NJC 2007 Prelim H2 P1 & P2 Answers

National Junior College Humanities Department

Preliminary Examination 2007 Answer Booklet

JC2 H2 Economics (Syllabus 9732)

2007 JC2 H2 Economics Preliminary Examinations

Case Study: Question 1 (a) (i) Labour productivity measures the output per worker; (or per man-hour.)

(ii) - Both total labour productivity and labour productivity in manufacturing exhibits a decreasing trend in growth rates, OR both are increasing at a decreasing rate between 2002 and 2006;

- Both total labour productivity and labour productivity in manufacturing observes similar direction of change across the years;

- The y-o-y changes in labour productivity in manufacturing are consistently larger in its magnitude compared to total labour productivity across the years.

(Any 2 will be sufficient. Note also that the data is presented in %, whereas the questions look at movements in these 2 economic data)

(iii) - Real total wages rose because while total wages increased by 4.5%, inflation rose only by 1.0%, leading to an increase in real total wages by 3.5%.

- Unit labour costs includes real total wages and expenses on Skills Development Fund by the employers, and

- Examining Table 1, while real total wages have increased by 3.5%, expenses on the Skills Development Fund has fallen by 9.1% (using available data up till 2005). Therefore accounting for the fall in unit labour cost, assuming employers’ contribution to the SDF remains unchanged.

(b) (i) - Absolute real income per capita between rural and urban working population widens - It however widens at a slower rate between 2002 and 2006.

(ii) Students are expected to account for why income gap is widening and also eventually at a slower rate - Demand for urban workers is higher (higher skilled) and supply is lower (relative fewer

people with higher skills) as compared to the rural workers; accounting for the wage gap

wage

- The wage gap is widening as the demand for skilled workers are increasing in the rapidly industrializing urban areas in China compared to the urban areas; whereas the increase in the supply of skilled labour in the urban areas remains slow (perhaps due to labour immobility – geographical as well as occupational)

- From Extract 3, given that while China is 26% less productive than ASEAN, by 2005 it had become 5% more productive generally and its productivity has been growing at 6.6% per year (Note that in Figure 1, the gap narrows in 2005). This increase in productivity could explain the general rise in demand for workers (across both rural and urban areas) and also more rural workers are equipped with the necessary skills

($)

0

wage ($)

0Qty of unskilled

SL

DL

● Ws

Ls Qty of skilled urban labou

SL

DL

● Wu

Lur rural labour

National Junior College 2 Humanities Department (Economics)


to promote factor mobility between rural and urban areas. - Therefore, while the wage gap is still widening, the rate of widening is slowing down.

(c) wage ($)

- As in extract 3, DL can be increased if the government increase the productivity of the rural

workers, leading to increases in wages, ceteris paribus, narrowing the wage gap. It also increases employment (L0 to L1) for the rural workers.

- Alternatively, the government can restrict supply of rural workers [to evaluate]. - The Chinese government can also impose a minimum wage law, other than the rest of the

legislative measures indicated in Extract 2 [note unemployment that results]. - The ideal situation is for the Chinese government to facilitate factor mobility in all areas,

either through the price mechanism or via legislative means. The attempt will ensure that the market clears and allocative efficiency is achieved in the long term.

L3: Depth in analysis is observed on how the income gap can be narrowed with some

evaluative comments made.

L2: Explanation with the clear use of DD, SS and price fixing as solutions, but lack clear rigour

in analysis (e.g. giving good suggestions on how to shift the DD).

L1: Explanation without clear use of DD, SS and price fixing as possible methods.

(d) - Define comparative advantage with focus on opportunity costs and reference to reasons that account for the differing opportunity costs.

- Changes in China: (i) Average annual productivity gains of 6.6% may allow China to start competing in

higher-valued goods and services and if the attempts at narrowing of the income gap are successful, it will lead to changing of opportunity costs for China. Therefore, given these changes, China’s opportunity costs may move closer to that of Singapore’s opportunity costs.

(ii) However, the productivity changes in China may not be a shift towards higher-valued goods and services that Singapore may have comparative advantage in, but rather the gains in productivity is within the low-cost goods and services industries. Hence, it may not have significant effect on Singapore’s comparative advantage and patterns of trade.

(iii) Likewise, the attempts at narrowing the income gap may not be successful as it

appears that post-2005 data in Figure 1 shows that the income disparity is widening at a faster rate again.

Qty of rural labour

0 Qty of rural labour

SL

DL0

● W0

L0

DL1

●

wage ($)

0Qty of rural

wage ($)

0

labour

SL0

DL0

● W0

L0

● SL

DL0

● W0

L0

W1

L1

SL1

W1

L1

une/m

W1

LD LS

National Junior College Humanities Department (Economics)

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- Changes in Singapore: (iv) Based on David Ricardo’s Theory of Comparative, where differences in opportunity

costs is explained by differences in labour productivity, Singapore may lose comparative advantage in certain products to China as it moves up the value chain, hence the differences in opportunity costs is less apparent. [Data: Singapore’s productivity growth averages at [(5.7+4.4+7.0+2.1+1.2)/5 = 4.1% compared to China’s 6.6%]. Hence, Singapore’s patterns of trade will change as China start producing products that Singapore is also producing. Singapore’s export earnings will most probably fall as there is greater competition now, unless it actively seeks new comparative advantage.

(v) However, if points (ii) and (iii) holds, then Singapore’s comparative advantage and hence patterns of trade may not be that significantly affected by China’s productivity gains and attempts at narrowing the income gap.

L3: Depth in analysis is observed utilising the theories of trade. A good use of the case material

and balance in the impact presented is required.

L2: Some depth in analysis is observed, with attempts at the use of case material. The analysis

is likely to be incomplete, or there is some but poor balance in the impact discussed.

L1: The answers are unlikely to have utilised appropriate theories, or no reference of case

material, or no attempts at providing a balanced approach for discussion.


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Case Study: Question 2

(a) (i) - Students have to calculate the % change in nominal GDP throughout the period. - The growth rate increases generally.

(ii) - Students have to make use of the equation Inflation rate = %change in nominal GDP - %change in real GDP

- The inflation rate increases throughout the period, except in 01-02 where inflation rate turns negative OR

- Therefore, price increases throughout except in 01-02 where prices decrease. (b) - India has 9.4% growth rate

- The significant sectors that contributed to the growth are the telephone equipment sector (43.5%), passenger growth in civil aviation (32.2%) and IT (31%).

- This may be due to the rising Per Capita GDP into 06-07, increasing Indians purchasing power, leading to a rise in demand for telephones, holidays travel.

- It may be due to globalization that foreign countries are buying telephone equipment from India due to lower cost. IT services are engaged due to the lower labour cost and the IT specialists in India. Note: Demand for these goods/services is income elastic, hence increases in incomes result in a higher growth in these sectors.

- In contrast, the less significant sectors are electricity, gas & water supply (7.4%). - Growth is less significant as demand for these commodities is income inelastic given

that they are more of necessities. (c) - Theoretically, if exchange rate depreciates, this improves the price competitiveness of

exports, worsen price competitiveness of imports, assuming M-L condition, this will increase (X-M) value. AD increase causing multiple effect on national income, therefore, real output increases, promoting economic growth. OR

- If there is economic growth in the country, the ability of the households to buy imports increase. Assuming ceteris paribus, current account may worsen, leading to BOP deficit, causing exchange rate to depreciate.

- An inverse relationship exists between Economic growth & exchange rates. - The only year when the data supports the inverse relationship is 01-02. - For the other periods, M-L condition may not be true or some government policies

intervention that may have resulted in the positive relationship. OR - With economic growth, foreign investors have more confidence of greater returns

from their investments, hence increasing FDI inflows, increasing demand for Rs, hence resulting in appreciation of Indian Rs cet par. Hence a positive relationship between economic growth & exchange rates.

- Data largely shows the positive relationship except for ’01-’02, where there is an inverse relationship.


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(d)

- From the data, there is increasing exports and imports value between India and Singapore, with export value bigger than import value over the years.

- With the signing of FTA, tariffs will be removed or reduced between these 2 countries. The demand for each others’ exports will increase further, assuming demand is price elastic. The X value may be increasing faster than M value, (X-M) increases, AD will increase, leading to multiple increase in real output. Economic growth improved further. Export related industries may have increased in employment levels.

- However, this may result in BOP surplus in India causing external instability. - There is insufficient data to support the impact on India economy. More data such as

India’s trade relation with other ASEAN economies should be provided, to determine if there is a net increase in trade activities between India and ASEAN. Inflation rate in India for the period to see if ASEAN demand for India’s exports may have caused inflation.

L1: Consider the benefits and cost of the India economy without evidence.

L2: Consider the benefits and cost of the India economy with evidence.

L3: Able to analyse the cost and benefits of the India economy and point out the lack of

certain data to come to an accurate conclusion. (e) - ‘Globalizer’ means India goes into foreign countries to carry out trade, production

and etc. - Cost: In Extract 2, more technological talent Indian are in US rather than in India,

resulting in brain drain. - Benefit: Indians penetrate into neighbouring nation’s media market, creating job

opportunities beyond India. In addition, increase in number of tourists, number of foreigners study yoga, this has promoted exports of service, leading to higher economic growth.

- From the given info, it seems that there are more benefits than cost. - As a ‘globalised’ city means foreign countries enter India. - Cost :End of monopoly state channel. Govt may have lost a source of revenue. - Benefit: British ruled India and left behind useful facilities such as harbour,

infrastructure which had facilitated economic growth. Entrance of new players in the market such as McDonald fast food allowing more choices for the households.

- From the info, more benefits than cost. - Base on limited info, we cannot deduce an accurate conclusion whether India

benefited or lost both as a globaliser or a globalised city. - If we make use of allocative efficiency as a criteria …

L1: Consider both benefits and costs without evidence.

L2: Consider both benefits and costs with evidence.

L3: Consider both benefits and costs with evidence, and able to come to a conclusion.


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Essays: Question 1 Jakarta heavily subsidizes the cost of fuel for ordinary Indonesians and faces a huge subsidy bill of as much as 138.6 trillion rupiah (S$22.3 billion) this year as a result of record high crude oil prices.

The Straits Times, 1st Sep 2005

Explain what could lead to the record high oil prices. [10](a)

Critically examine whether the use of subsidies is the best solution for the Indonesian government in view of such high oil prices.

(b) [15]

Suggested Outline: (a) Explain that the price of crude oil is determined by the market demand and supply of oil. 1. Demand factors:

• Economic boom in major economies (such as China and US) which raise the demand for oil as a source of energy to power their industries.

• Countries raising their stockpile of oil in anticipation of higher oil prices in the future. • Speculative demand. • Consumers in various countries, including Indonesia, may have experienced increases in

incomes due to economic growth and hence increase demand for private transport e.g. cars, that require petrol that is derived from oil, hence increasing demand for oil.

2. Supply factors: • Disruptions to the supply of oil in some major oil exporting countries:

- such as war in Iraq and Afghanistan. - natural calamities that affect oil explorations

• Depleting oil fields. • Deliberate actions by OPEC to restrict oil supply in order to raise prices.

3. PED and PES of oil is price inelastic (provide reasons).

Students are expected to draw diagram to illustrate the effect on price level due to an increase in demand and fall in supply of oil, coupled with the effect of elasticities.

Able to briefly describe both demand and supply factors. A poor score is awarded to scripts that only

analysed demand/ supply factors. L1

Able to provide adequate analysis of both demand and supply factors with well labeled diagram to

illustrate how an increase in demand and fall in supply of oil may lead to an increase in oil prices. Able

to show awareness of PED and PES. A low L2 score is awarded to scripts that have failed to

synthesize demand and supply factors.

L2

Able to apply a combination of at least 3 factors, both demand and supply, to the context of oil with

excellent analysis of how an increase in demand and fall in supply of oil may lead to an increase in oil

prices. Good explanations/application of PED and PES of oil to explain the ‘surge’ in prices.

L3


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(b) 1. Explain and evaluate the use of subsidy to reduce oil prices (with diagram)

• Evaluation: - Subsidy provided may be very significant in order to reduce the price of oil. This may pose a

problem to the Indonesian government in consideration of its debt situation. - The important issue is the intervention by government to internalize the high cost of oil

which distorted the market mechanism and hence, causing continued excessive demand for oil by the general public.

2. Provide alternative policies: • Maximum price - Evaluation: The excess demand for oil would have to be met by the use of

buffer stock. If not, a black market for oil may emerge which undermine the government’s objective of making oil affordable to the general public.

• Rationing - Evaluation: Administration of such policy may be difficult and the shortage may lead to social unrest.

• Campaign / regulation / legislation to reduce the demand for oil - Evaluation: While the use of campaign requires government funding, legislation/regulation will definitely be met by protest by the public.

3. Measures to increase the supply of oil or sourcing for alternative fuel. • Evaluation: The result can only be seen in the LR.

Overall assessment: 4. Remove price control to allow market to reflect the true cost of oil and hence provides motivation

for the consumers to control demand for oil. As such, campaign and sourcing for alternative fuel may be better solutions compared to the use of subsidy.

Able to explain the rationale of providing subsidy and illustrate with the use of well labeled diagram. L1

Able to provide good explanation and evaluation on the use of subsidy to reduce oil prices with brief

description on alternative policies (in the context of oil) L2

Able to provide good explanation and evaluation on the use of subsidy and alternative policies (apply

to the context of oil and Indonesia). L3

E1 Able to provide an assessment on which policy(s) is better compared to the rest.

E2 Able to provide a reasoned assessment on the better policy(s) mentioned in E1.


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Essays: Question 2

Explain, with the use of examples, the various types of price discrimination seen in the market.

(a) [10]

To what extent is a monopoly more beneficial than a monopolistically competitive industry?

(b) [15]

Suggested Outline: (a) 1. Define PD. 2. Explain the conditions of PD. 3. Explain the various degree of PD and illustrate with examples (best fit):

• 1st degree PD – Auctions • 2nd degree PD – Public utilities fees • 3rd degree PD – Public transport fares

Able to define and state the conditions of PD with 1 detail description of one of the PD. L1

Able to provide adequate explanation of various degree of PD with the use of well labeled diagram.

Examples given may be merely listed without any illustrations. L2

Able to provide a good explanation of various degree of PD with well labeled diagram. Examples are well

illustrated. L3

(b) Monopoly is more beneficial than monopolistically competitive industry: • able to practice PD to make production possible in view of the high fixed costs. Whereas for the

MC industry, each firm will be making losses if they have to provide the good. In the end, no firm will provide the good. It could be a necessity like electricity supply which is important to households. This will ensure higher consumer’s welfare.

• able to enjoy greater EOS which reduces the cost of production. Whereas the MC firms cannot enjoy such EOS because each will be producing at a lower level of output compared to the monopolist. Assuming the cost savings are passed to consumers, the price level charges by a monopoly may be lower than a MC firm.

• The ability to earn supernormal profits in the LR implies that a monopoly is able to engage in R&D for product development which benefits the consumers in terms of better and cheaper products. Whereas in the MC industry, firms will only earn normal profits in the LR, they have no incentive to engage in R&D.

(Note: the above analysis is based on the assumption that the market in contestable which provides incentive for a monopoly to practice the above mentioned measures in view of the potential competition in the LR)

National Junior College 9 Humanities Department (Economics)


Monopoly may not be more beneficial than monopolistically competitive industry: • a monopolist will only produce a kind of good, provides no variety or choice to the consumers.

Whereas in MC industry, firms will try to differentiate their goods from one another. Therefore there are varieties provided to the consumers.

• a monopoly will be less productively efficient than a MC firm as it has a higher level of excess capacity. In fact, monopolist can be X inefficient which means cost controls may become lax without competitive pressure on profit margins. The result may be overstaffing and spending on prestige buildings and equipment, as well as less effort to keep technologically up-to date, research new products or develop new markets. Whereas the competition in the monopolistically competitive industry will ensure that firms are more productive efficient than the monopolist. This will mean there is more wastage of resources in the case of monopolist.

Overall assessment: Even though a monopoly is generally less beneficial than a monopolistically competitive industry in terms of consumer and social welfare, the existence of some monopolies may arise due to the high set up costs involved which make it impossible for more than one firm to operate. Hence, even when competition tends to lead to more competitive pricing and better quality of products and services, monopolies in some industries should be allowed to operate to provide essential goods and services to better satisfy the needs of consumers. But, government monitoring and intervention is required such as through the use of MC pricing, AC pricing or legislation to ensure efficiency and prevent consumers being exploited by the monopoly.

Able to provide adequate explanation on the characteristics of both monopoly and a MC firm. 1 detail

comparison must be explained. L1

Able to provide comparisons (with adequate explanations) between monopoly and a MC firm in terms of

their behavior, the point on PD must be one of them. A balanced answer is expected. L2

Able to provide good explanations to compare between the 2 market structures with well balanced

answers that provide a good scope (discusses benefits enjoyed by consumers, producers and the

society)

L3

E1 Able to provide an assessment on which market structure is more beneficial.

E2 Able to provide a reasoned assessment on which market structure is more beneficial with brief

explanations on policies to regulate a monopoly.


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Essays: Question 3 “Singtel yesterday launched its much anticipated Pay-TV service with 33 channels; bringing an end to StarHub’s 12-year stronghold on the market…”

Adapted from The Straits Times, 21st July 2007

Explain how, a firm such as Starhub, may present a case of market failure [10](a)

Comment on the available policies to correct the above form of market failure. [15](b) Suggested Outline: (a) Candidates are expected to be able to recognize the characteristics of monopoly in StarHub, e.g. “… StarHub’s 12-year stronghold on the market … only cable TV provider … having full autonomy in its pricing policies.” Candidates should also be able to identify that the source of market failure in this case is StarHub’s monopoly power. Students may have also included inequity issues that arise due to StarHub’s monopoly power. 1. Reasons for Monopoly power:

• High Barriers to Entry (both natural and artificial) • High start-up cost • Starhub’s awarded sole broadcasting rights for FIFA World-Cup. • Sole cable TV provider • Product has no close substitutes • Cable TV programs e.g. World-Cup matches are non-substitutable, hence 0 < PED < 1.

2. Monopoly power allows StarHub to charge high prices and restrict output as compared to the PC market. Hence, resulting in underproduction (misallocation of resources)

3. Candidates are to compare and contrast the PC market and the monopolist’s pricing and output equilibrium and hence show that the monopolist produces at P > MC hence failing to achieve allocative efficiency since the consumers place a higher value on additional units of the good produced than what it cost the firm to produce it. (Using a diagram comparing PC market and monopoly, show that PM > PPC, QM < QPC, whereby PPC and QPC is the socially optimal equilibrium.) Candidates can also use CS and PS approach to explain the market failure problem.

4. Monopolist’s equilibrium results in a misallocation of resources and hence a DWL (net welfare loss) as the additional consumers’ benefit that was lost due to the underproduction is greater than the firm’s additional cost savings due to the underproduction.

5. StarHub’s monopoly power may have also led to inequity issues since its market power has allowed it to charge a higher price than a PC industry (assuming equal cost structures) hence allowing it to reap excessive profits at the expense of consumers. These monopolistic profits are not widely distributed as corporate stock ownership is largely concentrated in the hands of the upper income groups, benefiting the owners of StarHub at the expense of the society.


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Ability to identify the source of market failure and provide some relevant points with respect to the

question. L1

Undeveloped but a clearer explanation of the market failure problem posed by StarHub’s monopoly

power in the context of cable TV industry. Candidates may have included relevant examples as part of

their analysis. Candidates should be able to identify the impact of market failure on welfare.

L2

A detailed analysis (comparison with PC industry) as well as application of the market failure problem (in

terms of efficiency & equity) with reference to the context of StarHub’s monopoly power. Relevant and

appropriate examples should be included to illustrate analysis. Candidates are also able to identify and

explain the impact of the market failure on welfare.

L3

(b) Candidates are expected to explain and evaluate at least 2 policies (of which one is already provided in the stimulus of the question) to correct market failure due to imperfect competition, in the case of StarHub’s monopoly power in the Cable TV industry. Students are expected to identify that Singtel’s entry into the Cable TV market signals greater competition in the Cable TV industry and MDA’s approval of Singtel’s entry itself serves as a policy to solve the market failure problem ( introduction of competition via increasing licenses). The policy of taxation will only be credited if candidates had identified and explained that StarHub’s monopoly power created the problem of inequity. 1. Increasing competition within the Cable TV industry – Singtel’s entry into the Cable TV market.

• Positive effects:

For consumers: a. Greater competition with the entry of Singtel into the Cable TV market would probably

weaken StarHub’s market power. With a smaller market share, the demand curve facing each firm will be more price elastic as compared to the relatively more price inelastic demand with the existence of a monopolist. Rivalry among the 2 producers will lead to more competitive pricing, hence reducing the prices of Cable TV services and at the same time increasing the variety and choices for consumers due to the additional services offered by Singtel’s entry. This results in higher consumer welfare. E.g. StarHub’s response to Singtel’s entry with a package of broadband and pay TV services that was cheaper by $20 as compared to Singtel.

b. The increasing affordability of Cable TV services, would allow more people to gain access to these programmes and hence resulting in greater equity within the economy.

c. Greater competition also results in more incentive among firms to engage in R&D, therefore likely to spur innovations in new products and services so as to maintain or increase their market share. E.g. Singtel’s consumers can look forward to using their mobile phones to remotely programme and record TV shows in future. With such R&D efforts, consumers gain in terms of greater variety of high quality products e.g. more


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interactive features like video-on-demand services. Hence raising consumer welfare. Firms are also likely to engage in other forms of non-price competition to differentiate their products to cater to a wider range of consumer wants. E.g. a la-carte TV programmes. Hence, consumer sovereignty increases with consumer choice.

For producers: a. Greater competition gives firms more incentive to adopt more efficient techniques or

methods of production; they have to be more cost-efficient and innovative to stay competitive.

b. To the economy, this increased productivity through R&D could help to stimulate and spur economic growth. With greater competition, the society may also experience a reduction in DWL as resources are now more efficiently allocated, hence solving the market failure problem.

• Negative effects:

For consumers: a. With the increasing competition, consumers might be exploited due to distorted

information presented through persuasive advertising undertaken by firms. b. Consumers may face higher prices in the event that huge advertising expenses incurred

by firms raise their cost of production substantially, causing firms to charge higher prices to cover the higher cost.

For firms: a. The MES for cable TV industry tends to occur at a relatively large volume due to the

presence of very high fixed costs (ie. Natural monopoly). The relatively small market in Singapore may only be able to accommodate a single firm. With the entry of Singtel into the market, each firm will have a smaller market share as compared to a single monopolist. Hence, each will have less scope for large scale production would fail to reap substantial internal economies of scale. This result in higher operating costs and firms may be forced to charge higher prices in the process.

b. To the economy, there may be a duplication of resources with the 2 firms providing similar services, hence resulting in inefficiency in resource allocation.

c. The incumbent firm, StarHub, may lose its incentive to innovate since new ideas may be imitated by Singtel. Thus, consumers may lose the possible benefit of enjoying better quality services.

d. With the presence of a competitor, StarHub may no longer have the ability to practice price discrimination. As such, consumers who initially paid lower prices may have to fork out more money to enjoy the same benefit.

2. It is important to note that Singtel’s entry into the industry results in duopolistic cable TV industry.

Firms in the duopoly still have substantial market power; in this case, it is not likely that there will be a drastic fall in prices of cable TV services. Furthermore, to avoid the situation of losses (or subnormal profits), there is a possibility of collusion between the 2 firms. In the long run, due to


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the small domestic market in Singapore, one firm may be forced out or a merger results. Thus the entry of Singtel is not likely to solve the market failure problem effectively.

3. In the event of the Cable TV industry being a natural monopoly, students are to suggest other regulatory policies such as MC pricing and AC pricing in order to regulate StarHub.

• MC pricing: Government may require StarHub to produce at the socially desirable level of

output. This means reducing the price and increasing the output level as opposed to before regulation. A natural monopolist like StarHub would be required to produce at P = MC and to charge accordingly. Hence, bringing about allocative efficiency, solving the market failure problem.

This, however, means that the monopolist faces an AC that is higher than its AR, and is therefore making losses. This will then require subsidy from the Government. Alternatively, StarHub may be allowed to charge a 2-part tariff to cover its MC.

• AC pricing: Under this method, price is set equal to AC to achieve the maximum output possible without making a loss. With MC or AC pricing, price is lower and output is higher, so consumer welfare increases. This however, assumes that the Government knows the firms’ demand and cost conditions so it is able to set the price. Candidates have to bear in mind that even with AC pricing; AE is not achieved in the society.

4. Taxes on Monopoly’s excessive profits so as to solve the inequity issues. In view of the excessive

profits reaped by StarHub and the eventual creation of inequity in the society, the Government can levy lump sum taxes on StarHub’s profits.

Candidates are expected to include diagram showing effects of lump sum taxation shifting up the AC of StarHub, reducing its monopolist profits. • Positive effects: This lump sum tax on StarHub’s profits work like fixed costs, hence shifting

StarHub’s AC upwards without changing its MC. By raising its costs, the tax reduces monopolist’s profits, hence bringing about greater equity.

• Negative effects: While the lump sum tax may have brought about greater equity in the

society, it merely transfers economic profits from StarHub to the government. There was no effect on its pricing and output decisions. Hence, resources are still misallocated in the sense that StarHub still continues to under-produce and overcharge consumers, reducing consumer surplus in the process. In this case, the market failure problem due to inefficiency may not have been solved.

5. Conclusion/ Evaluation: Students might want to compare among the different policies they have

commented on and come to a reasoned conclusion as to which may be a more appropriate policy to implement especially with respect to the Cable TV industry. In view of the fact that the Cable TV industry may be one whereby a natural monopoly is inevitable, students could comment that the current policy of introducing competition in the form of Singtel’s entry may not


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solve the market failure problem effectively. Hence, students should come to a stand that regulatory policies are the most appropriate policies to solve the market failure problem due to inefficiency here. Students might also want to include the prospect of government failure that arises in government intervention, due to bureaucracy, red tape and imperfect knowledge etc., hence failing to solve the market failure problem.

For an answer which has some basic correct facts. However there is likely to be very poor content

development. The response is likely to demonstrate a poor understanding of the requirements of the

question. A broad range of policies may be identified but lacks detailed analysis of each policy and how it

solves the market failure problem.

L1

Undeveloped & unbalanced explanation but likely to have a clearer framework of content development

evident (e.g. able to analyse effects of the proposed policies on the society). At least 2 policies must be

analysed, but they may not necessarily relate to solving the market failure problem created by StarHub’s

monopoly power.

L2

For a good analytic assessment of at least 2 policies (of which one must be the introduction of

competition) with respect to solving the market failure problem clearly in context of the cable TV industry.

A good balance of content development is observed (e.g. positive & negative effects of the proposed

policies on producers, consumers and the economy are discussed).

L3

E1 For a list of unexplained assessment of the policies available in the context of the Cable TV industry.

Candidates may have included some reference to government failure in regulation etc.

E2

For an evaluative assessment based on economic analysis with specific explanation of the limitations of

increasing competition in the Cable TV market especially in the context of a small domestic market.

Better candidates may demonstrate an attempt at judgment.


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Question 4 “The Government will continue to keep a tight watch … for Singapore to remain on its growth path”.

Minister Lim Hng Kiang’s Parliamentary reply on 27 Aug 2007

Discuss the extent to which some policies are more likely than others to stimulate growth for the Singapore economy. [25] Candidates are expected to identify and evaluate the effectiveness of how the various macroeconomic policy choices available to the Government stimulate the actual and potential growth of the Singapore economy. Some attempt to demonstrate judgment and balance is expected. Most candidates are likely to have presented various policy choices all with the aim of stimulating growth without taking the context into consideration (e.g. instead of controlling AD, the candidates are likely to present an argument to increase AD further). The best candidates would have identified and explain the economic indicators that present the greatest source of concern that may prevent growth, and offer appropriate policy choices to “keep them in check” to stimulate growth. Suggested Outline: 1. Introduction

• Identify and define (i) actual growth – formula is expected and (ii) potential growth. • Identifying key features of the Singapore economy and factors that are contributing to

long-term sustained growth for the economy (e.g. export-oriented growth, price stability to ensure sustainable growth, small-open economy, etc)

2. Macroeconomic Policy Choices (i) Aggregate Demand-Side Policies

• Monetary Policy: Singapore being a SOE is an interest rate taker has limited control over money supply and its MEI is interest-inelastic. Candidates are expected to substantiate their claims with knowledge of the Singapore economy.

• Exchange Rate policy: Singapore has maintained a relatively strong and stable Singapore Dollar (SGD) and it has been effective in curbing inflationary pressures arising from external and domestic demand. - More importantly, import prices (and hence imported inflation) are kept low in terms of

SGD. If M-L condition holds, then the appreciating SGD will have contractionary effects on AD and hence curbing inflationary pressures. With price stability growth can be sustained. Alternatively, considering the nature of the Singapore economy, lower import prices may have positive effects on prices of exports and positive impact on actual growth.

- It is also noted that with the strong SGD, import of factors of production and technology becomes relatively cheaper and hence it will have positive effects on Singapore’s potential growth, despite having short term effects of possibly lowering actual growth and employment.

- The rising external value of SGD has also provided incentive for producers to move out of competing in terms of prices and focus on moving up the value chain. This policy is


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also effective in ensuring that the Singapore economy restructures into a knowledge-based economy based on its comparative advantage.

• Fiscal Policy: - Lowering of income and corporate taxes are expansionary by nature and can stimulate

actual growth. ↓T ↑C and I ↑AD ↑Y (actual growth and e/m). Lowering of corporate taxes also lowers unit business costs (improving price stability also) and hence when it ↑I, it also stimulates potential growth.

- ↑G in terms of development expenditure will improve both actual and potential growth. The government can also increase expenditure on the training and retraining of its workforce to reduce structural unemployment which then provides the necessary factors of production necessary for growth.

- It is noted that, (i) G as a percentage of GDP is low, (ii) crowding-out effect and (iii) size of domestic sector relative to its external sector limits the effectiveness of FP as a discretionary policy. However, it does have an effect of stimulating S’pore’s potential growth.

(ii) Aggregate Supply-Side Policies • Incomes policy: These policies can be used as supply side measures to promote growth

in the economy. For example, increases in unit business costs can due to wage increases can be capped by recommendations made by the NWC to employers and employees such that wages increases follows productivity increases. As such it increases AS and stimulates growth by ensuring price stability.

Evaluation: (i) Productivity increases may vary across industries and hence a guideline recommendation may not be applicable to various industries, (ii) wages, while being a large component of unit business cost, is not the only factor leading to rising business cost, (iii) unless companies adopt a variable-wage component, wages are generally downward sticky, and hence when productivity falls, trade unions may not agree with a corresponding fall in wages.

• Manpower policy: Promoting training and retraining will increase AS and stimulate potential growth. It also makes Singapore an attractive centre for FDIs and hence also stimulating actual growth. Evaluation: (i) Retention skills learnt and transfer of training into actual productivity gains need to be considered, (ii) moral hazard of training (i.e. lack of incentive for private companies to train workers)

3. Conclusion: Stimulating growth in the economy covers both actual and potential growth. For the case of Singapore, while the government takes proactive measures to ensure actual growth in the short run through a policy mix of AD and AS side policies, its openness to trade and its large external sector limits the effectiveness of AD side policy choices especially in the face of external shocks. The AD and AS side policies are mainly used for ensuring long term sustainable growth in Singapore, with AS policies and maintaining a strong SGD being the main policy choices and using FP to smoothen fluctuations in the macroeconomic indicators.


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L1

Where the answer is mostly irrelevant and contains only a few valid points made incidentally in an

irrelevant context. For an answer that shows some knowledge of policies targeted at either actual OR potential growth. The

meaning of the question has not been properly grasped, and there is inadequate development of

analysis AND application.

L2

Where the answer shows an ability to identify facts, some ability at graphs, fair ability to apply known

laws in using AD and AS policies to stimulate growth. Expect an accurate though undeveloped

application to the Singapore economy. There should be some ability to discriminate and form elementary

judgments, BUT do not expect a clear logical presentation. There will not be much evidence of the ability

to recognise unstated assumptions.

Where the answer has a more thorough relevance to the question but where the theory is incompletely

explained

Expect a good knowledge of the facts and theory of the question, clear evidence of the ability to use the

facts and theory with accurate reference to addressing “keeping a tight watch” in Singapore’s context to

stimulate BOTH actual and potential growth. Clear statements, supported by reasoned arguments should

be given and there should be some attempt at a conclusion to the question. There should clearly be a

reasoned structure to the whole answer. Do not expect too many extra illustrative points which are not

explicitly referred to in the question, do not expect too much critical comment, and do not expect any

recognition of, or comment on, unstated assumptions.

L3

Expect a thorough knowledge of facts and theory with an excellent ability to describe and explain this in a

precise, logical, reasoned manner. Expect an ability to query some of the assumptions. New illustrations

and examples apposite to the material discussed should be introduced as further evidence of the ability

to recognise the principles of the question and their application to relevant current situations.

E1 Mainly unexplained judgment

E2 Judgment based on analysis


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Essays: Question 5 “Asia has seen rapid growth, dramatic transformation and deepening interdependence and integration. Rapidly changing patterns of production and trade are causing painful structural adjustments. However, to grow and prosper, we must stay open and integrate ourselves with the global economy.”

"America and Asia: Our Shared Future"

Speech by Mr. Lee Hsien Loong, Prime Minister of Singapore May 3 2007

Discuss whether Singapore should “stay open and integrate with the global economy” to achieve its macroeconomic objectives in the light of the problems resulting from the structural adjustments. [25] Suggested outline: 1. Explain what is meant to ‘stay open and integrate with the global economy’. This can be inferred

for Singapore to remain open to trade and capital flows and taking advantage of the opportunities presented by globalisation.

2. State the macroeconomic objectives of Singapore: (i) Full employment, (ii) Sustained economic growth, (iii) Price Stability, (iv) External stability.

3. Comment that the attainment of the above macroeconomic objectives has to be examined against the structural adjustments that would take place like structural unemployment, income disparities between the skilled and lower skilled workers due the effects of changing comparative advantage of Singapore in the context of a globalised economy. (i) External stability

• By remaining open to trade and integrating with the global economy, Singapore can aim to boost its export growth by leveraging on the opening up of markets brought about by the increasingly integrated regional and international economies due to globalisation.

With the emergence and rise of the economies of China and lndia, new patterns of trade have developed. China is a major export destination for many ASEAN countries and more importantly for Singapore. Singapore can take advantage of its comparative advantage in higher-value added manufacturing and financial services and export such goods and services to the Chinese and Indian markets. At the same time, Singapore can also source for cheaper raw materials and components from economies such as China, India and the regional economies to lower its domestic production cost and raise its export price competitiveness. This is especially important given Singapore’s high import content. This has beneficial effects for Singapore’s current account and could contribute to a B.O.P surplus.

Evaluation: Singapore would be faced with the need to confront its changing comparative advantage as emerging economies such as China and India develop at a rapid rate and develop new areas of comparative advantage. Given the relatively abundant and cheaper


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labour in the emerging economies, some domestic labour intensive industries and low value-added industries would face stiff competition and would be forced to rationalise their production process or face the problem of being forced out of the market, i.e structural adjustments in industries will take place. This has the unwanted effect of threatening Singapore’s export competitiveness and moderating gains in Singapore’s balance of trade, current account and balance of payments.

• Singapore can integrate with the global economy by establishing strong economic links with the regional and international trading partners through FTAs.

E.g. The proposed APEC-wide Free Trade Area of the Asia Pacific (FTAAP). Within East Asia, different overlapping regional groupings exist, including AFTA, ASEAN-6 (Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand) which aims to eliminate all tariffs by 2010. Such FTAs allows Singapore improved access to the markets of the member states, raising Singapore’s export growth benefiting its B.O.T, current account and resulting in possible B.O.P surplus.

Evaluation: However, FTAs also increase the complexity of the trading system and can raise transaction costs for Singapore exporters. For example, complicated rules of origin are required to prevent third country product entering via the other party. With different rules negotiated under different agreements, enforcement of these rules and compliance with them by firms can be a complicated task and burdensome tasks thus raising production costs.

In addition, similar structural changes faced by affected industries can be experienced by Singapore with FTAs just as in the competition posed by emerging economies like China, India and Vietnam etc.

• Impact on S.T capital flows: Integration and openness can also be viewed in terms of the effect on short-term capital flows especially given Singapore’s aim to be a regional financial hub.

Evaluation: Too large an inflow of short-term capital can result in pressure for the S$ to appreciate and unwanted increase in liquidity and inflationary pressures for the local economy. Likewise, sudden outflow of short-term capital has the opposite effects.

(ii) Full employment • Openness and integration has the effect of increasing export growth. This has the benefit of

raising Singapore’s AD promoting higher levels of national income and employment via the multiplier effect which results in a more than proportionate increase in national income. [Support with AD-AS analysis]

• Other than raising export growth, Singapore could also benefit from an increase in FDI in the relevant growth industries like high value-added manufacturing, bio-medical, financial and banking services. Increases in FDI have the similar effect of increasing Singapore’s AD and the subsequent effect on national income and employment.


20


Evaluation: This analysis assumes the existence of available spare resources in the economy. Given that Singapore is close to its full employment in recent years, significant increases in national income and employment may not be registered but instead greater inflationary pressures may be produced due to demand pull inflation.

Gains in employment may also be uneven between industries. While there may be gains in employment for sectors or industries benefiting from rising export growth and FDI, like bio-medicals, high-value added manufacturing and financial services, at the same time, there will be losses in employment in sectors which have lost or are losing comparative advantage especially those in the low-value added and labour intensive sectors. This presents the case of structural unemployment and implications for widening of differentials in wage growth between industries, i.e. income inequality.

(iii) Economic growth • Actual growth: This can come about from the increase in AD from the increase in

Increase X and FDI. Gains in AD increase the utilisation of previously unemployed resources thus contributing of actual growth.

• Potential growth: Gains from the expected increase in FDI extends also to the longer-run effect of raising potential growth through investments in infrastructure spending and technology transfer as well as the gains in human capital stock with the transfer of management expertise which raises the productive capacity of Singapore.

Evaluation: However the gains from FDI and X for it to contribute to Singapore’s economic growth depends on the existence of spare capacity and the avoidance of serious bottlenecks in the internal economy which prevents the ease of mobility of factors of production. This can threaten Singapore’s attractiveness as a destination for FDI as well as decreasing Singapore’s export competitiveness should cost-push inflation becomes develop.

In addition, the extent of transfer of technology, knowledge and management expertise depends on the willingness and openness of the foreign firms to share with their local counterparts.

Singapore could also face competition in terms of retaining and attracting foreign talent and highly skilled workers. This has implications on its ability to attract foreign investment (e.g. in areas of scientific research and life sciences) and sustain its economic growth over the longer term.

(iv) Price stability

• Lower import prices: By staying open and pursuing integration with the regional and international economy, Singapore can source for cheaper inputs and finished products/services. This lowers import prices on goods/services and factors of production. The benefits are two-fold: Lowering domestic prices of consumables and lowering cost of production for firms through cheaper imported inputs, thus lowering cost-push inflationary pressures as the economy grows. Overall, this has the effect of achieving greater price stability by keeping inflation low.


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Evaluation: However, the drawback from the openness and integration for Singapore is that it has to be on guard against imported inflation as well as demand-pull inflation caused by excessive growth in external demand and FDI. With its high import content for its exports, Singapore’s greater reliance on imported inputs puts it in a vulnerable position should supply-side shocks in global commodities occur overseas, sending prices of global commodities up. Excessively strong external demand and FDI do also have the effect of increasing AD strongly and contributing of demand-pull inflation.

4. Conclusion: Given the nature of the Singapore economy being small and open as well as the

increasing globalisation pressures, Singapore has little option but to stay open and remain integrated with the global economy. Problems resulting from its openness and integration although have obvious conflicts with its macroeconomic objectives can be overcome through the use of relevant demand and supply side policies.

Singapore should leverage and capitalise on the opportunities presented by staying open and by remaining integrated especially with the regional economies through FTA platforms such as ASEAN and AFTA so as to among other things, expand its export market and resource base. This is especially relevant in the light of rising Asian economies like China and India which will create pressure to make structural adjustments in open economies like Singapore.

L1

Where the answer is mostly irrelevant and contains only a few valid points made incidentally in an

irrelevant context

Where the answer shows some knowledge but does not indicate that the meaning of the question has

been properly grasped. (Students are not likely to have addressed the benefits/costs of Singapore’s

openness and integration with the global economy in terms of the impact on Singapore’s macroeconomic

objectives. No evidence of addressing the structural adjustments.) Basic errors of theory or an

inadequate development of analysis may be evident.

L2

For an accurate but undeveloped economic explanation of the benefits of Singapore staying open and

remaining integrated in terms of achieving Singapore’s macroeconomic objectives, little reference to the

structural adjustments and no evaluative comments.

Expect an accurate though undeveloped economic explanation of the facts (e.g. macroeconomic aims

not covered adequately) relating to the question together with an explanation of the theory, and evidence

of some ability to discriminate and form elementary judgments, BUT do not expect a clear logical

presentation. There will be some evidence of examining the impact of Singapore’s openness and

integration on Singapore’s macroeconomic objectives in the light of the structural adjustments but the

macroeconomic objectives are not fully covered. Some attempt at evaluation.


22


Expect a good knowledge of the facts and theory of the question. Clear evidence of the ability to present

a logical and reasoned analysis. Good attempt at examining the impact of Singapore’s openness and

integration on Singapore’s macroeconomic objectives in the light of the structural adjustments with the

macroeconomic objectives are fully covered. Good attempt at evaluation by providing a clearly reasoned

structure to the whole answer.

L3

Expect a thorough knowledge of facts and theory with an excellent ability to describe and explain this in a

precise, logical, reasoned manner. Excellent attempt at examining the impact of Singapore’s openness

and integration on Singapore’s macroeconomic objectives with in depth discussion of the structural

adjustments and with the macroeconomic objectives fully covered. Excellent attempt at evaluation by

providing a clearly reasoned structure to the whole answer. New illustrations and examples apposite to

the material discussed should be introduced as further evidence of the ability to recognise the principles

of the question and their application to relevant current situations.

E1 Mainly unexplained judgment

E2 Judgment based on analysis


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Essays: Question 6

“The undervalued yuan is one important cause of China’s rising inflation and huge trade surplus with America. Many foreign economists argue that the government should revalue the yuan’s peg, widen its trading band or shift from a dollar peg to a basket of currencies”.

Discuss whether ‘the undervalued yuan’ is the only cause to ‘China’s rising inflation and huge trade surplus with America’.

(a) [12]

Comment on the implication of a revaluation of the yuan on Singapore’s economy. [13] (b)

Suggested Outline (a) 1. The meaning of ‘undervaluation of yuan’- the exchange rate is artificially fixed below the market

exchange rate. It means that yuan is made cheaper, with US$1 more yuan can be exchanged.

2. Explain and evaluate how the cheaper yuan will lead to rising inflation in China. • Foreigners (US consumers) will find price of China’s goods relatively cheaper, demand will

increase, may even use Chinese goods as substitutes. This leads to an increase in China’s export revenue (X).

• Chinese will find imports (from US) relatively more expensive, hence, they will demand less imports, leading to a fall in import expenditure (M). Therefore, (X-M) with US shows an increase.

• Foreign investors will make find investment in China relatively cheaper, in addition to the lower wage costs. This increases I in China.

• Since (X – M) and I are the components of AD, an increase in both components will cause AD to increase in China. If AS cannot match the increase in AD, this will lead to demand pull inflation. (Students are expected to illustrate with the use of AD-AS diagram).

Evaluate: • However, the above analysis is based on the assumption that the quality of the Chinese

products is comparable to goods produced by other countries (especially the developed countries). But the recent incidents whereby the Chinese goods were recalled had raised some concerns over the quality of its goods. This may discourage the demand for Chinese goods. This will mean X will not increase as much or may even fall.

• The rising inflation in China can also be due to the increase in domestic consumption leading to increase in AD. With 1.3bn population in China, huge increase in domestic households’ income arising from their double digit economic growth has enhanced their purchasing power. At the same time, to prepare for 2008 Olympics in Beijing, govt has pumped in large amounts of funds to improve infrastructure in China, causing G to increase. These internal factors can also lead to AD rising faster than AS causing inflation in China.

3. Explain and evaluate how the cheaper yuan will lead to huge trade surplus with US. • US consumers will find Chinese goods relatively cheaper, thus increases the demand for

imports. This leads to increase in M. Therefore, China’s X improves. In addition, US


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firms will find imported raw materials from China to be cheaper with this undervaluation; they may now switch to buy from China to lower their cost of production. This will further increase China’s X value.

• US exports will be relatively more expensive to the Chinese, hence causing a decrease in demand for US exports, leading to a fall in US’s. This means a fall in China’s M. (X-M) for China improves.

• Since (X-M) is balance of trade and therefore China experience trade surplus with US. Evaluate: • Other reasons that may have resulted in US huge trade deficit with China could also be due to

the low interest rate in US that encourage borrowing and enhance consumption. US citizens do not saved very much, MPC is high. Secondly, it may be due to China’s comparative advantage that allows them to produce goods relatively cheaper than other countries. This includes the vast amount of resources that China possesses, such as labour, and the low cost of living in the country has allowed them to lower the cost of production. Hence, even without an undervalued yuan, Chinese goods will already have a competitive edge against other countries.

• Removal of trade barriers between US and China also allows more transactions. 4. Therefore, undervaluation of yuan is just one of the causes of the 2 effects.

For an answer that has some basic correct facts such as an unexplained list of key features. L1

Can explain the effects but lack evaluation. L2

Clear explanation of effects and in depth evaluation L3

(b) 1. Revaluation of yuan means the external value is increased artificially. China govt could increase

the upper band that the exchange rate can fluctuate or drop the peg to US exchange rate system and switch to peg to a basket of trading partners exchange rate system, this will reflect the real market forces of demand for and supply of the yuan.

2. Effects on EG and employment • Therefore, revaluation of yuan will mean Chinese will get more S$ with the same amount of

yuan and Singaporeans will get lesser yuan with the same S$. • Singaporeans will find the price of Chinese goods relatively more expensive, and Singapore’s

exports will be relatively cheaper to the Chinese. SR effects: • Due to contracts and the limited amount of time to source for alternative goods, the PEDX and

PEDM tend to be of very low value. Hence, with the decrease in the foreign prices of Singapore’s exports, quantity demanded will increase less than proportionately. Similarly, when the prices of import in local currency increase, quantity demanded for imports will fall less than proportionately. This causes the export revenue in foreign currency to decline and import expenditure in local currency to increase. As Marshall-Lerner condition does not hold, where sum of PEDX + PEDM < 1, net exports in Singapore will decrease.

• However, Chinese firms will find investing in Singapore relatively cheaper. This may attract such foreign investments into Singapore lading to an increase in investments.


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• As such, the overall impact on the AD will depend on the extent of decrease in net exports and the increase in FDI. Since the amount of FDI from China has not been significant, AD will decline. The decrease in AD will bring about a fall in NY and employment, raising demand-deficient unemployment. (Diagram to illustrate).

Evaluation: • Due to the small multiplier of the Singapore economy (as the leakages in Singapore tend to

be large), the fall in NY and employment may not be significant. • Not all Chinese firms will flock to Singapore, only those high value added production and

services will attract them. In addition, with the vast improvement in China’s technology and efficiency, they do not have to look outwards. Investment could be inside China itself.

LR effects: • Even though in the long run, the Marshall-Lerner condition holds, revaluation of yuan may not

improve Singapore’s net exports. This is because the higher import prices will raise the cost of production in Singapore as the country is highly reliant on imported resources for production purposes. This will inevitably reduces her export competitiveness in the LR, undermining the positive impact on the net exports.

3. Effect on external stability • As explained above, Singapore current account may experience a deficit. • As for short term capital account, Singapore speculators may expect further revaluation of the

yuan in future, they will want to buy yuan now to sell later and make capital gains. This will result in capital outflow more than inflow. As for long term capital account, with more Chinese firms investing in China, together with the growing interest of local firms to invest in China, capital outflow here may be more than inflow. The lower cost of investment in Singapore due to the revaluation may be insignificant in view of the already low cost of production in China and the potential of the Chinese economy. This will result in BOP deficit.

Evaluation: • But, the net returns that come back to Singapore in the long run through the invisible current

account may improve the BOP position. 4. Conclusion: So far, the impact on Singapore economy has been undesirable. However, the

above mentioned effects depend on the extent of revaluation of the yuan. If the extent of revaluation is minute, impact on the economy will not be significant. Even if it does affect Singapore, the supply side policies that the government implement to enhance our cost competitiveness of our exports will reduce the negative impact of revaluation of yuan on the economy. With the development in new comparative advantage areas such as bio-tech industry and medical industry, together with the lower corporate tax rate to entice foreign investors, firms from China may increase their investments in Singapore, contributing to Singapore’s actual and potential growth.

An answer that shows some knowledge on the effects on Singapore economy. L1

For explanation of effects on Singapore economy in greater depth but lacks evaluation. L2

For a detailed analysis of the effects and in depth evaluation of these effects (with M-L condition). L3

For an unexplained assessment on the overall impact on the economy. E1

For an evaluative assessment based on economic analysis. E2


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Documents

NJC 2007 Prelim H2 P1 & P2 Answers