C2 H1 Econs Prelim Ans & Mark Scheme

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HWA CHONG INSTITUTIONC2 H1 Economics Preliminary Exam 2009

Answer & Mark Scheme

SECTION A: CASE STUDY

Question 1

(a) (i) With reference to Chart 1, explain why the price of photovol taic (PV) energy isexpected to drop in 2010. [2]

• Chart 1: Production of PV energy has seen an exponential increase from 1995 onwards. [1m]• Assuming that this trend continues and that market demand stays the same, this would result in

an exponential increase in market supply [1m], contributing to a fall in price.

(ii) Analyse how the entrance of PV energy is expected to impact the demand forcoal-fired electricity.

[4]

• PV energy is a substitute source of electricity. [1m]• Given that PV energy is getting increasingly cheaper, coal-fired electricity will experience a fall in

demand. [1m]• Moreover, the demand for coal-fired electricity is likely to become more price elastic [1m].

Reason: Availability of cheaper substitutes. Based on the data, it seems that consumers caneasily switch to PV energy. [1m]

(b) (i) Define the term “ merit good” . [1]

• Goods or services that have been deemed socially desirable through the political process, i.e. bythe government.

• Usually generate positive externalities.

Remarks:- Students are required to define the concept completely and accurately in order to gain the full 1

mark.

(ii) Explain how social allocative ineffic iency will result in the market for PVenergy.

[4]

• In integrating (consuming) PV systems into for eg. buildings / rooftops, firms will only considerthe private benefit. Students are to provide at least an eg of the private benefit. Egs include costsavings as PV energy is cheaper than current sources of electricity.o 1m – Correct identification of the source of the positive externalities Consumption.

• But in doing so, there are positive externalities generated (in terms of conserving theenvironment associated with lower carbon emissions & greenhouse gases), creating adivergence between social values and that of the individual firms, the former being larger inmagnitude.o 1m – Generating examples of ext benefits.o 1m – Recognising that social (true) benefit > private benefit.

• As a result, firms would under-consume [1m] clean energy.o 1m – Correct identification of how market fails.

Remarks:- While it would be useful for students to illustrate how the market will fail, they are not required to

do so. As long as the explanation is clear, students will be given due credit.


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2(iii) Evaluate the Singapore’s government policy of using subsidies to overcome

the market failure.[6]

• Explain how the subsidy (=EMB) might increase the consumption of PV energy.• Students are to evaluate / discuss the effectiveness of the policy. Examples include the inherent

difficulty of measuring EMB; strain on public finance.• Students are to suggest a supplementary policy. Examples include:

o Regulation New building codeso Education / Campaigns encouraging property developers to install PV systems.

Mark scheme:L1[1 - 3m]

Clear and accurate explanation of how subsidy helps to overcomethe market failure concerned.

L2[4 – 5m]

- As above.- Evaluated the policy measure (if the students merely stated the

limitation points, max mark – 1)

Bonus 1m students who suggested a supplementary policy.

(c) (i) Explain why Singapore might have a potential comparative advantage in theproduction of clean energy.

[3]

• Definition of CA [1m] A country is deemed to have CA in the production of a good if it incurs a lower opportunity cost thananother country.

• Why Singapore might have potential CA in the production of clean energy? [2m]- ** Factor endowment: Evidence: Ext 2 Para 4 – “Manufacturing solar wafers, cells and modules

has many parallels with semiconductor and electronics manufacturing processes [whichSingapore excels in]” Singapore already has the physical facilities, technology and skilledlabour that allows it to have CA in the production of goods/services that are knowledge-based,capital intensive in nature. Hence it would be easier to adapt the existing infrastructure tofacilitate the development of the clean energy sector.

Remarks:- As with any definition, students must do so completely and accurately. Otherwise, the 1m would

not be awarded.- In explaining for the potential CA, students must refer to the concept of “factor endowment”. In

addition, they must refer to the text to provide specific egs of the factors / resources.

(ii) In the light of an increasingly globalised world, discuss the potential benefitsand threats pertaining to Singapore’s strategy of developing clean energy forexport.

[10]

• Rationale behind this strategy:- Driven by the fact that the external demand is the key driver of Singapore’s growth.- In addition, given how globalised Singapore is, it is especially vulnerable to any threats posed by

foreign competition. Hence Singapore’s strategy of shifting towards high-end manufacturing andservices.

- Clean energy is just another form of diversification of its manufacturing.


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3• Benefits:Singapore can leverage on the positive impacts of globalization to drive her development of thisindustry.- If Singapore successfully develops CA in the production of clean energy, it would secured itself a

market that is predicted to flourish given the increasing concerns wrt climate change, high oilprices, and energy security.

- With existing intellectual property right laws, Singapore will also be able to attract inbound FDI

from different countries, eg Norway’s Renewable Energy Corporation has invested $3 billion toset up a complex in Singapore.

- Singapore will attract scientists and foreign talents who work in this sector. Singapore willconsciously build up its capability and reputation as a regional centre for photovoltaic energy.

- There will be spin-off when new businesses and workers are needed in the maintenance andlogistic industry as Singapore develops the clean energy industry too.

• Threats:- The ownership of factors of production for clean energy will initially be in the hands of large

foreign companies that have invested in Singapore. EDB has played an important role inattracting these FDI. In the long run, for potential growth of Singapore to increase on a sustainedbasis, it is necessary to have a pool of local entrepreneurs and scientists to play a greater role in

expanding this industry.- Meanwhile, there is also the problem of workers in sunset industries whose jobs have

disappeared. One possible example would be retrenchment of workers involved in readingelectricity consumption when Singapore Power faced a decline in demand for its service.

• Conclusion / Judgment / Comments:- The market for clean energy can only expand as cost fall. Consumer awareness and acceptance

of positive externality involved in the consumption of clean energy is important to how Singaporecan develop a global market for clean energy.

- Globalisation has helped in the transfer of technology and information but this comes with ahigher level of competition to all existing industries. There is always the possibility that evenwhile the clean energy is an infant industry, the high cost of production in Singapore may lead tooff- shoring before the industry can develop further.

L3(6 -7m)

For an answer that analyses the potential benefits and threats according to shortterm and long term effects on Singapore.

L2 For an answer that discusses the potential benefits and threats to Singapore whenbuilding clean energy industry as supported by the case study materials.(3-5m)

Max 3m for answer that explains either benefits or threats only.

L1(1-2m)

For a sketchy answer that just lists or briefly explains how Singapore’s try todevelop a clean energy industry.

E2(2-3m)

For substantiated evaluations on why the clean energy industry would be importantto Singapore’s potential growth.

E1(1m)

For an evaluation that tries to weigh the potential benefits against the potentialthreats of developing the clean energy industry in Singapore.


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4


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5Question 2

(a) Summarise and account for the changes in the S$NEER since October 2007. [5]

Summary [1m]:From Extract 3

• Gradual appreciation from Oct 07 – Oct 08.

• Zero percent appreciation from Oct 08 onwards.

Explanation [4m]:Initially from the period October 2007 to Sept 2008, MAS followed a policy of allowing slightlysteeper appreciation of the S$ nominal effective exchange rate. This was to prevent import-price-push inflation [1m].

This is especially so since external prices of imports were going up as a result of “rapidincreases in global commodity prices”. This had translated into higher production costs, andhence higher costs of domestic goods (“build-up in domestic cost pressures”), whose contentwas mainly import-based. [1m]

In October 2008, however, the MAS “shifted to a zero per cent appreciation of the S$NEERpolicy band”. When the currency shifted to zero per cent appreciation, this would makeSingapore exports more price competitive vis-à-vis other countries’ exports. [1m].

This was a necessary move because there was a further deterioration in the external outlookafter Sept 2008 (current account surplus worsened based on Table 1 stats), so to encouragedemand for Singapore exports, the currency was not appreciated further so as to makeSingapore goods seem relatively more attractive and more export price competitive [1m].

Acceptable: explanation on why depreciation is bad for Singapore due to import price pushinflation making our exports less price competitive since Singapore’s exports have high importcontent

Must make reference to the evidence from the passage for full 4m.

(b) (i) Explain one protectionist measure that can be adopted by the UK government tosave local jobs.

[3]

1m : Correct identification / stating of a protectionist measure.

2m: Clear explanation of how the measure concerned helps to decrease unemployment.

(ii) Discuss the view that “ ultimately nobody wins” from protectionism. [6]

Students should briefly describe the context of the quote. Iain Begg from LSE said this withreference to the current worsening economic climate in Britain, whereby Britain (and the rest ofthe world) is trying to deal with the global recession, and there is a temptation to turn inwards(and thus resort to protectionism). Although students are not given the downside ofprotectionism in the extract, they are ALSO expected to infer (and based on their ownbackground knowledge of theory) come up with the downsides of protectionism. The directionword is ‘discuss’ and not ‘explain’ so students need to show both sides of the argument withreference to the context given.

Thesis: somebody wins from protectionism

Extract 2 states that protectionism will 1) “save local jobs” and 2) “help aid declining industries”.So students will need to justify these points.


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61) Save local jobs: already explained in (b)(i) so no need to explain. Can just state.

2) Help aid declining industries: in the case of the UK, the infant industry argument mightnot apply so much (though to some countries it might). Of more significance could alsobe helping sunset/declining industries from foreign competition. Some sunset industrieshave lost comparative advantage in the production of certain goods to foreign firms.These sunset industries may face increased financial losses especially during

recessions especially when people become more price conscious, and realise that thegoods from these countries are overpriced. Thus they may face potential shut-downs.The government may deem it necessary to protect these struggling industries frommass unemployment. Obviously, the protection provided is also a buffer for workers inthose declining or sunset industries with the opportunity to retrain and seek employmentin other expanding sectors of economy (buy time for declining industries to restructure).

Anti-thesis: somebody loses from protectionism

1) Other countries are likely to retaliate with their own trade barriers, thereby sparkingglobal trade wars. The net result is the rapid contraction in world output and income,worsening the global recession. Protectionism often breeds more protectionism. UK

consumers may suffer from higher prices of goods whether imported or domesticallyproduced. This would lead to welfare loss in consumption for UK consumers. In the longrun, UK economy suffers from inefficiency, low productivity and resource misallocationdue to the existence of inefficient / uncompetitive firms that can survive only undergovernment protection.

2) In addition, protectionism is likely to delay economic recovery as countries closed theirmarkets to each other thus foregoing the possibility that internal recovery could besparked off by multiplier effects created from external demand through exports.

Evaluation: ultimately nobody wins

1) Protectionist measures are merely stop-gap measures to help save jobs and alleviateunemployment in the short-term. If the countries have lost comparative advantage in theproduction of certain goods, propping up the industries by giving them subsidies, etcincurs a large opportunity cost and financial drain on the country’s resources. Ultimately,the jobs will still be lost and restructuring of the economy will occur, i.e. local jobs can’tbe saved and struggling/declining industries will still be eliminated.

2) Furthermore, the danger of prolonged recessions is that they lead to idle capacity, wasteand inefficiency in the use of scarce resources. In terms of social implications too, thiswill lead to social unrest and great economic hardship.

L3(5-6m)

For an answer that discusses the disadvantages and advantages ofprotectionism, and applies well to the context of recession.

L2(3-4m)

For an answer that explains some of the advantages and disadvantages ofprotectionism, without applying to the context of recession.

For an answer that only explains the advantages or disadvantages ofprotectionism (one-sided) – cap at 4 marks.

L1(1-2)

A very sketchy answer, with brief / poor explanation of advantages ordisadvantages of protectionism. May state the definition of protectionism

vaguely.

(c) Consider whether the data would lead you to expect a further deterioration in the [4]


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7balance of payments of Singapore in 2009.

Thesis: Yes, there will be fur ther deterioration in the BOP• Deterioration of capital and financial account means that Singapore is facing an

increasing amount of outflows, hence BOP will worsen.

• In spite of an improvement in current account as % of GDP from 15.2% to 15.5%, the

absolute value of the current account has actually worsened (15.5% of 240.9 is lessthan 15.2% of 257.4).

• Productivity levels fall to -8.7%, implies unit cost of production will increase, henceSRAS shifts to the left, resulting in higher general price levels. Sg exports lose pricecompetitiveness. Assuming PEDx>1, BOT worsens

Anti -thesis: No, there wil l not be fur ther deterioration in the BOP Inflation seems to be moderating, from a high of 6.5% in 2008 to an estimated 0.1% in

2009. This means that Singapore exports will be relatively cheaper to foreigners andassuming PEDx>1, then Singapore’s export revenue will increase and improve BOT.

GDP growth at constant prices shows a declining trend. In 2009, this is estimated to bea fall of 8.8%. This falling trend of GDP growth is likely to continue, especially given thefact that productivity growth is also expected to fall and given that it takes time forproductivity falls to filter through to GDP, there will be further deterioration in GDPgrowth. This is accompanied by an increase in unemployment rate. Thus, Singaporeanswill have less income to spend on imports. Hence import expenditure decreases andBOT improves.

Evaluation:Based on data that is forecasted as at 2nd quarter 2009, it seems that the BOP will furtherdeteriorate. However, we could project that there are “greenshoots” in the form ofimprovements in the BOT, hence the situation may not be all that pessimistic. Besides, therehas been an upward revision of the projected contraction of Singapore’s economic growth atthe beginning of 2009 Q3 (from -9% to -6%, to -6% to -4%)

L2(3-4m)

Considers at least 2 pieces of information each for and against the deterioration ofhealth of the Singapore economy in 2009 and explains interpretation well.

Credit to be given for students who take a stand.

L1(1-2)

Identifies limited data and interpretation of whether this bodes well for theSingapore economy in 2009 is limited.

(d) Discuss and compare the choice of growth policies adopted by Singapore and the UK inresponse to the current global downturn.

[12]

Use data to justify the use of growth policies

a. Real GDP: projected negative for both economies – Sg (-8.8%); UK (-4.1%)b. Increase in unemployment rate – Sg (2.2% to 3.6%); UK (5.6% to 7.4%)c. Productivity: negative growth – Sg (worsen to -8.7%); UK (from positive to -2.4%)d. Inflation: All time low (be careful of possible deflation) – Sg (0.1%); UK (0.8%)

SIMILARITIES (Similar problems caused by the global downturn)


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8Fiscal PolicyEvidence [Ext 1 and 3]:

• UK – £750 million Strategic Investment Fund; Additional £1.7 billion to supportemployment; £75 billion programme of asset purchases

• Singapore – $20.5 billion Resilience Package (expansionary Budget)

Effects of FP:

Increase in G ==> Increase in AD ==> unplanned fall in stocks + via multiplier effect ==>Increase in Real National Income ==> Economic growth improves Limitations of FP:

• UK – Borrowing to pump-prime the economy is forecast to peak at 12.4% of GDP in2009-10 [Ext 1]. This could signal large budget deficits, which could lead to the crowdingout effect on UK private investments. Future generation may suffer as they will need toservice the debt if borrow from abroad

• Singapore – [contextual knowledge] Unlikely to borrow due to large reserves. Moreover,small size of k makes FP relative ineffective (explain why small k)

• For both – opportunity costs of government spending (as opposed to economic boomtime)

Supply-side PolicyEvidence [Ext 1 and 3]:

• UK – £750 million Strategic Investment Fund; guaranteed job, training or workplacement; new training courses

• Singapore – Jobs Credit Scheme; Skills Programme for Upgrading and Resilience(SPUR)

Effects of SSP:• UK – Investment Fund will enable UK to increase its productive capacity in the future as

capital accumulation takes place. The work placement and training courses will enhance

skills of workers• Singapore – Jobs Credit Scheme will lower business costs for firms, whilst SPUR will

enhance skills of workers. Will also help position Singapore better for the recovery,when there is a pick-up in the demand for exports

• Overall effect – Increase in human capital investment ==> Increase in productivity andboth SRAS and LRAS will shift to the right ==> Increase in Real National Income ==>Economic growth improves

Limitations of SSP:• Singapore – Job Credit Scheme might not be as effective if cyclical demand for exports

is still low worldwide and firms will still shut down if total revenue cannot cover totalvariable costs in the SR and/or cannot make normal profit in the LR

• The inherent problem with training, skills upgrading and education lies chiefly on theattitudes of the workers. Additionally, the skills and knowledge attained may take a whileto internalize (long gestation period), this is especially so for the older workers. With anageing population, this will be one of the main limitations for UK and Singapore[contextual knowledge]

DIFFERENCESMonetary PolicyEvidence [Ext 1 and 3]:

• UK – The Bank of England has cut Bank Rate to half a per cent•

Singapore – zero per cent appreciation of the S$NEER

Effects of MP:


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9• UK – MP is interest rate centred. Fall in cost of borrowing for the firm and hence

increase expected rate of return, I increases. Increase in demand for consumer durables(eg cars, furniture and big purchases) due to lower interest repayments [lower cost ofborrowing for the household], hence C increases. Also people will tend to save lesssince the opp cost of consumption is now lower, C increases. With a lower domesticinterest rate, there will be hot money outflows to countries with higher interest rates,since the returns on these short-term investments will be higher. Supply of domestic

currency in the forex market will increase as investors convert to the foreign currency.The domestic currency will depreciate and net exports will rise if Marshall-Lernercondition holds. the collective increase in C, I, and (X-M) will increase AD. This wouldmean a run-down on unplanned stocks and producers will produce more ==> Increase inReal National Income ==> Economic growth improves

• Singapore – MP is exchange rate centred due to smallness and openness of theeconomy. Effects and rationale would have been explained in (a)(ii). With animprovement in BOT ==> AD increases ==> Increase in Real National Income ==>Economic growth improves

Limitations of MP:• UK – poor economic outlook implies an interest inelastic MEI, plus poor consumer’s

confidence so C also interest inelastic. Hence lowering of interest rates will have littleeffect on raising I and hence AD and Real National Income

• Singapore – exchange rate policy is a short-term measure because the most importantthing is to improve the quality of the exports (through R & D, etc) so as to make themnot so easily substitutable with that of competitors’

Fiscal Policy (tax policy)Evidence [Ext 1 and 3]:

• UK – Corporate tax kept the same at 21%• Singapore – Reduction of the corporate income tax rate from 18% to 17%

Effects of tax policy:• UK – Instead of raising corporate taxes, which might deter investments, keeping it

constant is a ‘wait-and-see’ approach to the recession.• Singapore – Lowering corporate tax rates would increase firms expected rates of return

on investment and encourage I, which will increase AD and hence enhance growth.Moreover, with increase in I, productive capacity will increase, LRAS increase andeconomic growth will be achieved

Limitations of tax policy• UK – Since the recession is steep [ext 1], adopting a ‘wait-and-see’ approach may slow

down the economic recovery in the UK. However, with an increasing budget deficitlooming, lowering corporate tax would worsen the budget deficit.

• Singapore – the recession could be so severe that the 1%-point fall in corporate taxrates might do little to stimulate investment in Singapore. Moreover, a small k wouldmake this policy less effective.

Other Policy used by SgEvidence [Ext 3]: FTAEffects of the policy:

• Singapore – aggressive pursuit of FTAs can lead to trade creation and extension ofmarkets for Singapore’s exports plus encourage FDI

Limitations of the policy:• Singapore – trade diversion


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10Conclusion:The UK and Singapore’s choice of growth policies are largely similar in terms of FP and SSP.However, there are different approaches to using MP as a solution for the recession.

It should be noted that SSP alone is not good enough as that might possibly lead to deflationwith a sustained fall in GPL. Hence, both economies will still need dd-mgmt policies to achievesustained economic growth.

Basically, tackling a downturn of this nature and dealing with its consequences requires acomprehensive policy / multi-pronged response to support the economy: fiscal and monetarypolicy, financial sector interventions, and targeted support for individuals and businesses.

L3(7-9m)

For an answer that discusses the policies very well, and compares the differencein focus of the 2 countries’ policies.

L2(4-6m)

For an answer that explains and/or compares the choice of policies between theUK and Singapore.

L1(1-3m)

Sketchy answer, just lists or briefly explains the policies of both countries brieflywithout comparison.

E2

(2-3m)

For substantiated evaluation on the type of policies the 2 governments employ.

E1(0-1m)

For some relevant judgments on the type of policies the 2 governments employ.


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11SECTION B: ESSAY

3 Air travel for leisure purposes is growing worldwide and is set to skyrocket overthe coming decades. However, aircraft emissions are one of the fastest growingcontributors to global warming. In an effort to control pollution, the EuropeanUnion plans to impose the carbon trading scheme on the air travel industry.

(a) Explain the factors that influence the market demand for air travel. [10]

(b) Discuss whether the carbon trading scheme would be effective in correcting thenegative externalities arising from air travel. [15]

Suggested Answer & Mark Scheme

Part (a)Students are expected to explain, with the use of egs, 3-4 determinants (price & non-price) ofmarket demand.

Possible determinants:Price• Decrease in air fare caused by an increase in market supply (eg. deregulation precipitating

an increase in the number of airline companies). This would cause an increase in thequantity demand for air travel services. Would be ideal if the students could illustrate thiswith a DD-SS diagram; in this case, an increase in quantity demand (caused by a fall inprice) is reflected as a rightward movement along the given DD curve.

• Increase in air fare caused by a fall in supply (eg. higher cost of production due to higherfuel prices).

Non-price• Growing affluence of households in the emerging economies [TJC Prelim 2008 Case Study:

Consumers’ spending power in emerging economies is estimated to rise to more than US$9trillion] Increase in demand for travelling as a leisure activity (normal goods).

• With the proliferation of guide books, travel websites, television shows and etc. greateravailability of travel information with respect to the destinations greater incentive forfamilies to venture overseas for a holiday.

• There are increasingly more well-established places to visit, with governments pumping inmore resources as well as welcoming FDIs to develop its infrastructure.

• Seasonal demand – peak versus non-peak period.

• Taste & preferences fear of air travel after the shock of Sep 11 attacks.

Diagrammatically, changes in non-price factors would cause a rightward shift of the DD curve.


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12 Mark schemeL1: 1 – 4m • For an answer that has major mis-conceptual errors / poor grasp

and/or use of economic knowledge.

• For an answer that merely lists the various determinants of marketdemand, with no attempt to develop the content.

L2: 5 – 6m • For an answer that explains adequately and clearly 2 (either priceor non-price) determinants of market demand, with the use ofappropriate egs.

OR• For an answer that lists the various determinants of market

demand. Elaboration is lacking or there is little attempt to applywith ref to the context.

L3: 7 – 10m • 7 – 8m: For an answer that explains adequately and clearly 3(either price or non-price) determinants of market demand.

Max 8 marks: For an answer that focuses only on non-price factors.

• 9 – 10m: For an answer that struck a good balance in explainingboth price and non-price factors, using appropriate egs andaccurate economic analysis.

Part (b)Students are expected to explain how carbon emissions (negative externalities) will result inmarket failure; hence providing grounds for the government to intervene. From which, they areto explain and discuss whether carbon trading is effective in curbing the negative externality

concerned. Discussion includes benefits and costs / difficulties encountered. Students are toexplain other possible measures that EU could adopt to correct the market failure holistically.

Explanation of how the air travel industry is an eg of market failure.• Explain how carbon emission generates external costs (negative externalities), with the use

of egs.• Airlines, in providing their service (ie transporting passengers from one destination to

another) only considers their PMC (eg. the cost of aviation fuel, cost of labour – pilots, airstewards) and PMB (eg. the revenue earned from the sale of tickets).

• In maximizing profits, they would produce where PMC = PMB.• However, they ignore the external costs generated, hence the true opp cost of providing the

services (SMC) is higher than PMC at every output level.• Hence, the socially efficient level of production is where SMB = SMC it will be lower than

the level achieved under free market.• Over-production over-allocation of resources (partial market failure).

Hence, the government ought to intervene to minimize inefficiency.

Explain and discuss how the carbon trading scheme works to correct negative externality.• Each polluting firm can choose to buy a permit which gives it permission to emit a certain

amount of pollution. If not, it will have to clean up the pollution. These permits aremarketable, so firms are able to buy and sell such permits.

•

The government will estimate the socially efficient level of emission before it decides on thenumber of permits to issue. The price of each permit will then be determined in the market.The higher the price of permit, the greater the incentive for the firms to reduce emission.


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13 Advantage• This effectively establishes a market for pollution; that is, carbon trading scheme controls

pollution through market forces and internalising an external cost.

Disadvantages (avoid cut-and-paste from lecture notes)• Large airlines may use this platform as an opportunity to engage in anti-competitive acts to

ooze out smaller players buy bidding very high price for the permits. (Smaller airlines withoutpermits will not be able to fly!)

• The demand for air travelling is price-inelastic and airlines can easily pass the permitscharges or fuel tax to consumers without reducing the number of flights much. I.e. Eventhough the consumers are bearing most of the rise in cost, the quantity demanded will fallless than proportionate so long the passengers are willing and able to pay. As people getmore affluent, they will be willing to absorb such costs and the truth is transatlantic travellerscan’t just row from London to New York!

Supplement with other policies – Students are required to just explain the alt policies. No needto discuss pros and cons.• Long term measures: Governments should pump resources into developing “greener”

methods of air travel, since it is an indispensable way of travel.

Mark schemeL1: 1 – 5m • For an answer that has major mis-conceptual errors / poor grasp

of economic knowledge.

• Max 5: For an answer that has only explained how carbonemissions give rise to market failure, using the air travel industryas the context.

L2: 6 – 7m • For an answer that has not only explained how carbon emissions

give rise to market failure, using the air travel industry as thecontext, but also explained how carbon emissions work to correctthe problem. However, explanation is inadequate / has flaws.

L3: 8 – 11m • 8 – 9m: As in L2, but explanation of the carbon trading schemewas done well; the candidate was able to show clearunderstanding of how the scheme works.

• 10 – 11m: Suggest and explain alternative policies.

E1: 1 – 2m For an unexplained judgment that is not supported by analysis.In other words, mere listing of evaluative points (adv and disadv)

associated with the implementation of marketable permits; there is noattempt to evaluate with ref to the context. Alternatively, judgmenttends to be sweeping.

E2: 3 – 4m For an evaluative judgment based on analysis and supported with astrong conclusion.


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14 4(a) Explain what might cause an appreciation of a country’s currency in a floating exchange

rate system. [10]

(b) Discuss how the Singapore government might use the concept of price elasticity ofdemand to determine the impact of an appreciation in exchange rates on the currentaccount of the Singapore balance of payments. [15]

Suggested Answer & Mark Scheme

Part (a)

Introduction• Assume a floating exchange rate regime, briefly explain.• State that exchange rate is determined by interaction of demand and supply of

currency in the forex market.

Body

Explain and illustrate with the use of a diagram how an appreciation takes place,using Singapore as an eg.

With ref to figure above, a rightward shift in the DD curve for Sing $ and/or a leftward shiftof the SS curve for Sing$ would cause the Sing$ to appreciate against the USD.

Explain the causes of an exchange rate APPRECIATIONSince demand for currency is a DERIVED demand, it is necessary to examine theUNDERLYING determinants that would cause a shift in dd/ss of the currency in the forexmarket.

Underlying determinants:Linked to mainly Trade and Capital flows.

Trade [X and M] flowsTrade flows are in turn influenced by the following major economic fundamentals:• Differences in price levels• Differences in growth rates and economic performance (income effect on

consumption of imports)• Differences in productivity etc (costs competitiveness)• Changes in taste/preferences (new products; new rivals)

Qty of Sing$

US$ per Sing$

DDS$

SSS$

US $0.5DD’ S$

US $0.6

SS’ S


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15

Capital [Real and Money] flowsCapital flows are in turn influenced by:• Differences in interest rates (hot money flows)• Speculative activities (to make windfall gains from currency fluctuations)• Biz confidence / prospects FDI inflows


and/or use of economic knowledge.

• For an answer that merely lists the various determinants ofcurrency appreciation, with no attempt to develop the content.

L2: 5 – 6m • For an answer that explains adequately and clearly 2determinants, with the use of appropriate supply and demandanalysis within correctly drawn and well-labelled diagrams. Theanswer explains clearly the underlying reasons for both demand

and supply side movements that would lead to an appreciation ofthe currency.

OR• For an answer that is lop-sided, concentrating solely on the

demand side, or factors that involve the current account (tradeflows) / financial account (investment flows).

L3: 7 – 10m • 7 – 8m: For an answer that explains adequately and clearly 3determinants, both trade and investment.

• 9 – 10m: As above, plus the use of real-life egs.

Part (b)

Intro• Explain the concept of PED: Definition, formula, sign, magnitude & determinants.

o Students must explain the concept as it was not tested in part (a).

BodyExplain how the Singapore govt might use PED to assess the impact of an appreciationin S$ on the current account of the BOP.• Define current account; or more specifically, the main international economic

transactions it captures trade: exports and imports of goods and services.

• A stronger S$ would result in the price of exports to increase and the domestic priceof imports to decrease.

• The effect on the trade balance (export revenue – import expenditure) will depend onthe PED of Singapore's exports and imports. Application (Singapore's pattern oftrade):o Imports: Our demand for imports is likely to be price inelastic. This is because of

our heavy dependence on imports for consumption as well as production.

Singapore is a small country with hardly any natural resources to produce goodsand services for our own consumption, let alone production for externalconsumption.


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o Exports: The demand for our exports is likely to be price inelastic. Reasons:- The rival products available in the global market and their attractiveness

relative to our key exports – Singapore's tops in the world production ofelectronic goods (e.g. computer peripherals); pharmaceuticals andpetrochemicals, and financial services and tourism (MICE).

- Marketing / branding - The competitiveness of our exports is not just on pricing but also non-price

factors e.g. quality, reliability, and value.

• Based on the analysis, a stronger S$ could still be in our favour, that is, trade balancewill improve.

• Suppress domestic inflation boost trade balance.

Evaluation:• SR vs LR The demand for Singapore's exports may become more price elastic, as

foreign consumers have more time to adjust.

• The Singapore govt does not rest on its laurels; it emphasizes on high productivityand innovation (with the use of strong SSP) to gain a competitive adv in the worldmarket.

• The prices of exports in general may not necessarily increase. Singapore'smanufactured exports has high import content (this is a result of Singapore lackingnatural resources, hence requires imports for final consumption and production).


of economic knowledge.

Max 5m: For an answer that has only explained the concept of PED.

L2: 6 – 7m • For an answer that makes use of PED to explain the effect of astronger currency on BOT.

• Little attempt to apply to Singapore context / attempt to do so isincorrect.

L3: 8 – 11m • For an answer that effectively makes use of PED to explain howthe stronger S$ would impact on the BOT.

• Strong application to Singapore's context.

E1: 1 – 2m For an unexplained judgment that is not supported by analysis.

E2: 3 – 4m For an evaluative judgment based on analysis and supported with astrong conclusion.

Documents

C2 H1 Econs Prelim Ans & Mark Scheme