagrammatic analysis on how and why

the removal of tariffs on imports leads to potential welfare gains in the long run (Removal of tariff diagram is applicable from the importing country‟s perspective. Note that the tariff diagram assumes that the importing country does not have a comparative advantage in the production of the good, that there are other countries which have a CA in producing the good and that the importing country is a small country and a price taker. In other words, the importing country has to accept the world price as given when it opens its economy to international trade in the absence of protectionism.)

o For the exporting country, include a AD/AS diagrammatic analysis on how and why removing tariffs on goods and services will lead to increase in national income

o For the recipient country, include a AD/AS diagrammatic analysis on how and why removing restrictions on capital mobility (FDI) between countries can lead to actual and potential growth

o For the source country, consider that its current account may improve in the future when profits are repatriated back to the source country

o Provide an analysis on the positive effects arising from greater labour mobility between countries (if time permits)

Anti-thesis: o Provide an analysis that in practice and over the short term, protective measures

might be considered necessary to produce a level playing field. For instance To develop a comparative advantage in the production of the good As a measure against unfair trade practices like dumping Evaluate that in the short run protective measures will lead to costs for some

parties and gains for others within the economy

Conclusion: o Make a stand on whether you agree with the economist‟s view and explain why you

arrive at that conclusion



GCE A levels Nov 2008 Case Study 2: Macroeconomics

Questions

(a) (i) How does the value of the Yuan in September 2006 compare to its value in 2000?

[1]

Suggested Answer Outline:

The Yuan has appreciated from 2000 to 2006. [1 mark]

(ii) Describe what happened to the US balance on current account over the period 1998 to

2006. [2]


General Trend and refinement:

- US experienced a trade deficit on the current account from 1998 to 2006. [1 mark] - The trade deficit was increasing. [1 mark]

If there is poor use of economic terminology, e.g. negative current account balance or

falling balance. [No marks to be awarded]

General Trend – 1 mark

Refinement – 1 mark

(b) Identify and explain any evidence contained in the data that suggests that the Chinese

government is a ‘currency manipulator’. [5]


Establish what is meant by „currency manipulator‟ government intervene in the foreign exchange

market to fix the external price of the Yuan below the equilibrium price in the market for foreign

exchange. [1 mark]

Students are required to identify and explain any 2 pieces of relevant case material [4 marks]

Relevant case material:

- Table 4: no change in the value of the Yuan unlikely that this will happen in the free market.

- Figure 2: rise in China‟s foreign exchange reserves from 2000 to 2006. Increase foreign reserves must mean that Chinese authorities are selling Yuan (increase SS of Yuan in FX market) and purchasing foreign exchange (increase DD for FX) over the years to exert downward pressure on the value of the Yuan.

- Table 3: current account surplus in China Yuan is undervalued.

(c) Explain how you would decide whether the low price of Chinese shoes in EU markets

occurred as a result of ‘dumping’. [4]


Define dumping – Dumping occurs when goods are sold in overseas markets at a price below the

marginal cost of production. Dumping usually occurs to drive domestic producers

out of the market in order to establish monopoly power in the future. [1m]



Possible causes of low price of Chinese shoes in EU markets:

- Low input costs lower cost of production China will have C.A. in the production of shoes compared to EU countries. Not a case of dumping. [1m]

- Through export subsidies from the Chinese government This will reduce the price of exports to EU markets. Lower prices are not reflected by lower costs of production, but due to deliberate government policy. Case of dumping [1m]

Need to know: 1. Cost of producing shoes in China, 2. any deliberate government policy surrounding

the production of shoes. [1m]

Definition of dumping – 1 mark

Explanation of 2 factors – 3 marks

(d) Discuss whether the Indian government’s treatment of Scotch whiskey and the EU

government’s treatment of imported bras from China can be justified in terms of

economic theory. [8]


Introduction:

- Identify Indian government‟s treatment of Scotch whiskey: imposition of tariffs on imported drinks

from EU

- Identify EU government‟s treatment of imported bras: quotas imposed on textile imports from China

Imposition of tariffs and quotas are examples of protectionism.

Thesis: Protectionism is justified in terms of economic theory.

- To protect infant industry Potential C.A. from the infant industry if there‟s no protection, the industry will not be able to survive lose an industry with C.A. in the future. Economic welfare is not maximised. (not applicable to bra production in EU cos EU already have the technology and knowledge to produce bras just that EU has lost its CA in bra production)

- To protect against sunset industries protect domestic producers and high unemployment. if there is no protection, it may result in massive unemployment cost of unemployment is high (applicable to EU).

- To diversify the economy to reduce reliance on imports prevent over susceptibility to external shocks.

- To prevent dumping may lead to inefficient allocation of resources in the long run due to establishment of monopoly power. In the case of Chinese made bras, “the Chinese were accused of dumping bras in the EU market”

Anti-thesis: Protection is not justified in terms of economic theory

- Protectionism goes against the theory of comparative advantage. In the case of India, “representatives of India‟s domestic drinks industry claim that it will be destroyed if tariffs are removed”. India does not have comparative advantage in the production of whiskey as it is unable to compete against foreign competitors.

- Protection of infant industry and sunset industry should only take place in the short run as the cost of protectionism > benefits of protectionism in the long run. leads to inefficiency.

- Tariff diagram & explanation of the diagram

Overall evaluation:

- Whether or not protectionism can be justified based on the economic theory depends on the reasons for protectionism.



o If it can be proven that dumping is the cause behind imposition of quotas, protectionism can be justified based on inefficient allocation of resources in the long run.

o India‟s case of protectionism cannot be justified based on economic theory.

(e) Assess whether the ‘growing doubt about globalisation’ is well founded, using both

the case study and your own relevant knowledge. [10]

Students are required to discuss the advantages and disadvantages of globalisation and make a

judgement based on their analysis. Answer should be based on the context of the case material as far

as possible.

Establish what is meant by globalisation:

- Define globalisation: growing economic interdependence of countries worldwide through increasing volume and variety of cross-border transactions in goods and services, free capital and labour flows.

- Globalisation occurs due to removal of natural and artificial barriers in the movement of trade in goods and services, capital and labour flows. Natural barriers: lower transport costs due to technological advancements, artificial barriers: removal of protectionist measures.

Thesis: Advantages of globalisation (growing doubts is not well-founded)

- freer movement in trade in goods and services o positive effects from trade creation more efficient allocation of world‟s

resources o increase export markets Table 3: Trade in goods increased o keeps prices low

- freer movement in capital flows o increase in FDI

- freer movement in labour flows o increased factor mobility more efficient allocation of resources

Macroeconomic Effects: stimulate economic growth, increase employment, and reduce

inflationary pressure

Microeconomic effects: globalisation moves economy towards free trade and leads to

more efficient allocation of world‟s resources.

Anti-thesis: Disadvantages of globalisation (growing doubts is well founded)

- increase import competition lead to structural unemployment - Bring about global imbalances? Figure 1: US‟s growing trade deficit - freer capital flows and trade flows leads to interlinked production processes more

susceptible to external shocks - income flows can lead to greater income disparity - environmental problems in some countries

Macroeconomic effects: may lead to greater unemployment, BOP deficit

Evaluation:

- attempt to weigh the costs vs benefits of globalisation - Gains and losses for countries differ and to some countries - Globalisation where there is completely no barriers, will lead to a more efficient outcome

that is supported by economic theory. - Depends on governments to overcome the costs of globalisation.



MORE ON BALANCE OF PAYMENTS: Did you know that

1. When we say that the BOP always balances, it means that the sum of current account plus financial account plus official financing account equals zero. However, when we say that the BOP is in a deficit, we typically mean that the sum of current account and financial account is in a deficit

2. In a freely float ERS, the BOP always balances. In other words, there is automatic elimination

of BOP disequilibrium via changes in the exchange rate. a. For example: Economy purchasing more goods, services and assets from the world

than it is selling overseas year after year Excess Qd for foreign currency (Qdfc > Qsfc) equals excess supply of domestic currency (Qsdc>Qddc) domestic currency depreciates eliminate the BOP deficit

b. In a freely float ERS, a current account deficit will always be completely offset by a surplus on the financial account and vice-versa

c. In a freely float ERS, there is no need for an official financing account (OFA is zero) because there is no need for foreign reserves

i. Countries like USA and Britain which are currently operating on a freely float exchange rate system, their OFA (change in foreign reserves) is zero in the BOP accounts.

ii. However, countries like China which are operating on a fixed exchange rate system will accumulate foreign reserves when they are experiencing a BOP surplus and run down on their foreign reserves when they are incurring a BOP deficit. Hence, their OFA will reflect changes to their foreign reserves which in turn reflect whether the Central Banks in these countries are devaluing their domestic currency or revaluing their domestic currency.

3. In a fixed ERS, when there is a BOP deficit, it means that the sum of current account surplus

plus financial account is in a deficit. If the exchange rate is fixed, the BOP disequilibrium will not be automatically eliminated. For example, the BOP deficit might be primarily due to trade deficit Economy purchasing more goods, services and assets from the world than it is selling overseas year after year Excess supply of domestic currency (Qsdc>Qddc) However, if the domestic currency is not allowed to depreciate, BOP deficit cannot be eliminated

a. Under a fixed ERS, to prevent the depreciation of the domestic currency (when the BOP is in a deficit), the central bank can buy domestic currency and sell foreign reserves (that is, run down on previously accumulated foreign reserves)

i. Note that the run down on foreign reserves is recorded as a credit in the official financing account (OFA)

b. Likewise to prevent an appreciation of the domestic currency (when the BOP is in a surplus – current account plus financial account result in a surplus), the central bank can sell domestic currency and buy foreign reserves (adding to the foreign reserves they have previously accumulated.

i. Note that the purchase of foreign reserves is recorded as a debit in the official financing account (OFA))

c. Note that the amount credited into the OFA is equal to the size of the BOP deficit and vice versa. For example, if the BOP deficit is -$10billion, the OFA will be +$10billion.

i. Hence, when you add the OFA plus the BOP together, the BOP always balances and equals zero.

ii. The Official Financing Account tells us what the country does when the country incurs a BOP surplus or BOP deficit

1. If the country is incurring a BOP surplus, the country can accumulate foreign reserves and/or lend to other countries and these activities are recorded in the OFA

2. If the country is incurring a BOP deficit, the country can run down on its foreign reserves and/or borrow from other countries and/or the IMF and these activities are recorded in the OFA

Documents

Outlines to a Level Economics Paper 2008 and 2009