2008 TPJC H2 Economics Prelim Exam Answers

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TPJC Economics / 2008 / H2 Preliminary Examination / Paper 2 1

TAMPINES JUNIOR COLLEGE

Preliminary Examination 2008 ECONOMICS 9732/02 Higher 2 Paper 2 (Essay) Monday 25 Aug 2008 08 00 – 10 15 (2 hours 15 mins) READ THESE INSTRUCTIONS FIRST Write your name and civics class in the spaces provided on the answer paper. Answer three questions in total, of which one must be from Section A, one from Section B and one from either Section A or Section B. Write your answers on the separate answer paper provided. Write the question numbers of the questions you have attempted on the cover sheet. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question. You are reminded of the need for good English and clear presentation in your answers. You may answer with reference to your own economy or other economies you have studied where relevant to the question.

This question paper consists of 3 printed pages and 1 blank page.

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Answer three questions in total

Section A

One or two of your three chosen questions must be from this section 1 “The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub,

offers a wider range of goods than the typical FairPrice supermarket, and includes new lines like electronic products and fashion wear.”

(a) Explain how the scale of a firm influences its costs. [10] (b) Assess the relevance of price elasticity of demand, income elasticity of

demand, cross elasticity of demand to the supermarkets in Singapore. [15] 2 (a) Explain how, in economic theory, a firm in a perfectly competitive

market determines the price and output that would maximise profit. [8]

(b) Discuss whether this model of market structure is the most

appropriate to explain the behaviour of firms in Singapore. [17] 3 A new carbon capture and storage technique known as carbon

sequestration is being developed. This involves capturing greenhouse gas pollution from power stations and locking it deep beneath the ground. (a) Explain why greenhouse gas pollution from power stations are

likely to cause market failure. [8] (b) Assess the policies that the Singapore government currently adopts

to overcome this market failure and consider whether the government should finance the development of new technology such as carbon sequestration. [17]

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Section B

One or two of your three chosen questions must be from this section 4 The Singapore economy continued to expand at a healthy pace of 6.7% in

the first quarter of 2008. Employment expanded strongly, increasing by 68,000. …… Oil and food prices have risen more rapidly and are expected to continue to increase. Consumer price inflation trended upwards to 7.5% in June 2008.

Source: MTI, 10 July 2008

(a) Explain the likely causes of inflation in an economy. [10] (b) Discuss whether monetary policy is the best policy to curb inflation

in Singapore. [15] 5 The two casinos set to open in the Integrated Resorts in Singapore are

part of the government’s longstanding effort to reorient the economy toward higher-value service industries like tourism and biosciences as it loses manufacturing competitiveness to China.

New York Times, 19 April 2005 Explain the rationale for the above policy and discuss whether it is the best policy to achieve the government’s macroeconomic goals in a globalised world. [25]

6. (a) Using economic theory, explain why there are gains from free

trade. [10] (b) Discuss how exchange rate changes may affect a country’s

international trade. [15]


Suggested Approach Essay Question 1 “The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub, offers a wider range of goods than the typical FairPrice supermarket, and includes new lines like electronic products and fashion wear.” (a) Explain how the scale of a firm influences its costs. [10] (b) Assess the relevance of price elasticity of demand, income elasticity

of demand, cross elasticity of demand to the supermarkets in Singapore. [15]

Part (a) Introduction A firm refers to a business unit which employs productive resources to produce goods and services. Scale of firm is characterised by the amount of capital outlay / fixed assets, employment size and the levels of output / market share. In Singapore, the employment size of the Small Medium Enterprises does not exceed 200 workers and fixed assets not exceeding S$15 million. Development As a firm increases its scale of production, it is able to enjoy cost advantages - internal economies of scale. Internal Economies of Scale are lower unit cost achieved by a firm when it expands its output or enlarges its scale of production. The internal EOS arises within the firm as a result of its own expansion and are independent of the size and expansion of the industry. Internal Economies of Scale (require to explain only two) 1. Marketing / Commercial Economies

A large firm buys its raw materials in bulk and large discount are often offered by the suppliers. Instead of buying from the wholesaler, the large firm can buy directly from the producer. For example, a supermarket can obtain its meat, egg supplies, vegetables and fruits directly from the farms at a discount while an independent stall at the wet market may have to obtain his supplies from the wholesaler.

In selling a large volume of output, the firm may be able to use more expensive but more cost-effective advertising. In other words, advertising cost will be spread out. A firm such as NTUC Fairprice supermarket with a nationwide market can afford to advertise in the papers, etc, to bring its product to the notice of potential buyers whereas a small firm may not have the capacity to advertise. Though such firms may spend large sums on advertising, their advertising costs per unit sold may be well below those of a small firm.


Advertising costs can spread over a large volume of sales. Moreover, the large firm can save on advertising costs as the same advertisement helps to promote its range of products and not just one product.

2. Administrative / Managerial Economies As the scale of a firm increases, specialists can be employed to manage the firm. In other words, division of labour can be introduced into tasks of management. Different experts can be employed to take charge of planning, production, accounting, sales promotion and personnel management. Efficiency in management thus can reduce unit costs in large firms.

3. Financial Economies

A large firm is often able to obtain finance more easily or on better terms than a smaller firm. Its larger assets and greater selling potential provides banks with greater security and makes it possible for them to provide loans at lower rates of interest. The larger firm can also raise substantial capital through public issue of shares.

4. Risk- bearing Economies

Large firms are in a better position to spread risks. Furthermore, large firms have greater opportunities for reducing risk through the diversification of markets or products. Thus, if sales drop in one market, a large firm can still rely on sales in other markets to compensate for the loss or if one product becomes unpopular, the firm can make up for the loss from its sale of other products. In the case of FairPrice Xtra hypermarket, it offers a wide range of goods and includes new lines like electronic products and fashion wear.

Diseconomies of Scale (require to explain only one) When a firm enlarges its scale beyond the minimum efficient scale, it may experience diseconomies of scale where the unit cost increase. 1. Management problem

As a firm continues to expand, coordination and control become more difficult. Communication becomes a time-consuming process, so that decisions are inevitably delayed. In addition, communication in a large firm tends to be one – way; i.e., a superior will pass on to his subordinates something to do without discussing the matter with them. One-way communication often leads to ill-feeling and misunderstanding.


2. Financial Problems When a firm is very large, it requires a lot of capital to finance further expansion. It may be possible for the firm to obtain such finance only from sources which charges increasingly higher rates of interest.

3. Marketing Problems

When a firm becomes too large, it will experience difficulties in finding sufficient demand for the commodity it produces. After a certain point is reached, expansion of the existing market can be achieved only by huge expenditure on advertising and publicity.

External EOS(required to explain only one) Large as well as small scale firms are able to enjoy external economies of scale. External EOS are cost savings enjoyed by individual firms as a result of the expansion of the industry as a whole. These economies are independent of the firm’s own output and are outside the control of the firm. External economies are possible to an industry as a whole when most of the firms in a particular line of production comprising the industry are concentrated in one area, i.e. when localization of industry occurs.

1. Economies of Concentration These are mutual benefits to be derived when the firms in a particular industry are concentrated together and the industry expands. Development of infrastructure & marketing facilities When an industry is first set up in a new area, transport, amenities (like water, electricity, telephone facilities) and marketing facilities (for the purchase of materials and sale of the product, specialized warehousing and banking) may not be well developed. With the entry of firms leading to expansion of the industry, it is possible for transport and marketing facilities to be developed. Thus, individual firms need not build their own road system and generator. This will help to cut down unit cost of production. For example, in Singapore, the Ang Mo Kio Hub or IMM building housed a large number of retail outlets including supermarkets which enjoy the well-developed transportation (MRT and SBS Transit) and other amenities.

2. Economies of Information

The development of the industry often leads to the development of research facilities to improve the existing production techniques and the publication of specialist journals. It becomes possible to set up research associations which will carry out research work on behalf of individual firms and publish the results for all firms to use. Such researches are of enormous advantage to the industry as a whole but far too expensive for a single firm to undertake unaided.


Conclusion In conclusion, the large scale production enjoys internal EOS as AC decreases. However, when a firm enlarges its scale beyond the minimum efficient scale, it may experience diseconomies of scale where the unit cost increase (AC increases). The external EOS are enjoyed by both the small and large scale firms. Besides cost advantages, the scale of the firms also influences its revenue. Firms must be large enough to capture a bigger market share and therefore able to exert market power to set prices or output in order to increase its revenue. Part (b) Introduction Supermarkets, like all other business organizations, conduct their day-to-day business with the aim of maximizing their profits, ie. Revenue – Cost. The use of the 3 concepts of elasticity of demand helps the supermarkets to maximise its TR. Some supermarkets may see growth maximising and expansion of market share as their long term objectives. Development Explain how each concept may be relevant to the supermarkets seeking to max TR 1. Price Elasticity of Demand

Usefulness Ep measures the degree of responsiveness of the quantity demanded of a good with respect to its price changes, ceteris paribus. It is useful in helping the firm to determine the price that should be set to maximize its TR.

Application

Most of the items sold one supermarket are available in other supermarkets. Examples, rice, meat, ice cream, daily essentials etc. Due to the availability of substitutes, we shall consider the case of Ep > 1. In this case, the supermarket should decrease price to maximize TR. (diagram). A fall in price will lead to a more than proportionate increase in quantity demanded, therefore increasing its TR.

Supermarkets should make its demand more price-inelastic so as to

increase price and capture more revenue. This can be done through branding, promoting customer loyalty through discount privileges, link points etc.

2. Cross Elasticity of Demand

Usefulness EAB measures the degree of responsiveness of quantity demanded of good A to a change in the price of good B, a related good, ceteris


paribus. It is useful in helping the supermarket to decide what strategies they should adopt in response to a price change of a related good (substitutes or complements) in order to maximise its total revenue.

Application If EAB high & positive (due to availability of substitutes) Supermarkets need to take note of rivals’ pricing policies & strategies. In the short run, if their rivals reduce price, supermarkets might have to follow so that demand will not fall drastically. In the long run, in order to reduce the degree of substitutability, supermarkets should differentiate its product from rivals. E.g. creating unique services like delivery EAB high & negative. Strong complements like salad and seasoning. Supermarkets can offer bundled packages at attractive prices to increase customer base

3. Income Elasticity of Demand

Usefulness Ey measures the degree of responsiveness of quantity demanded of a good to a change in the income, ceteris paribus. It is useful in helping the firm to determine its strategies and what to stock up in different economic situations in order to maximise its total revenue.

Application Ey is positive During economic boom or end of the year where most people receive their bonus, the supermarket could advertise more aggressively the luxury goods which are income elastic (Ey > 1). Examples are organic and premium food items. This is because during periods of increasing income, the demand for luxury goods will increase by more than proportionate. By exploiting on the higher Ey, the supermarkets could increase its TR thus increasing its profits, ceteris paribus. At the same time, supermarkets need not stock up too much income inelastic goods (Ey <1) such as daily essentials as the increase in demand is less than proportionate to the increase in income. There is afterall physiological limit to how many loaves of bread and rice one can consume – even for someone very wealthy. Instead, the additional income is more likely to be spent on manufactures like electronic products and fashion wear.

Implication on growth and sales Relying on the sale of staple items like bread and rice means that supermarkets will see only very slow growth in the demand for their


products as consumers’ income rise. By diversifying, offering a wider range of goods and includes new lines like electronic products and fashion wear, supermarkets can benefit from exploiting their higher income elasticity of demand and experience a more rapid growth in demand and sales revenue. In Singapore, some supermarkets exploit the high Ey by setting up premium outlets in high income residential area that supply premium food items to meet the demands of the high income group.

Ey is negative Supermarket could promote inferior goods (some house brands) during periods of decreasing income (recession, increase in tax rates).

Evaluate the relevance of the 3 concepts and its limitations All the 3 concepts of elasticity of demand are relevant to the supermarkets to a certain extent. The concept of price elasticity of demand can be considered as useful in that it explains the price rigidity of supermarkets as oligopolistic firms which are mutually interdependent. As a result, supermarkets may be hesitant to increase or decrease the price of its products, they may instead follow the price set by the most dominant firm in the industry. Cross elasticity of demand is also useful as there are several supermarkets in the industry. Each supermarket is watchful over the strategies that their rival supermarkets are engaging in. They will tend react accordingly so as not to lose their customers. Income elasticity of demand is especially useful in the long run where the economic situation and income of the consumers changes. By offering a wide range of goods also serves to meet the changing consumer patterns resulting from rising affluence, the focus here is, therefore, on income rather than price as a determinant of demand. However, there are limitations with using elasticity concepts. Difficulty in estimating elasticity values Firstly, it is the ability to gather accurate data for analysis. Furthermore, precise figures might not be so readily available and even if they were, historical trends may not be adequate to correctly predict future ones. A normal good today might be an inferior good tomorrow. The data therefore must not be obsolete as the economy and preferences are not static but dynamic. Ceteris Paribus assumption does not hold Secondly, there are other factors that might be taking place concurrently, thus influencing the outcome predicted using the elasticity concepts. For example, even if there is a reduction in price for a price elastic good, its revenue may end up falling if other factors (eg. a change in taste and preference) cause the


demand to fall at the same time. The assumption of ceteris paribus is rarely true in real life and so elasticity estimates may be unreliable. Elasticity values explain the effect on Demand & TR but did consider TC Thirdly, demand elasticity concepts are only useful in explaining the changes in demand and revenue. The long term survival of a firm however depends on its profits. In other words, supermarkets must also keep a close watch on their costs especially as it expands its scale. Conclusion In the short run, the supermarkets may still use the 3 elasticity concepts to increase its total revenue although there are limitations. Supermarkets being oligipolistic firms, in the long run, they may be concerned with building up barriers to entry to increase their market share to increase their profits. By offering a wide range of products, supermarkets position themselves as a one-stop shopping place which provides convenience for customers, which enables them to capture a wider market thus increasing their profits. At the same time, they are maximising the use of their floor space, thus lower average cost. In so doing, they are building barriers to entry preventing new firms from entering into the industry.


Mark Scheme Essay Question 1 “The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub, offers a wider range of goods than the typical FairPrice supermarket, and includes new lines like electronic products and fashion wear.” (a) Explain how the scale of a firm influences its costs. [10] (b) Assess the relevance of price elasticity of demand, income elasticity

of demand, cross elasticity of demand to the supermarkets in Singapore. [15]

Part (a)

Knowledge, Understanding, Application, Analysis L3 For a well-balanced answer with both internal EOS (2), DEOS (1) and

external (1) economies of scale. Analysis is largely accurate and expressed rigorously. Only internal EOS and DEOS, no ext EOS up to 8m

8 - 10

L2 For a correct but underdeveloped explanation. Only internal EOS (3), no DEOS and no external EOS, up to 7m

4 – 7

L1 For an answer that shows some knowledge of internal economies of scale as cost advantages enjoyed by large scale production. Some conceptual errors.

1 – 3

Part (b)

Knowledge, Understanding, Application, Analysis L3 A well-balanced answer with both application of elasticity concepts and

consideration of other factors. Analysis is largely accurate and expressed rigorously. Good application of all 3 elasticity concepts & little or minimal evaluation

cap at 9

9 – 11

L2 Ability to apply elasticity concepts in analysis Low L2 application of elasticity concepts (7 – 8) High L2 a largely accurate application of elasticity concepts (5 – 6) Two elasticity concepts only cap at 8 One elasticity concept only cap at 5

5 – 8

L1 Mere definition of elasticity concepts. An answer that is more descriptive than analytical. May be laced with serious conceptual errors.

1 – 4

Allow up to 4 additional marks for Evaluation E2 Ability to assess the relevance of the elasticity concepts and recognize

the cost considerations for supermarkets. Recognise the exploitation of Ey on growth and sales. Attempt to write a reasoned conclusion to the question.

3 – 4

E1 Attempt at evaluating the limitations of the use of elasticity concepts in the supermarkets in Singapore.

1 – 2


Suggested Approach Essay Question 2 (a) Explain how, in economic theory, a firm in a perfectly competitive

market determines the price and output that would maximize profit. [8]

(b) Discuss whether this model of market structure is the most appropriate to explain the behaviour of firms in Singapore. [17]

Part (a) Introduction In general a perfectly competitive market is characterized by the fact that no single firm has influence on the price of the product it sells. A perfectly competitive market has several distinguishing characteristics: there are many buyers and sellers in the market; the commodity sold is homogeneous; there is free entry and exit from the industry; perfect mobility of factors of production; transport costs are assumed to be negligible; both buyers and sellers are independent in their decision making and there is perfect knowledge. Development 1. Explain that a perfectly competitive firm is a price taker

Due to the fact that there are many buyers and sellers in the market and a homogeneous product, no single buyer and seller can control the market and therefore has no influence over the market price of the product. Examples of perfectly competitive firms are vegetables stalls and money changers. Price is determined by the market forces of demand and supply and each has to accept whatever price that is prevailing in the market. Both the sellers and buyers are price-takers and there is only one market price at any one time. It is not possible for the seller to increase the price of the product by reducing his output as his clients can easily turn to other sellers. Similarly, no single buyer can have the ability to reduce price as he is only of the many buyers. Because of the vast number of buyers and sellers, buyers do not receive any preferential treatment. In addition, because the commodity is identical in the eyes of the consumers and they will not be able to tell whether the product comes from firm A, firm B or firm C. Products from different firms are perfect substitutes for the consumers, therefore, they are not prepared to pay more than that is prevailing in the market. Because of the homogeneity of the product, no firm can increase or decrease the price of its product above or below the market price without serious effects on its sales. If the seller were to increase price, he will lose all his customers as they can turn to other firms. Therefore, a perfectly competitive firm is a price taker and hence its demand curve (AR) is a horizontal straight line and also MR = AR = price.


2. Explain the determination of equilibrium output to maximize profit As a perfectly competitive firm is unable to determine price, it will seek to determine the output that will maximize its profits. There are two approaches to achieving profit maximization. Firstly, the total output approach where the firm aims to produce the level of output at which (TR- TC) is maximum. The second approach is the marginal approach where the firm maximizes its profits by producing up to the level of output where MC = MR. (MC must cut MR from below). MR refers to the change in a firm’s total revenue arising from the sales of one more unit of the product while MC refers to the increase in the total cost arising from producing the one more unit. If MC > MR, reduce output; If MC < MR, increase output.

Figure 1 shows a perfectly competitive market where the equilibrium price and quantity are determined by the interaction of the market demand and market supply. OP is the market-clearing price and this price is then taken by each of the firms. Because the market price is constant for each unit sold, the AR curve also becomes the MR curve. A firm maximizes its profits when MC = MR. The equilibrium output for the firm is thus OQe ie, the firms sells OQe quantity at OP price. With reference to Figure 2, profit maximising or equilibrium occurs when MR = MC at OQe where the last unit of output adds on as much to the firm’s revenue as it does to the cost. Therefore the profits cannot be increased further and thus the firm has achieved maximum profits. At OQ1, where MC < MR, the firm can increase its profits by expanding production to OQe since the additional cost arising from producing one more unit is less than the additional revenue from the sales of one more unit. On the other hand, at OQ2, where MC > MR, in order to maximise

output

Cost, Revenue, Price

AR = MR = P

output

Price

D

S

P

Figure 2: A Perfectly Competitive Firm Figure 1: A Perfectly Competitive Market

E

Q O O

MC

E Pe

Qee Q2 Q1


profits, the firm should cut down production to OQe as the additional cost arising from producing one more unit is more than the additional revenue from the sales of one more unit.

Conclusion In the short run, a firm in a perfectly competitive market is unable to determine the price, it will seek to determine the equilibrium output that would maximize profit by producing at MC = MR. In the long run, due to freedom of entry and exit of firms in the industry, the PC firm will have to adjust its output accordingly. In the worst scenario, where the AR < AC in the long run, the firms will have to shut down. However, perfect competition is a static model and the assumptions are most unlikely to be found in the real world. Part (b) Introduction Singapore is a small and open economy with firms of different models of market structure in the service and manufacturing sectors. There are four basic types of market structures: perfect competition; monopolistic competition; oligopoly and monopoly. They may differ in their behaviour through price and non-price competition as they seek to maximize profits. Development 1. Explain the Behaviour of Perfectly Competitive Firms in Singapore

Perfectly competitive firms are price takers as there are many buyers and sellers. They do not engage in non-price competition due to the homogeneity of the products. Examples of perfectly competitive firms are vegetables stalls and money changer. There is freedom of entry and exit of firms as it does not require much start-up cost to set up the vegetable stall or money changer. Any firm can enter or leave the industry at anytime it chooses. If the industry is making supernormal profits, new firms can enter. Similarly, any existing firm can leave if the industry is making losses.

The commodity is identical in the eyes of the consumers and they will not be able to tell whether the product comes from firm A, firm B or firm C. In the case of money changers, the money that is changed is the same be it from money changer A or money changer B. Products from different firms are perfect substitutes for the consumers, therefore, they are not prepared to pay more than that is prevailing in the market. Because of the homogeneity of the product, no firm can increase or decrease the price of its product above or below the market price without serious effects on its sales. If the seller were to increase price, he will lose all his customers as they can turn to other firms.


Each firm has an insignificant share of the market and therefore has no influence over the market price of the product. Price is determined by the market forces of demand and supply. Firms are price-takers, i.e. they accept the prevailing price in the market. As the price is set by the industry and each firm takes the price as given and can sell as much as he wants at the prevailing price, there is no need to consider the actions of other firms. Hence the firms are mutually independent.

Evaluation The perfectly competitive firm model is not the most appropriate model to explain the behaviour of firms in Singapore due to its unrealistic assumptions. The products are not perfect substitutes for example, even though there are many vegetable stalls, the freshness of the vegetables may vary from stall to stall. Due to imperfect information, the prices among the various vegetable stalls or money changers may vary. Firms will not enter an industry if they are unaware of the supernormal profits currently being made, or if they underestimate the demand for the particular product they are considering selling. Even if they know of the supernormal profits and would want to enter the industry, there may be some barriers to entry for example; one has to obtain the license to set up the business. In reality, pure perfectly competitive firms do not exist. Due to imperfect knowledge and imperfect substitutes of products and services as well as the existence of barriers to entry, the more appropriate models of market structure would be the monopolistic competition and oligopoly. In Singapore, the behaviour of monopolistic competition are commonly exhibited in the service sector such as the Food and Beverage industry (egs restaurants and hawker stalls). Other examples are hair salons and fashion retail outlets. On the other hand, the behaviour of the oligopoly are commonly exhibited in the manufacturing sector such as automobile industry and electronics industry. Other examples are petrol retailing, supermarkets, banking and telecommunication service providers.

2. Explain the behaviour of Monopolistic Competitive firms in

Singapore There are many monopolistically competitive firms in the service sector. As a result, none of them is large enough to dominate the industry. Consider the number of hair salons, restaurants, hawker stalls, optical shops, spas, beauty salons and fashion retail outlets that are commonly found in a Singapore. The barriers to entry are generally weak. Although the monopolistic competitive firms has some influence on the price of the service or product they are selling, they avoid price competition as they are small in size and may not have the financial means to survive price wars. Engaging in price competition is thus detrimental to them, as such, they engage in non-price competition through product differentiation and other strategies so as to boost their sales and increase their profits.


a. Product differentiation Each firm's product is slightly different from the others in the industry, i.e. their products are close (though not perfect) substitutes egs clothings from Mango, Zara and Forever 21 etc. The firms highlight the differences in their products which may be real or imaginary. This is to influence consumers’ preference and demand for their product. Because of product differentiation, each firm is able to carve out a share of the market for themselves. If each were to increase its price each will not lose all its customers unlike perfect competition. In this sense, each of these small firms is said to have some monopoly power and hence faces a slightly downward sloping demand curve (though more elastic as compared to the case of a pure monopoly).

b. Non-price competition

The firms engage in non-price competition. Since each firm produces a similar but somewhat different product from the other firms in the industry, it has to emphasize the difference in order to increase sale. This is known as 'non-price' competition. It takes many forms. "Service with a smile" or "Buy $20 worth of Brand X and get a glass bowl free" are common examples. Advertising (promotional advertising) in local newspaper, shoppers' guides, online and other media outlets is common.

3. Explain the behaviour of Oligopoly in Singapore

An oligopoly is a market with only a few dominating sellers which is common in the manufacturing sector in Singapore, such as the automobile industry and electronics industry. Other examples of oligopolistic firms are Singtel, Starhub and M1 dominating the telecommunication market; Shell, Esso and Caltex in the retailing petrol industry; Cold Storage, NTUC Fairprice and Carrefour in the supermarket industry.

In pure oligopoly, the few firms produce a homogeneous product (eg petroleum). In imperfect or differentiated oligopoly (eg automobiles – different makes of cars), there is product differentiation through the use of established brand names and trademarks. (Toyota, Honda, Nissan) Oligopolistic firms engage in price and non-price competition to enlarge their market share and thus increase their profits.

a. Price Wars

Oligopolistic firms such as those in the petrol retailing industry in Singapore (Shell, Esso, Caltex) often engage in a price war. The individual firms outdo each other in price undercutting in an attempt to drive some of the firms out of the industry so that the remaining firms may each have a larger share of the market. Thus, the price of the product may even fall below the average variable cost of the firm in the short run (in the case of


predatory pricing). Survivors of intensive and prolonged price wars are likely to be those firms with larger resources.

b. Collusive Behaviour

To prevent a costly price war, a common price is often tacitly agreed upon by all firms in the industry. Oligopolistic firms may get together and agree to cooperate in setting prices and output levels. For example, SingTel, Starhub and M1 may agree on certain price range for the telecommunication services packages. They do so to maximise the industry’s total profit. In Singapore, the Competition Law is put in place to prohibit anti-competitive activities that unduly prevent, restrict or distort competition among firms.

c. Price rigidity

Because of the existence of only a few large players, the firms in such a market structure are heavily mutually interdependent. Actions by one firm will trigger off retaliatory / defensive measures by the other firms. For example, when one petrol company reduces the price of the petrol, its rival will follow suit. But when one increases the price of petrol, no one will follow. Either way, a firm is unable to increase its market share and TR by raising or lowering the price of its products. As such, prices may be rigid at a particular level – no firm wants to be the first to adjust the price.

d. Non-price competition

They engage in non-price competition through advertising, different packaging, better services and free gifts are some examples of promotional gimmicks firms resort to promote product recognition; product complexity and product proliferation.

i. Product recognition

A potential new entrant typically must introduce its product into a market where the products of existing firms are already well-known and established in the minds of consumers. A sizable advertising campaign is then needed which may mean that a very high cost is involved. In Singapore, brand consciousness is prevalent.

ii. Product complexity

For products such as automobiles, television sets, refrigerators, stereo equipment and many others, the very complexity of the product requires that consumers have more information about the product. It is not enough to recognise the product but also to know about the availability and quality of product service. Therefore, unless a new entrant into the industry is able to guarantee such service network, it may find great difficulty in entering. Consumers will buy from those with extensive and established dealer network which can handle major services and other product related


problems. Some examples in Singapore are the firms selling computers (Fujtsu, Acer, IBM etc) and cameras (Canon, Fuji, Panasonic) as they are service centres that provide after-sales services.

iii. Product proliferation

Each firm in the oligopolistic industry may produce many variations of the same product for example Nissan produces cars which have two doors or four doors, different colour combinations, different engine sizes and even station wagons. So each firm is able to capture and preserve its respective share of the automobile market from entry of new firms. A potential new entrant has to compete with the many kinds of automobiles already in existence. The oligopolistic firms often engage in R & D to further enhance its product recognition, complexity and proliferation. They are able to do so as they are large and enjoy economies of scale. Such a behaviour further builds up barriers to entry preventing new firms from entering. This enables them to enlarge their market share and increase their profits. Evaluation – Contrasting Monopolistic Competitive and Oligopolistic firms in Singapore Monopolistic competition market structure is an appropriate model in the service sector, for example the Food and Beverage industry and other businesses where personalised services are required such as the beauty care – spas, hair salons etc. Such firms remain small as there is not much scope for them to expand to enjoy economies of scale. Also, it is relatively easy to enter and leave the industry due to its weak barriers to entry such as low capital set up for a hawker stall or hair salon. On the other hand, oligopoly market structure is an appropriate model in the manufacturing sector, for example the automobile industry and electronics industry. There are few large firms dominating the industry for example in the automobile industry, the large players are Toyota, Honda and Nissan. There are strong barriers to entry in such industries with much scope for exploitation of economies of scale for example technical economies of scale.

4. Explain the behaviour of monopoly in Singapore

A monopoly is a market structure in which a single producer controls the whole supply of a commodity which has no close substitutes. An example in Singapore is the Singapore Power supplying utilities to the whole country. This is a case of a natural monopoly with a downward-sloping


long run average cost curve over the entire range of market demand. This means that the lowest average total cost is achieved if one firm serves the entire market. As there is only one firm, they do not engage in price or non-price competition. However, with the support of the government, they do engage in R & D to further improve on their product and services.

Conclusion Perfect competition is not an appropriate market structure to explain the behaviour of firms in Singapore. Instead monopolistic competition and oligopoly are more appropriate as their behaviour are exhibited in the service and manufacturing sectors. The people prefer choices and variety whenever possible which monopolistic competitive and oligopolistic firms provide. However, essential goods and services such as utilities are often produced by natural monopoly with government intervention to ensure that the poor are provided for. Also, to prevent the abuse of monopoly power, the government has set in place anti-trust laws and Competition Act to enforce healthy competition that will benefit the society at large.


Mark Scheme Essay Question 2 (a) Explain how, in economic theory, a firm in a perfectly competitive

market determines the price and output that would maximize profit. [8]

(b) Discuss whether this model of market structure is the most appropriate to explain the behaviour of firms in Singapore. [17]

Part (a)

Knowledge, Understanding, Application, Analysis L3 For a well-developed answer, illustrated with correct and well-labeled

diagram of PC firm and PC market.

6 - 8

L2 For a correct but underdeveloped explanation. No mention of key features or its link to PC as price taker.- up to max of 5m

3 – 5

L1 For an answer that shows some knowledge of the key characteristics of perfectly competitive market. Some conceptual errors.

1 – 2

Part (b)

Knowledge, Understanding, Application, Analysis L3 A well-balanced answer recognizing that perfectly competitive market is

not the most appropriate to explain the behavior of firms in Singapore. Analysis is largely accurate and expressed rigorously that the more appropriate models of market structure are monopolistic and oligopolistic competition.

10 – 13

L2 Ability to explain why PC is not the most appropriate and suggest the more appropriate models of market structure to Singapore by supporting with relevant examples. Correct but lacks in-depth analysis.

5 – 9

L1 Listing of features of market structures and examples. An answer that is more descriptive than analytical. May be laced with serious conceptual errors.

1 – 4

Allow up to 4 additional marks for Evaluation E2 Ability to justify that the more appropriate models of market structure are

monopolistic and oligopolistic competition and write a reasoned conclusion to the question.

3 – 4

E1 Ability to recognize perfectly competitive market is not the most appropriate to explain the behavior of firms in Singapore. Some attempt to justify the different types of market structures in Singapore.

1 – 2


Suggested answer Essay Q3 A new carbon capture and storage technique known as carbon sequestration is being developed. This involves capturing greenhouse gas pollution from power stations and locking it deep beneath the ground. (a) Explain why greenhouse gas pollution from power stations are likely

to cause market failure. [8] (b) Assess the policies that the Singapore government currently adopts


(a) Explain why greenhouse gas pollution from power stations are likely

to cause market failure. [8]

>> Step 1: definition The power stations, through the burning of fossil fuel, adds on to greenhouse gas emission. This is a clear case of negative externality -- negative effects of production or consumption which fall on people other than the producers or consumers. >> Step 2: use examples The external cost includes more frequent and more severe hurricane damage, reduction in fish catch due to the global warming. When there is a negative externality, the community bears costs additional to those borne by the individual firm or consumer. The MSC of the activity exceeds the MPC. The negative externality is said to drive a wedge between MSC and MPC. >> Step 3: why it constitutes market failure In the absence of any government intervention, negative externality creates a resource misallocation problem as producers will produce up to the point where marginal private benefit equals marginal private cost, ignoring the external cost of their actions. As producers do not face the full cost of their actions, they will produce in excess of the socially optimum level.

>> Step 4: graph


The private equilibrium is at Qptewhere MPB = MPC. Here, marginal social cost (aQpte) exceeds marginal social benefit (bQpte), i.e. production of the last unit adds more to society’s costs than to its benefits and the society would be better off with reduced production. In fact, to maximise society’s welfare, production should be reduced to the point where MSB = MSC. The welfare loss arising from the over-production is given by the area abc. The market fails because pareto optimality has not been achieved at Qpte.


Part (b) The main thrust through which Singapore reduces GHG is through improving energy efficiency. With an improvement in energy efficiency this allows the same output to be produced using lesser energy input. Approach 1: Answers organised according to the source of energy use Main fuel consumption comes from the following activities • power stations (51%) • industries (31.7%) and • transport (15.8%) In terms of electricity consumption • industries (43%) • buildings (31%) • households (18%) GHG emissions can be cut by reducing fuel and electricity usage in these activities i. Reduce GHG emissions in power generation

1. Natural gas has replaced oil as the major fuel used by power stations. 2. The by-product of power generation – heat – is harvested and sold to

industries that require heating in a process known as cogeneration. This reduces the need for additional electricity to generate heat. Cogeneration facilities and the firms will therefore have to be sited in close proximity to each other.

Evaluation As power stations are the main fuel consumers, cutting GHG emissions of power stations have the greatest leverage and is effective. However, there must also be efforts to control power usage by the end users

ii. Reduce GHG emissions in industries & buildings The most energy intensive industries in Singapore are the petroleum refining, petrochemical, electronics and pharmaceutical industries which are of strategic importance to the economy. Energy-efficiency is thus a cost-effective means of improving the competitiveness of Singapore’s industries. 1. Energy Efficiency Improvement Assistance Scheme funds up to 50%

of energy appraisals for buildings and industrial facilities. The energy appraisal can identify degraded plant components that contribute to overall efficiency losses and enable a company to take the necessary corrective actions.


2. A tax allowance is given to capital spending that results in more efficient energy utilization

3. From 2008 onwards, all new buildings and existing buildings undergoing major retrofitting works with gross floor areas above 2000m3 must meet the Green Mark certified standard (a green building rating system) with a possibility of enjoying cash incentives. Design features such as natural ventilation, natural light and vegetation can be added and the air-condition system configured to reduce energy use.

4. Singapore Certified Energy Manager Programme to train a pool of specialists energy managers, equipping them with the technical skills and competencies needed to plan and implement energy efficiency managers for companies.

Evaluation This encourages investment and R&D into energy efficient methods of production.

iii. Reduce GHG emissions in motor vehicles

1. Fighting vehicle emissions through ERP and providing better public transport system • Vehicles stuck in traffic burn more fuel. ERP, by reducing

congestion, reduces the burning of fuel by motor vehicles. 2. The Green Vehicle Rebate is given to buyers of green vehicle

• This reduces the relative price of green vehicles, encouraging more people to substitute these green vehicles with petrol-based vehicles.

3. Fuel economy labels inform buyers on the vehicle’s fuel economy, helping car buyers choose fuel-efficient car models. • The labels help to close the information gap for car buyers.

Evaluation • ERP does not discriminate between the oil guzzlers and the fuel-

efficient vehicles but imposes the same tax on all types of vehicles. This is clearly inefficient. To correct the negative externality, drivers should be taxed an amount equivalent of the marginal external cost. This gets the drivers to internalize the external costs thereby cutting down their driving. To this end, owners of oil guzzlers should be taxed at a higher rate to reflect the high GHG emissions of their vehicles to get them to reduce driving or to switch to more fuel-efficient vehicles which are taxed less heavily.

• Despite the rebates, hybrid vehicles are still more costly than petrol-based vehicles and this may deter buyers. The recent increase in oil prices, however, has made the investment in hybrid vehicle cost-effective and encouraged more to make the switch.


• The labels not only attract buyers who want to continue to drive but are looking for “greener” vehicles but drivers who are looking for savings from more fuel-efficient cars. This further reduces GHG.

Approach 2: Answers organised according to the nature of policy Policies to tackle negative externalities can be categorised into: • Market-based solution • Command-and-control • Bridging information gap Market-based solutions: Use of taxes & subsidies to get “prices right”, i.e. so that prices reflect the true benefits & costs and private equilibrium will be in line with the socially efficient output. • Subsidies / tax allowance to buyers of ‘green’ vehicles • Subsidies / tax allowance for firms to engage in R&D • Raising the electricity tariffs in line with higher fuel costs • Petrol & diesel taxes Command-and-control solutions: • Green Mark certification standard Bridging information gaps: • Education & campaign on the ways to conserve electricity • Mandatory energy-efficiency labels for air-conditioners and refrigerators • Singapore Certified Energy Manager Programme to train a pool of specialists

energy managers Others • Promoting renewable energy, by investing in R&D and test-bedding to

improve their performance and cost-effectiveness. This includes the setting up of research institutes, provision of funds and test-bedding platforms

• International cooperation e.g. sharing of technology and best practices … whether the government should finance the development of new technology such as carbon sequestration In general, countries can reduce their GHG emissions in the following ways: • increasing energy efficiency; • using less carbon-intensive fuels; and • increasing carbon 'sinks' such as forests Carbon sequestration is an example of carbon ‘sinks’ where CO2 is captured and stored, offsetting the country’s emissions.


Whether the government should finance the development of any new technology depends on its estimation of the benefits against the cost. While there are overall benefits to carbon sequestration, actual benefits to Singapore may be somewhat limited as most of the benefits are external. Carbon capture technique to reduce the GHG concentration in the atmosphere, slowing down the global warming, benefiting all countries. And while the benefits are diffused, the costs are likely to be high, particularly since the technology is only in its infancy. In so far as the costs outweigh the benefits to Singapore, the government can do better by spending on alternative projects. Even if the benefits exceed the costs, the case may not be strong enough to justify spending on carbon sequestration. Such spending involves an opportunity cost – the government could have used the funds on other projects. To determine whether the government should finance the development of a technology such as carbon sequestration, it needs to weigh the net gains from carbon sequestration to the net gains from alternative projects e.g. improving energy efficiency & using less carbon-intensive fuels (e.g. LNG instead of petrol). Other than reducing GHG emissions, the move towards improved energy efficiency has other benefits. In addition to greenhouse gas emissions, the burning of fossil fuels also generates air pollutants such as sulphur dioxide and particulate matter. By adopting more efficient technologies or practices we can reduce these pollutants and improve air quality as well. Improving energy efficiency will result in overall cost savings to businesses, helping Singapore to maintain its competitiveness in the long term. Right now, Singapore is almost totally dependent on imported fossil fuels for her energy needs. Through improvement in energy efficiency, Singapore will be less reliant on imported fossil fuels (making the economy less vulnerable to increase in the international prices of these fuels) and defer the need for installing new energy infrastructure.


Mark Scheme Essay Q3 A new carbon capture and storage technique known as carbon sequestration is being developed. This involves capturing greenhouse gas pollution from power stations and locking it deep beneath the ground. (a) Explain why greenhouse gas pollution from power stations are likely

to cause market failure. [8] (a) Explain, with examples, the meaning of private costs and external

costs. [8] (b) Assess the policies that the Singapore government currently adopts


Part (a)

Knowledge, Understanding, Application, Analysis L3 For an answer that clearly explains the spill-over effects on the

third party and the impact on resource allocation, all in the context of the power generation. Effective use of graph to explain resource misallocation and welfare loss. 7 m effective use of graph 8 m need to explain the significance of MSC > MSB and the reason for over-production (that private decision-making ignores the external costs).

7 – 8

L2 For an accurate though undeveloped explanation of the theory There is evidence of an ability to identify facts, some ability at graphs, fair ability to apply the concept of negative externality in the context of power generation. High L2 noted and explained the divergence between MSC and MPC, noted the divergence between MSB and MSC though there was no reference made to the graph. Noted the area of welfare loss with weak attempt at explaining. Low L2 showed the divergence in the graph without explanation

4 – 6

L1 For an answer that shows some knowledge but does not indicate that the meaning of the question has been properly grasped. Basic errors of theory or an inadequate development of analysis may be evident. Mainly definitions with graph that is drawn but not explained.

1 – 3


Part (b)

Knowledge, Understanding, Application, Analysis L3 Use of sound economic analysis to explain at least 3 policies and

their limitations with constant reference to the Singapore context Weigh the costs and benefits of financing the development of new technology against alternative measures of emissions [Answer to the first part largely theoretical in nature with limited reference to the context + good attempt to consider the 2nd part of the question - up to 10m]

10 – 13

L2 Attempts to use economic analysis Explanation of policies and their limitations Answers at the top end of the mark range need to make some reference to the Singapore context & weigh the costs and benefits of financing the development of new technology [Answer to the first part largely theoretical in nature with limited reference to the context + feeble attempt to consider the 2nd part of the question - up to 7m]

5 – 9

L1 Answers are descriptive Ability to list policies but the economic analysis of the policies is lacking or erroneous.

1 – 4

Allow up to 4 additional marks for Evaluation E2 Judgement based on analysis, providing a reasoned conclusion

based on well-considered comparison. Shows awareness of Singapore’s constraints and how this favours one policy over another.

3 – 4

E1 Mainly unexplained judgements. Analysis is largely evaluative but lacking in comparison, providing an unconvincing conclusion.

1 – 2


Suggested answer Essay Q4 The Singapore economy continued to expand at a healthy pace of 6.7% in the first quarter of 2008. Employment expanded strongly, increasing by 68,000. …… Oil and food prices have risen more rapidly and are expected to continue to increase. Consumer price inflation trended upwards to 7.5% in June 2008.

Source: MTI, 10 July 2008 (a) Explain the likely causes of inflation in an economy. [10] (b) Discuss whether monetary policy is the best policy to curb inflation

in Singapore. [15]

Part (a) 1. Introduction

Define inflation - Inflation is defined as a situation in which there is a sustained and inordinate increase in the general price level 2 main types of inflation in industrialised economies - demand-pull & cost push inflation/imported inflation

2. Demand-pull inflation - It is a situation where AD persistently increases and is greater than AS when the economy is near or at full-employment. When AD rises and is in excess of AS, consumers will be willing to pay a higher price to get the goods and services they want. Businessman would take advantage of the situation and raises the prices of their goods and services. This causes an upward surge in prices of gds and services. - Use AD-AS diagram to explain

Price Level AS

YF

P0

P2

AD0

AD2 AD1

P1

NY

Fig 1


Figure 1 illustrates an ↑ in AD from ADo to AD2, pulling GPL upward without any ↑ in real output. So a persistent ↑ in AD will generate a sustained & inordinate ↑ in GPL - Keynesian economists believe any increase in the components of AD will cause demand-pull inflation, i.e increase in C (rising incomes, economy continued to expand), I (business confidence, tax incentives), G (expansionary FP) and net exports (opening up of export markets, more FTA, globalization). The more inelastic the AS, the greater the increase in the GPL. When is AS inelastic? When there are structural rigidities This is common in developing countries due to the presence of structural rigidities like shortage of capital or skilled labour or inflexible government policies that hamper an ↑ in AS. Demand-pull inflation occurs alongside with structural unemployment. AS is unable to respond to ↑ in AD. - Monetarists believe that demand-pull inflation is due to an increase in money supply. At full employment, increase in money supply increase in spending increase in AD

3. Cost push inflation - Define cost-push inflation: Cost-push inflation is defined as a situation when there is a sustained ↑ in the cost of production. - Using AD-AS diagram, explain how persistent increase in costs can lead to cost-push inflation

- Figure 2 shows the economy if initially at price P1 and output Y1. An ↑ in the cost of production will shift the AS curve to the left from AS1 to AS2 to AS3. Consequently a persistent ↑ in costs will shift the AS curve leftwards resulting in a sustained ↑ in GPL from P1 to P3 and national output drops from Y1 to Y3.

P3

NY 0

P1

Y1Y3

AD1

AS2

AS1

P2

Y2

Fig 2 P3

NY 0

P1

Y1Y3

AD1

AS2

AS1

P2

Y2

Fig 2

Price level AS3


- Explain sources of cost-push inflation

o Increase in prices of imported inputs [such as oil price hike] and consumption goods & services Crude oil is an important input for industrial production, generation of power and electricity, for petrol and diesel as well as manufacture of plastic by-products. Thus demand is price inelastic. Higher production cost SRAS fall cost-push inflation if firms pass the higher production cost to consumers by increasing their prices higher cost of living

o Wage push inflation

When trade unions bargaining for wages in excess of productivity increase increase unit cost of production firm pass on the higher cost by raising prices increase prices of final g&s trade unions demand for further wage increase so as to maintain the real income of its members firms experience higher production costs if give in to demands of trade unions wage price spiral as the process may repeat itself with trade unions asking for another round of wage increment

o Tax-push inflation

GST is inflationary because GPL ↑ independently of the state of demand. (note: this is a one-off increase after which GPL stabilizes at the higher level)

4. Conclusion Inflation is usually multi-causal. Once inflation is underway, it is not easy to identify the underlying cause.

Part (b) 1. Introduction

- In Singapore, exchange rate is used as an instrument of its monetary policy - Define exchange rate

It refers to the external value of a currency in terms of another currency [OR exchange rate is defined as the price at which one currency exchanges for another]

- State your stand: Exchange rate policy is one of the effective policies, but not the best. It

is necessary to consider the nature or causes of inflation.


- Interest rate policy has limited effectiveness as Singapore has a small domestic DD and our interest rate has to move in tandem with the interest rates of our major trading partners. Moreover, changes in interest rates would cause changes in the exchange rate. Thus, it is not possible to control both.

2. Thesis: Explain how a modest and gradual appreciation of S$ can help to curb inflation The MAS policy is to maintain a modest and gradual appreciation of S$. [Managed Float exchange rate, measured against a trade-weighted basket of the currencies of her major trading partners]. Singapore lacks natural resources and with a small domestic market, is highly dependent on foreign market for her exports of its finished products and imports of raw materials for its production process and many final consumption goods and services. As the oil price hike and rising food prices are expected to continue, a modest and gradual appreciation of S$ can help to buffer Singapore against imported inflation and dampen the impact of imported inflation It reduces inflation via changes in import prices Appreciation of S$ imported crude oil and factors of production are relatively cheaper reduces production costs reduces prices of locally produced final goods that make use of imported factors of production curb inflation. Appreciation of S$ reduces the price that domestic consumers have to pay for imported goods curb inflation It reduces inflation via changes in aggregate demand Appreciation of S$ raises the price of Singapore’s exports in terms of foreign currencies, thus making our exports less competitive. Assuming the demand for our goods is price elastic, the increase in export prices will bring about a greater than proportionate decrease in quantity demanded, reducing TRX. Appreciation of S$ lowers the price of imports in Sing dollar terms. Again assuming elastic demand, the decrease in import prices will bring about a greater than proportionate increase in quantity demanded, increasing TEM. Overall, net exports fall, relieving dd-pull inflation. Viewed in another way, domestic demand will be reduced by the substitution effect as lower prices for imports decrease the demand for locally-made goods. This will lower demand-pull inflation on domestically produced goods.


Lower domestic prices could also result in less likelihood of workers asking for higher wages. Evaluation: o Transmission Lags

It takes time for changes in the exchange rate to work its way through the economy depending on the speed and extent with which importers and retailers pass through the price changes to consumers and the structural features of the economy.

o Maintenance of a Large Foreign Reserve Large foreign reserves have to be maintained by MAS to support the exchange rate policy and to build investor confidence in the strength of the Singapore Dollar. In the LR, the foreign reserves may be depleted.

o Exchange rate policy may not be effective in curbing demand pull

inflation, tax push inflation or wage push inflation, arising from an increase in increasing aggregate demand or money supply.

3. Anti-thesis:

Explain how SS-Side policy can help to curb inflation Inflation can also be induced by insufficient growth in productive capacity and structural rigidity and thus requires supply side policies. Singapore government implements a range of supply side measures to curb cost push inflation and demand-pull inflation. i) Promoting education and training Promoting education and training will increase productivity. This will help increase supply of goods at a lower cost of production. With the availability of skilled labour and various fiscal measures, such as cuts in corporate taxes, Singapore is an attractive centre for FDIs. The increase in productivity and inflow of foreign direct investments will raise the productive capacity of the economy, thus increasing long run AS. Hence, cost push inflation can be curbed. The expansion of productive capacity also allows prices to stay constant even as AD rises, thus relieving demand-pull inflation. Evaluation: It requires long gestation period before the returns on investment are seen. Moreover, it requires time for workers to obtain education and skills. The transfer of training into actual productivity gains need to be considered. There is also a lack of incentive for private companies to send workers for training.

The cuts in corporate taxes in order to attract investment have resulted in the government raising indirect taxes such as GST in order to avoid a


budget deficit. Increases in indirect taxes are regressive and may increase income inequality. ii) Increasing availability of substitutes Reduce dependence on crude oil as the only energy source and diversify to alternate forms of energy, e.g. liquefied natural gas. The availability of substitutes raises the price elasticity of oil and reduces imported oil inflation Evaluation: It is a long term measure. Despite the painful lessons from the global oil crisis of the 1970s, Singapore and many other countries are still heavily dependent on crude oil. For a number of reasons, it may not be viable or cost effective to generate nuclear, solar and thermal energy in Singapore.

iii) Using short run policy This involves the government varying its expenditure and taxation to help to lower the cost of production. Fiscal spending (increase G) to subsidize oil importers on condition that they will not pass on higher energy costs to the rest of the economy and consumers. Together with an increase in AS, demand-pull inflation could also be curbed. Evaluation: This will benefit oil consumers in the short term. Moreover, the Singapore government has the means to subsidize because it has accumulated substantial fiscal reserves over many years. But over the long term, the appropriateness and sustainability of continuing to use taxpayers’ money to compensate a few oil-importing firms becomes questionable. Such government intervention distorts the market. Also, subsidies will delay oil producers to switch to alternative energy and the adoption of energy-efficient technology, resulting in deadweight loss of providing subsidies. The Singapore government would thus avoid giving subsidy.

4. Anti-thesis:

Explain how incomes policy can control wage push inflation Keep business cost low by keeping labour costs under control and flexible, e.g wage adjustments in line with productivity growth, CPF adjustments, maintaining good tripartite relations, lower corporate taxes. National Wage Council sets guidelines recommending that wages increase in tandem with productivity increases. In this way, wage push inflation is controlled. Evaluation: However, productivity increases may vary across different industries and hence a guideline recommendation may not be applicable to all industries.


5. Conclusion The exchange rate policy, despite its limitations, has been successful in curbing imported inflation to some extent. A modest and gradual appreciation of S$ is able to reduce inflationary pressure and allows the economy to sustain its competitiveness. As inflation is usually multi-causal, the government needs to implement other policies such as SS-side policies, incomes policy and FP. While short term measures may not be viable if the oil prices were to continue to increase in the near future, long term policies will be the more appropriate measures to take to ensure sustainable price stability. For any policy to be effective in curbing inflation, there is a need to continually monitor the major root causes of inflation.


Mark scheme Essay Q4 The Singapore economy continued to expand at a healthy pace of 6.7% in the first quarter of 2008. Employment expanded strongly, increasing by 68,000. …… Oil and food prices have risen more rapidly and are expected to continue to increase. Consumer price inflation trended upwards to 7.5% in June 2008.

Source: MTI, 10 July 2008 (a) Explain the likely causes of inflation in an economy. [10] (b) Discuss whether monetary policy is the best policy to curb inflation

in Singapore. [15]

Part (a)

Knowledge, Understanding, Application, Analysis L3 Well-developed explanation of the causes of demand-pull, cost

push & structural rigidity inflation, supported by well-drawn diagrams. Suggest a range of likely reasons for changes in both AD & AS.

8-10

L2 Undeveloped explanation of demand-pull & cost push inflation, supported by well-drawn diagrams

4-7

L1 For an answer that shows some knowledge of the causes of inflation. Smattering of ideas.

1-3


Part (b)

Knowledge, Understanding, Application, Analysis L3 Well-developed explanation & analysis of how a modest and

gradual appreciation of S$ can curb inflation. Answers that gave a range of policy measures to tackle its inflation that is multi-causal. Answers that explain limitations of each policy. At least 3 measures [Exchange rate policy & 2 other policies].

9-11

L2 Undeveloped explanation & analysis of a modest and gradual appreciation of S$ can curb inflation. Brief explanation of 2 other policies in Singapore. 2 measures in Singapore – answer showing well-developed explanation & analysis – 8 marks.

5-8

L1 For an undeveloped answers that describes policies in Singapore to curb inflation. OR For an answer that explains policies to curb inflation, but policies are irrelevant to the Singapore economy.

1-4

Allow up to 4 marks for Evaluation E2 Evaluations and judgements based on economic analysis, such as

a modest appreciation of S$, characteristics of small & open economy. Recognizes the importance of exchange rate policy in curbing imported inflation. Accept alternative judgements, e.g. in the LR, supply-side policies will be more effective in curbing inflation and minimise trade-off of other policies.

3-4

E1 Judgments are mainly unexplained and unsupported by economic analysis. Shows awareness of limitations of policies and that there are other policies that could be used.

1-2


Suggested answer Essay Q5 The two casinos set to open in the Integrated Resorts in Singapore are part of the government’s longstanding effort to reorient the economy toward higher-value service industries like tourism and biosciences as it loses manufacturing competitiveness to China.

New York Times, 19 April 2005 Explain the rationale for the above policy and discuss whether it is the best policy to achieve the government’s macroeconomic goals in a globalised world. [25] Explain the rationale to “reorient the economy toward higher-value services industries” Loss of comparative advantage • Many countries, including Singapore, have lost their comparative advantage

in manufacturing to China with its abundant supply of labour who are willing to work for long hours at relatively low wages.

Effect on the macroeconomic goals • The shift in comparative advantage has repercussions on both investment

and exports: i. China has emerged as a more attractive destination for FDI, giving

Singapore a miss. Firms operating within Singapore are also shutting down their facilities here and relocating to China.

ii. With its lower cost of production and an under-valued yuan, exports from China are also cheaper relative to those from Singapore. Assuming a close degree of substitutability, demand for exports from Singapore will experience a greater than proportionate decrease as the relative prices increase.

• If nothing is being done about it, the loss of investment and export competitiveness may result in worsening BOP, an excess supply of the Singapore dollar in the foreign exchange market and a downward pressure on the Singapore dollar.

• For a country that relies on external demand to fuel its growth, the decline in FDI & export revenue will bring about sharp decline in the overall level of AD. Depending on the initial situation of the economy, a decline in AD may or may not be welcome. If the economy is facing demand-pull inflation, a decline in AD helps to curb the inflation. If the economy is not facing risk of over-heating, the reduction in AD may throw the economy into a recession with NY falling and UN rising. [graphs]


Explain the move to develop higher-value service industries like tourism and biosciences In view of the loss of comparative advantage in manufacturing, one solution is to move the resources into areas where Singapore has a potential comparative advantage as part of the country’s economic restructuring. The government hopes that investment and exports from the higher-value services industries will help to compensate for the loss in manufacturing and continue to provide growth and jobs for the local economy. The range of possible policies Policy to deal with the competitive pressure of globalisation

Evaluation

Develop higher-value service industries like tourism and biosciences • This involves the government

investing in the provision of infrastructure and training facilities. Fiscal incentives such as tax breaks could also be given to selected industries. For example, the government has built the Biopolis to house the various research institutes and laboratories and expanded intake into biosciences courses at the polytechnics and universities.

• The government might also relax certain rules. For example, the government has, for the first time, allowed casinos in the two integrated resorts.

Effect on the macroeconomic goals • Increase G, I and X • Improvement in CA and KA

balance • Increase in dd for Sing dollar ER

appreciation • Increase in AD increase in NY

and reduction in UN (reinforced by the multiplier & accelerator effects)

• Increase in AD may be inflationary in the SR

• Increase in AS in the LR non-inflationary growth

• Long gestation period – many years and months before the projects are completed and the facilities are ready

• This involves increased government spending which may result in budget deficit. Fortunately, Singapore has reserves accumulated from past surpluses. This helps to avoid deficit-financing problems such as crowding-out effect and higher national debt.

• May result in structural UN in the SR as workers who lose their jobs in the manufacturing sector do not have the relevant skills to be re-employed in the service industry

• Depends on attitude of workers towards the training. Even as more training opportunities in biosciences are made available, students may not necessarily enroll in these courses, depending on their interests. In many developed countries, physical sciences and engineering courses are losing in popularity to the softer options like liberal arts and social sciences.

• Compared to the countries in the region, Singapore has limited tourism resources e.g. beaches in Bali, rainforest in Sarawak, historical relics such as Angkor


Wat. Whether the construction of the integrated resorts with casinos will be sufficient to draw tourists is still uncertain. Besides, competitors, with their huge expanse of land, can build many more of such resorts.

• In contrast, the biomedical and pharmaceutical exports have shown strong growth. But biosciences, while helping to create high-end jobs, do not require huge labour force. It is also difficult to train workers with only secondary school education for jobs as researchers.

Exchange rate policy • To be competitive with the

emergence of China, MAS can devalue the Singapore dollar.

Effect on the macroeconomic goals: • PX decreases in foreign currency

terms, leading to a more than proportionate increase in quantity demanded, assuming dd for X to be elastic. TRX thus increase. At the same time, PM increases in domestic currency terms, leading to a more than proportionate decrease in quantity demanded, assuming demand for M to be elastic. TEM thus falls.

• Investment in Singapore will be cheaper in terms of foreign currencies, attracting more FDI.

• With an improvement in both CA and KA, BOP improves.

• As net exports and I increase, AD rises, bringing about increase in NY and employment. The increase in AD could be inflationary if there are no idle resources or in the presence of structural rigidities.

• In the SR, dd tends to be inelastic for reasons such as time required to collect info on prices & source for substitutes. As such, the CA could worsen in the SR can bring about a contractionary effect on the AD.

• While the weakening Sing dollar may help to restore the economic competitiveness somewhat, it puts Singapore at risk of higher imported inflation. Given the high import content of Singapore’s exports, the benefits of a weaker exchange rate on export competitiveness is also questionable.

• The move by MAS to devalue the Sing dollar could be countered by competitive devaluation of the other currencies.


Policy to deal with the competitive pressure of globalisation

Evaluation

Supply-side policies Productivity improvement • Training, R&D, adoption of latest

technology or more efficient methods of production

• Encouraged by fiscal incentives e.g. subsidies, tax breaks, low interest loans, etc

• Productivity improvement helps to keep down unit labour cost (wage cost per unit of output) even as wages are higher than competitors

Effect on the macroeconomic goals • Productivity improvement enhances

the economy’s productive capacity, shifting the LR AS rightwards. Economic growth rises while inflation decreases.

• The reduction in inflation improves export competitiveness. As export prices fall, assuming dd for X to be elastic, quantity demanded increases by a greater than proportionate amount, adding on to the overall export revenue and the CA of the BOP. Productivity improvement also attracts FDI, adding on to the KA.

• The increase in X & FDI creates greater demand for S$, pushing ER upwards.

• The FDI also helps to reduce unemployment and further adds on to AD in the SR & AS in the LR.

• Long gestation period – particularly for R&D

• The local pool of research scientists and engineers is limited.


Policy to deal with the competitive pressure of globalisation

Evaluation

Incomes and wages policies • Incomes policy, by keeping labour

costs down, helps to lower the overall cost of production. These include voluntary wage restraints and reduction in employers’ CPF contribution rate.

• Alternatively, the government could set guidelines on the rate of wage increases permitted. For example, wages may not be allowed to rise faster than the rise in labour productivity. This helps to check the unit cost of production in the face of low-wage competitors.

Effect on macroeconomic goals: • Keeps down COP increase in

SRAS reduce inflation & increase NY

• Lower labour cost less urgent for firms to resort to retrenchments to cut costs the maintain profitability

• Lower COP attracts FDI & improves X competitiveness improvement in BOP and appreciation of ER

• For such policies to work, there must be cooperation among the government, employers and trade unions. In Singapore, this tripartite body is the National Wages Council (NWC).

• The NWC wage recommendations may have limited effect because they are mere recommendations and firms are not obliged to observe the recommended wage restraints.

• Wages are downward sticky, i.e. wages tend to rise but not fall in reality. Firms may be reluctant to cut wages for fear of impact on workers’ morale and productivity. Another reason is that wage restructuring to raise the variable component of wages has limited success among private employers.

• Given that productivity growth varies across industries and even between firms of the same industry, to have one blanket wage recommendation for all firms may not be very useful.

• Where wages are reduced, this may spell hardship for the poorest workers.

• The reduction in wages depresses consumption and may cause NY to further contract and UN to rise.


Comparison of a range of possible policies • In a globalised world where new competitors emerge and comparative

advantage keep shifting, countries cannot always rely on devaluation to maintain their economic competitiveness. The use of devaluation weakens the incentive of domestic firms to innovate and improve on their efficiency in order to compete. Frequent devaluation will also lead to a loss of investors’ confidence. All these impede the LR economic growth of the economy. Devaluation, is at best, a short-run policy in response to rising competition.

• Similarly, where new competitors are constantly emerging, it is neither realistic nor possible to continuously cut wages to maintain competitiveness. The overall effect of wages policy on the level of AD and NY is also uncertain.

• In contrast, the policy of developing high-value service industries is important in response to the shifting comparative advantage in a globalised world – as Singapore loses its comparative advantage in traditional manufacturing, it needs to develop new areas of growth as a long term survival strategy. By moving up the value chain, this helps Singapore to avoid direct competition with China. However, the problem with “picking winners” is that government may not identify correctly the industries with the potential to develop comparative advantage. Picking the wrong winners results in resource misallocation and a lower standard of living.

• Despite the potential risk, the policy of developing higher-value service industries seems to be the best bet in a globalised world where comparative advantage are shifting rapidly as new competitors constantly emerge.

• However, one must note that it is not the movement towards higher-value service industries per se but constant economic restructuring that keeps the economy one step ahead of its competitors.

• Other than developing new areas of growth, existing industries can maintain their competitiveness through productivity improvement. After all, in terms of manufacturing wages, China is not the lowest. Wages in Bangladesh and Vietnam are even lower but China is able to continue to draw investment and outsell these other countries due to its more efficient infrastructure, higher labour productivity and the huge size of its domestic market. While the domestic market of Singapore is small, the eventual formation of the ASEAN Free Trade Area (AFTA) enlarges the size of the market, making it an attractive destination for FDI.


Mark Scheme Essay Q5 The two casinos set to open in the Integrated Resorts in Singapore are part of the government’s longstanding effort to reorient the economy toward higher-value service industries like tourism and biosciences as it loses manufacturing competitiveness to China.

New York Times, 19 April 2005 Explain the rationale for the above policy and discuss whether it is the best policy to achieve the government’s macroeconomic goals in a globalised world. [25]

Knowledge, Understanding, Application, Analysis L3 A clear understanding of the effects of the emergence of China

on the Singapore economy. Well-balanced argument which considers at least 2 other policies that the government can adopt to deal with the problems of globalisation, their effects on the 5 macroeconomic goals and the limitations. High L3 There must be a clear link between the policies and globalisation.

15 – 21

L2 High L2 Ideas are explained rigorously with evidence of sound economic analysis, for an answer that is lacking in scope but not in depth. Attempts at answering both parts of the question. Low L2 ability to apply some economic analysis and relate to some of the macroeconomic goals. Answer lacking in both scope and depth.

8 – 14

L1 Limited understanding of globalisation and the shifting comparative advantage with the emergence of China as a manufacturing hub. Answers are largely descriptive rather than analytical.

1 – 7

Allow up to 4 additional marks for Evaluation

E2 Judgement based on analysis, providing a reasoned conclusion based on well-considered comparison of alternative strategies.

3 – 4

E1 Mainly unexplained judgements. Analysis is largely evaluative but lacking in comparison, providing an unconvincing conclusion.

1 – 2


Suggested answer Essay Q6 (a) Using economic theory, explain why there are gains from free trade.

[10] (b) Discuss how exchange rate changes may affect a country’s

international trade. [15] Part (a) 1. Introduction

Free trade is defined as the exchange and free flow of goods and services between countries, unhindered by government imposed restrictions or protectionism measures.

2. Using either the Theory of Comparative Advantage or Demand &

Supply Analysis, explain why there are gains from free trade. Using Theory of Comparative Advantage The theory of comparative advantage states that a country should specialise in the production of the good if it incurs a lower opportunity cost in the production of that good. It states that even though a country has absolute advantage over the other in producing both goods, trade will still be beneficial if the opportunity cost ratios are different. a. List assumptions of the theory

- Zero transport costs - No trade barriers - Perfect factor mobility within the country

b. Details on the theory of comparative advantage Not required to give tables. Explanation should include the following: - Amount of resources - Opportunity cost ratios, lower cost of production - How complete or partial specialization will result in higher

production level for both countries and world output - How TOT is determined [TOT must lie between opportunity costs

ratios] - How IT, based on acceptable TOT, will result in higher output in the

production of both the products, higher consumption levels & SOL for both countries.

- Higher world output with free trade - Free trade enables a country to specialize in the production of

goods & services in which it has a CA, & hence mutual gains from free trade.


Comparative advantage Lower costs of production High export competitiveness High exports of that particular good from that country. Limitation: However, the assumptions made in the theory of comparative advantage are unrealistic.

OR Using Demand & Supply Analysis In a perfectly competitive market, the price of a good, which is determined by the interaction of demand and supply, plays an important role in influencing pattern of trade and achieving mutual gains. For simplicity sake, let us assume a two-country scenario: US and China. With reference to the diagram, the domestic equilibrium price of textiles in China is lower [at P1] than that of US [at P2].

In this case, it is cheaper for US to import textiles from China than to produce it at home. China is the exporter of textiles and US is the importer of textiles. The price at which trade will take place between the 2 countries will be between P1 & P2. At P3, imports of textiles by US exactly equal the exports from China, as illustrated by ab.

Benefits of trade to China: Compared to the case without trade, Chinese producers are able to

sell more (Q1 to Q3) and charge a higher price (P1 to P3) increase in producer surplus

Price of textiles

Quantity

Price of textiles

Quantity

China US

P1

0 0D

a

D

S

P2

P3 a bb

Q1 Q3

P3

Q2 Q4

Total welfare gain from trade


Benefits of trade to US: Compared to the case without trade, US consumers now get to

enjoy a higher quantity of goods (Q2 to Q4) at a lower price (P2 to P3) increase in consumer surplus

3. Explain other gains from Free Trade

a. A wider range of goods for consumers greater consumer choices greater satisfaction of wants higher SOL

b. Free trade enables a country, e.g. China, to specialize in the production of goods & services in which it has a CA, & hence exploiting EOS and lower AC which can be passed onto developed economies in the form of lower prices, c.p.

c. Lower prices of goods & services increase in consumers’ surplus in countries that trade.

d. Increased competition stimulates greater efficiency at home. It may stimulate greater research and development and rapid adoption of technology, thus lowering production costs which can translate into lower prices for consumers. Moreover, higher output and greater variety of goods are made available for consumers, raising SOL.

e. If the domestic market is small, it will not encourage production. With IT, the size of the market is enlarged. It will act as an incentive to produce and invest. Exports generate income & employment. The increase in employment and income creates an increase in demand for domestically produced goods in the country which further stimulates the growth of the local industries. Hence, this country gains from export-led economic growth, higher N & higher SOL.

4. Conclusion

According to the theory of CA, gains from free trade are possible if the opportunity cost ratios are different. Countries should specialise in the production of the good if it has a lower opportunity cost in the production of that good. Gains from trade can also be explained by using the demand and supply framework.

Part (b) 1. Introduction

Define exchange rate and international trade Exchange rate refers to the external value of a currency in terms of another currency [OR exchange rate is defined as the price at which one currency exchanges for another] International trade refers to the exchange of goods and services between countries.


While exchange rate is a significant determinant of international trade, it is not the only one. There are other factors which could affect trade between countries.

2. Thesis: ER changes is an important factor affecting international trade

Explain why exchange rate has influence on a country’s international trade It is because a country is usually required to pay in the foreign sellers’ currencies. Thus, the cost of an import or export includes the price of the good and the currency used. At times an export may be relatively cheap, but a strong currency makes it costly in other countries. Changes in exchange rates can affect a country’s terms of trade. TOT is the rate at which a country exchanges its exports for imports. With an appreciation of the country’s currency, its TOT has improved and is favourable. For a given amount of imports, the country needs to export less. Explain how an appreciation or revaluation of the domestic currency can affect exports & imports of goods & services

Appreciation of the domestic currency can affect trading of goods and services between countries. With the appreciation of the domestic currency, exports are now relatively dearer to foreigners while imports are now relatively cheaper to locals. When the price of exports increases in terms of foreign currencies, qty demanded of exports decreases by more than proportionately, assuming demand for exports to be elastic. This will reduce TRx and volume of exports. When the price of imports decreases in terms of domestic currency, qty demanded of imports increases by more than proportionately, assuming demand for imports to be elastic. This will increase TEm and volume of imports. This will cause a worsening of the balance of trade. Evaluation However, in the SR, demand of exports and imports may be inelastic.

It takes time to find substitutes or adjust consumption habits. The ER appreciation will thus bring about an improvement in the trade balance in the SR.

Also, trading in goods & services may not be that severely affected by the ER appreciation if firms are able to maintain their export competitiveness by improving their productivity and cost savings passed on as lower prices. Moreover, a stronger currency leads to cheaper imported inputs which aids export competitiveness for firms


that are dependent on imported inputs. Volume of trade may not be adversely affected. If the country is able to import cheaper capital goods it will increase her productive capacity in the long run, thus expanding her exports.

Similarly, revaluation of the currency by the government can also affect international trade. It is a deliberate action by the government to strengthen its currency if it is running an undesired trade surplus with other countries. Revaluation will raise the price of the country’s exports in terms of foreign currencies and decrease the quantity of exports. At the same time, it will lower the price of imports in domestic currency and increase the quantity of imports.

Hence, a strong and persistent appreciation or revaluation of its currency can erode whatever comparative advantage a country had in some exports and thus reduce exports. Converse holds true for depreciation or devaluation of the domestic currency. With the depreciation of the domestic currency, exports are now relatively cheaper to foreigners, thus increasing its exports. On the other hand, imports are now relatively dearer to locals, thus reducing its imports. [to take note of elasticity considerations]

3. Anti-thesis: Besides ER changes, there are other factors affecting

international trade (i) Explain how globalisation can affect international trade

Protectionist policies e.g. tariffs and import quotas, in contrast, reduce or restrict trade flows between countries by artificially raising the prices of imports. The shift towards globalization however has changed the economic landscape. Forces shaping globalization: A number of innovations have developed to reduce the transport costs

and promote greater trade between countries. For example, containerisation and bigger ships built makes it easier & cheaper to transport physical products around the world.

The reduction in transport costs also makes it profitable for firms to outsource segments of production to different parts of the world increase trade in intermediate products.

Effect of globalization on international trade: As a result of the opening up of China, India and Eastern bloc countries, world markets and opportunities to export have expanded considerably for advanced economies and developing countries alike.


Developing countries’ imports have been growing faster than those of advanced economies.

Share of advanced economies’ exports going to developing countries has been on the rise.

Significant increase in the trade between developing countries. Developing countries’ share in world exports of skilled goods and

services has been on the rise in recent years.

Free trade agreements (FTAs) such as ASEAN Free Trade Agree and APEC make imports and exports of goods cheaper via the abolishing or reduction of trade barriers such as tariffs. FTAs also give the country greater access to overseas market, potentially increasing its exports. But FTA is a reciprocal agreement. Signatories of FTAs must also open up their domestic markets to imports by reduction in trade barriers. This lowers import prices of raw materials and increase supply of goods and services, thereby lowering prices of final goods and services for local consumption and exports.

Formation of trading blocs shifts the pattern and volume of trade between countries. It stimulates trade between member countries and diverts trade from non-member nations.

(ii) Explain how demand and supply factors can affect international

trade

a. Demand factors Demand factors, such as changes in population, income, tastes & preferences are increasingly important in explaining the pattern of trade between countries

Examples Emerging economies such as China: increase in population and

growing affluence increase in demand for many goods and services, including agricultural products.

Brazil is one of the major suppliers of agricultural products, such as soya beans, for China opportunity for Brazil to increase its agricultural production increase volume of trade between Brazil & China

b. Supply factors

Supply factors such as improvement in technology and innovation lowers production and increases production efficiency. Other than factor endowments, technological changes will also affect the comparative advantage of a country. More output can be produced at each possible price level, thus expanding volume of trade.


8. Conclusion Frequent changes in exchange rate can lead to unstable currency and thus disrupt international trade. Both foreign & local investors and producers as well as traders are uncertain of future movements in exchange rates. Thus, it is difficult to make trading plans. In the LR, economic transactions between countries may be reduced. Exchange rate is but one of the factors affecting trade flows between countries. The increase in trade flows is predominantly a global or regional phenomenon as a result of globalization. As globalization gathers momentum and trade barriers gradually abolished, international trade flows of goods or services would be expected to be begin to flow gradually from countries which have a comparative cost advantage to countries with a cost disadvantage with the lower priced good in country B being exported to the high priced country A. With most nations committed to free trade and with the dismantling of trade barriers under WTO, international trade flows of goods, services, capital, and labour will continue to grow as a proportion of world GDP. This will increase interdependence between countries and their vulnerability to fluctuations in world trade.


Mark Scheme Essay Q6 (a) Using economic theory, explain why there are gains from free trade.

[10] (b) Discuss how exchange rate changes may affect a country’s

international trade. [15]

Part (a) Knowledge, Understanding, Application, Analysis L3 Well-developed explanation and analysis of either the Theory of

CA [using complete or partial specialization and in terms of opportunity cost] or the Demand & Supply Analysis. And well-developed explanations of at least 2 other gains from free trade.

8-10

L2 Undeveloped explanation of either the Theory of CA or the Demand & Supply Analysis. Shows some understanding that CA is based on opportunity cost. Explain how TOT is determined. Also include 2 other gains from free trade, without thorough explanation. If answers show one-sided explanation, cap at 7m. - either well-developed explanations on the Theory of CA/ Demand & Supply Analysis or at least 4 gains from free trade.

4-7

L1 For an answer which contains definitions and listing of facts concerning Theory of CA, Demand & Supply Analysis and other gains from free trade. Explain Theory of Absolute Advantage.

1-3


Part (b) Knowledge, Understanding, Application, Analysis L3 Well-developed explanation & evaluation on how exchange rate

changes and 2 other factors can affect a country’s international trade.

9-11

L2 Undeveloped explanation of how exchange rate changes and 2 other factors can affect a country’s international trade. Limited evaluation of how exchange rate changes and 2 other factors can affect a country’s international trade. If exchange rate changes & one other factor are explained with no evaluation, cap at 6m.

5-8

L1 For an undeveloped answer that focus on how exchange rate changes can affect international trade. Economic analysis is limited or erroneous.

1-4

Allow up to 4 marks for Evaluation E2 Evaluative assessment of frequent changes in exchange rate on

international trade. Reasoned judgement on relative importance of various factors affecting international trade.

3-4

E1 Unexplained assessment of frequent changes in exchange rate on international trade. Recognise the limitation of various factors affecting international trade.

1-2

2008 TPJC H2 Economics Prelim Exam Answers

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