2013 NJC H2 Econs Paper 2 (answers)

Essay Question 1

Sales of electronic cigarettes battery powered slim metal tubes - have doubled, attracting new firms into the market. Smokers of electronic cigarettes inhale the vaporised nicotine without the chemical, tar and smell inherent with conventional cigarettes. The market for conventional cigarettes has been in steady decline in recent years, and is still facing tax hikes imposed by governments around the world.

Adapted from theweek.com, 26 April 2013 Using demand elasticity concepts, discuss the likely effects of these changes on the revenue earned in the cigarette industry. [25]

Suggested Answer: Introduction

State that revenue earned is determined by equilibrium price and quantity in the market for both electronic (e-cigarettes) and conventional cigarettes.

Recognize that e-cigarettes and conventional cigarettes are substitutes in consumption and therefore revenue in one market is also affected by changes in the price of the substitute good. Body : Conventional cigarette market

Explain that a continuing tax hike by governments around the world increases the cost of production for conventional cigarette firms, there resulting in a fall in supply for conventional cigarettes.

Explain that the demand for conventional cigarettes is likely to be price inelastic, i.e Ep < 1, due to the lack of close substitutes and high degree of necessity for smokers addicted to nicotine. As such, an increase in its price will lead to a less than proportionate change in quantity demanded in conventional cigarettes, ceteris paribus. With reference to figure 1, given the relatively price inelastic demand curve of conventional cigarettes, a leftward shift of the supply curve from S0 to S1 results in a less than proportionate fall in quantity demanded from Q0 to Q1 to the increase in its price from P0 to P1, ceteris paribus. Revenue earned in the conventional cigarettes market increases as the rise in revenue (area A) due to the increase in price is greater than the fall in revenue (area B) due to the fall in quantity demanded.

E-Cigarette Market

Explain that the effect of changes in the e-cigarette market on its revenue is dependent on the values of Ep and Eab.

Ep

Explain that the demand for e-cigarettes is likely to be price elastic, i.e. Ep > 1. Smokers are likely to consider conventional cigarettes as a good substitute to electronic cigarettes. In addition e-cigarettes to social smokers, i.e. smokers who smoke only for leisure as part of a social group, is but one of many means / tools of socialising for them and therefore the degree of necessity is low in terms of consumption.

With reference to figure 2, as more new firms are attracted to the e-cigarettes market the supply of e-cigarettes producing firms will increase. Given the relatively more price elastic demand curve D0 , a rightward shift of the supply curve from S0 to S1 will see a more than proportionate rise in quantity demanded from Q0 to Q1 to the fall in price from P0 to P1 , ceteris paribus. Revenue earned in the e-cigarettes market will increase as the fall in revenue (area A) due to the fall in price is less than proportionate to the increase in revenue (area B) due to the increase in quantity demanded, ceteris paribus.

Figure 1 Market for e-cigarettes

Q0

Price

Quantity

S1

D0

S0

Q1

P0

P1 A

B

Eab > 0 (substitute in consumption)

Explain that both conventional and e- cigarettes are substitutes in consumption. This means that an increase in the price of conventional cigarettes will lead to an increase in demand for electronic cigarettes. However the extent of the increase in demand for e-cigarette is dependent on the value of Eab.

Explain that the cross elasticities of e-cigarettes with respect to conventional cigarettes is likely to be high and positive, i.e. Eab > 1. E-cigarettes and conventional cigarettes are strong / close substitutes for smokers addicted to nicotine, and therefore have high positive cross elasticities. A high and positive value of Eab means that for a given increase in the price of conventional cigarettes this will lead to a significant increase in the demand for e-cigarettes, ceteris paribus.

With reference to figure 3, as the price of conventional cigarettes increases, quantity demanded will decrease. According to the Law of Demand, there is an inverse relationship between price and quantity demanded, ceteris paribus. And as the quantity demanded for conventional cigarettes decreases, the demand for e-cigarettes will increase given that they are substitutes in consumption. And if Eab > 1, this results in a significant increase in the demand for e-cigarettes as illustrated by a rightward shift of the demand curve for e-cigarettes from D0 to D2.

Figure 2 Market for e-cigarettes

Q0

Price

Quantity

S1

D0

S0

Q1

P0

P1

D1

A

B

With 0 1 Markets for e-cigarettes and conventional cigarettes

D0

D2

Q2 Qty of e-cigarette

S0

Q0

P2

P0

Price of e-

cigarettes

D0

S0

Q0

S1

Qty of conventional cigarettes

Price of conventional cigarettes

P1

P0

Q1

Figure 1 Market for e-cigarettes

With reference to figure 4, as the price of conventional cigarettes increases, demand for e-cigarettes increases significantly since Eab > 1. The extent of the shift in demand is more than the shift in supply in the market for e-cigarettes, thereby giving rise to the resulting equilibrium price of P2 and equilibrium quantity at Q2. Revenue earned in the e-cigarettes market increases and is given by the area OP2E2Q2.

Explain that it is likely that demand for e-cigarettes is price elastic and that the cross elasticities of e-cigarettes with respect to conventional cigarettes is high and positive, i.e Ep > 1, Eab > 1 (due to the increasing awareness of healthy lifestyles). The extent of the shift in demand is likely to be more than the extent of the shift in supply in the market for e-cigarettes for sales of e-cigarettes have doubled which attracted new firms into the market.

On the whole, revenue earned in the cigarette market is likely to increase due to the increase in total revenues in both the conventional cigarette and e-cigarette markets. Conclusion / Evaluation Not all smokers addicted to nicotine consider e-cigarettes and conventional cigarettes to be strong / close substitutes in consumption. To these smokers, the experience of smoking from a metal tube (e-cigarettes) is unlike smoking the real thing (conventional cigarettes). To these smokers the overall experience of smoking a conventional cigarette is irreplaceable, from having to tap the conventional cigarette stick thereby packing in the tobacco to being able to taste the tobacco as they put that cigarette stick to their lips. As such, e-cigarettes and conventional cigarettes are weak substitutes with positive cross elasticities values ranging between zero and one, i.e. 0 < Eab < 1.

Figure 4: Markets for e-cigarettes and conventional cigarettes

Price of e-cigarette

S1 S0 Price of conventional cigarettes

S2

S0

P2 E2 P

1

P0

D2 P

0

D0

D0

0 Q0 Q1

Q1 Q0 Qty of conventional cigarettes

Qty of e-cigarette

Q2

The effect of changes on revenue in the markets for conventional and e-cigarettes depends on the values of Ep and Eab, as well as the relative extent of the shifts in demand and supply in the e-cigarettes market.

Knowledge of elasticity values in the respective markets allows cigarette manufacturers an opportunity to implement strategies aimed at increasing the revenue earned for their respective firms in the relevant market. Mark Scheme

Level Descriptors

Level 3 18 21 15 17

Answer shows excellent knowledge of demand and supply forces, and how revenue expenditure earned may be affected

Excellent consideration of elasticity concepts (must include BOTH Ep AND Eab) and its relevance in influencing revenue.

Excellent analysis of other possible scenarios where the overall total revenue may increase/decrease i.e. Analysis of different extents of shifts, demand and supply changes in the market for conventional cigarettes)

Excellent rigour in economic analysis and development.

Excellent use of diagrams that is adequately explained. Excellent attempts at contextualisation.

Good consideration of elasticity concept (must include BOTH Ep AND Eab) and its relevance in influencing total revenue.

Good rigour in economic analysis and development.

Good use of diagrams that are adequately explained.

Some attempts at contextualisation with some relevant examples.

Level 2 12 14 10 12

Answer shows good knowledge of demand and supply forces and how revenue may be affected.

Good consideration of elasticity concepts and its relevance in influencing market equilibrium.

Good rigour in economic analysis and development.

Relevant diagrams drawn with clear explanation.

Some contextualisation.

Some recognition that the extent of the shifts in demand and supply curves has an effect on price and hence overall revenue earned.

Answer shows adequate knowledge of demand and supply forces and how revenue may be affected.

Consideration of elasticity concepts and its relevance in influencing revenue (i.e. at least one elasticity concept).

Some rigour in economic analysis and development.

Relevant diagrams drawn but not well explained or clear explanation in absence of diagrammatical analysis.

Minimal or no contextualisation.

Possibly only 1 market analysed well and incomplete analysis for the other market (for example, the changes in demand and supply in the conventional cigarette market may be well explained but the

changes in demand in the e-cigarettes market was not well analysed or vice-versa)

Level 1 6 - 9 1-5

Answer shows some knowledge of demand and supply forces and how equilibrium price &/or equilibrium quantity may be affected in one markets.

Errors and inconsistencies occur in the explanation, showing lack of understanding of the economic concepts. (For example, if the changes in demand and supply in both markets may not be identified correctly or not explained correctly)

Answer lacks balance in consideration of demand and supply forces.

Lack of economic analysis and development

Minimal or no contextualisation.

Max 9m if analysis considers only equilibrium price and quantity with no reference to revenue earned.

Answer is mostly irrelevant.

Only few valid points which do not clearly address the question.

Evaluation

E1 (1-2)

For a mainly unexplained judgment on the likely effects on revenue in both markets.

E2 (3-4)

For well-reasoned judgment on the likely effects on revenue in both markets.

Essay Question 2

Singapore Post Limited (SingPost) has been steadily expanding beyond Singapore. It will continue to diversify its business and tap the overseas markets. Its online shopping platforms, vPOST and Clout Shoppe, will accelerate its expansion in the e-commerce business. Discuss how SingPosts growth strategies might impact SingPost, consumers and other firms in Singapore. [25]

Suggested Answer: Introduction: Identify SingPosts growth strategies as diversifying its business, expanding in the e-commerce business and tapping overseas markets, which can be seen as a form of vertical integration and horizontal integration. These growth strategies will diversify SingPosts goods and services as well as increase the level of competition in the e-commerce, international mail and delivery services industries, and have varied effects on consumers and other firms in Singapore. SingPosts expansion in the e-commerce business and diversifying its business is a form of vertical integration, which is an acquisition of the firm at different stages of production in the same industry. E-commerce is a type of industry where buying and selling of a product or service is conducted over the Internet. After consumers make online purchases, they will likely depend on postal services to deliver the products they have ordered. As for SingPosts entry in the overseas market, it can be seen as a form of horizontal integration which increases SingPosts scale of production in the postage and delivery services, as well as increases the level of competition in the mail and delivery industry. Body: Positive impacts: SingPost

Reap internal EOS (Any well explained sources of internal EOS) SingPosts growth will increase its scale of production and enable it to reap substantial internal EOS and gain cost advantages. These cost savings can help SingPost obtain greater profits (assuming ceteris paribus), and the cost savings could also be passed down to consumers in terms of lower prices. For example, the process of packing mail in SingPost could be made into a specialized one where different workers specialize in sorting, packaging, and delivering the mail to the different post offices. This would help to increase the productivity of the workers which would in turn lower the average cost of production as the output is being increased.

Increase total revenue (Any well explained reason)

Increase no of consumers By expanding in the e-commerce business, SingPost is able to diversify its business and capture a greater consumer base. SingPosts online shopping platforms, vPOST and Clout Shoppe provide consumers with more convenience and choices when they shop online. Increase Diversification Expanding in the e-commerce business allows SingPost to diversify its business and increase sales volume from new products and new markets. Product diversification involves addition of new products to existing products. These 2 factors could help to increase the demand for products provided by SingPost, which would in turn increase the total revenue earned by SingPost. Assuming cost conditions are kept constant, this could increase the profits of SingPost.

Dynamic efficiency SingPost is able to sustain its supernormal profit in the long run from its dominant position in the mail and delivery industry. Coupled with the probability of earning higher profit from diversifying its business and expanding in the e-commerce industry, SingPost is able to attain dynamic efficiency as it develops a more efficient production technique to produce goods and services, lowering its LRAC. This would increase the profits earned by SingPost, assuming ceteris paribus.

Consumers

Increase consumer choice and welfare SingPosts expansion in the e-commerce industry will increase the level of competition in the industry, and hence provide a greater variety of choices for the consumers to choose from i.e. a more competitive online shopping platform where consumers are able to gain access to more products and brands online. This enables consumers to choose better products that suit their needs, increasing their welfare.

Lower price, higher output and increase consumer surplus With the increased competition, demand for e-commerce services will become more price elastic due to the availability of more close substitutes. As such, firms in the e-commerce industry will have less market power to set price above marginal cost and restrict output sold, resulting in a lower price charged, and hence a higher consumer surplus.

Other firms

Less likely to suffer from X-inefficiency SingPosts entry in the overseas market will increase the level of competition in the mail and delivery industry. Dominant firms like United Parcel Service of America (UPS) and Deutsche Post DHL will face a stronger competition and a reduction of their supernormal profits earned in the long run. This will have

less incentive to be lax about cost controls and less likely to suffer from X-inefficiency.

Dynamic efficiency With the increase in the level of competition, dominant firms like United Parcel Service of America (UPS) and Deutsche Post DHL, including SingPost have more incentive to make use of their supernormal profits earned in the long run to engage in R&D and develop a more efficient method to produce goods and services (in order to maintain market share). As such, they are able to attain dynamic efficiency as more goods can now be produced from any given amount of resources. Costs are lowered and lower prices are charged to consumers.

Negative impacts:

SingPost

X-inefficiency As SingPost diversifies its business, expands in e-commerce and overseas market, and earns greater supernormal profits in the long run, it could be lax in cost controls and suffer from X-inefficiency. For instance, SingPost could pay large amount of rents to locate their offices in prestigious locations overseas or not use the most updated and efficient production methods. Such higher costs may be passed on to the consumers in terms of prices.

Other firms

Unable to reap internal EOS Smaller firms in the e-commerce industry will be left with less market share when SingPost enters the industry. They will not be able to reap substantial internal EOS(due to the lower quantities produced) to compete with SingPost and offer lower prices to consumers; hence they will need to rely on non-price strategies to compete, i.e. offering personalised services to consumers.

Decrease in total revenue With the increase in competition from SingPost, smaller firms in the e-commerce industry are likely to experience a fall in demand of their goods and services as consumers turn to SingPosts online platforms i.e. vPOST and Clout Shoppe which provide more attractive offers. Likewise, firms like United Parcel Service of America (UPS) and Deutsche Post DHL will now face a fall in the demand of their mail and delivery services, as SingPost diversifies its business and enters the e-commerce and overseas market. With a decrease in demand, and a more elastic demand (due to the greater availability of substitutes), lower prices will be charged. This could lead to a fall in total revenue for the other firms.

Overall : With an increase in total cost and a reduction in total revenue, profits of other firms will fall.

Forced to leave the industry The increase in competition when SingPost enters the e-commerce industry will result in smaller share of profits earned by the smaller firms. As such, they have no ability to devote their profits to Research & Development (R&D) efforts, which is essential in the e-commerce industry to provide consumers with better quality of goods & services. Examples of better quality and high technology services include domestic and international payment systems, efficient automated online assistants and order tracking. In the long run, these smaller firms will find themselves losing their consumers to SingPost and may not be able to remain in the industry. This is especially so as SingPosts dominant position in the mail and delivery industry will enable it to use its supernormal profits earned to innovate in high technology e-commerce services for its consumers, for instance providing both advanced data security and high frequency of page loads to increase the sales conversions and the number of shoppers checking out their online stores. This will affect the smaller producers, which do not have the relevant resources to engage in such non-price strategy, product differentiation and innovation to compete with SingPost and might be forced to leave the industry.

Consumers

Higher price If SingPost lax in cost control and suffer from X-inefficiency, these higher costs may be passed on to the consumers in terms of higher prices, such as higher postage and delivery fees or e-commerce sales charges. Likewise, firms in the e-commerce industry as well as mail and delivery services industry who now produce at a lower scale due to the fiercer competition faced from SingPost, may no longer be able to reap substantial internal EOS and enjoy the cost savings. Hence they have no choice but to charge the consumers at higher prices.

Decrease consumer choice and consumer surplus If the smaller firms in the e-commerce industry are able to compete with SingPost and are forced to leave the industry in the long run, consumers will be left with limited choice and access to products and brands online. On the extreme end, if SingPost capture a significant market share in the e-commerce industry, it might over exploit the consumers by charging them at high prices and restricting the output, decreasing the consumer surplus.

Evaluative Conclusion: SingPosts growth strategies will allow SingPost to diversify its goods and services, as well as increase the level of competition in both the e-commerce industry and international mail delivery industry. The increase in level of competition will benefit the consumers in terms of greater consumers surplus and welfare as they face lowered prices, greater availability of choices and quality goods in the markets.

However, the impact on producers will vary for SingPost and its competitors in the e-commerce industry and international mail delivery industry. In the e-commerce industry where a large number of smaller firms are present, the entry of a dominant firm like SingPost in the industry will have an adverse effect on these smaller firms in terms of their revenue and profits earned. They are unlikely to compete with SingPost which has the resources to engage in product innovation and differentiation to capture a greater market share, and get rid of its competitors. As such, these smaller firms will not be able to survive in the e-commerce industry in the long run, which might lead SingPost to over exploit the consumers, if it is left with significant market power in the e-commerce industry to do so. SingPosts strategies to diversify its business, expand in the e-commerce and overseas market will serve as threats to the dominant firms i.e. United Parcel Service of America (UPS) and Deutsche Post DHL in the international mail delivery industry. Yet, it is unlikely to drive these dominant firms out of business because their brands are very well-established, and hence their market power will remain relatively strong in the market. It will however, provide them with more incentive to be cost efficient and engage in product innovation to keep their market share, which will ultimately benefit consumers in terms of lowered prices and higher quality products. Mark Scheme

Level Descriptors

Level 3 (18-21) (15-17)

Answer shows excellent knowledge on the impacts of SingPosts various growth strategies

Excellent elaboration on the positive AND negative impacts on consumers, SingPost AND other firms.

Excellent explanation on the impacts on consumer welfare AND SingPosts AND other firms revenue AND cost advantages and their performances

Excellent rigour of analysis and minimal/no errors in elaboration.

Excellent use of diagrams to support elaboration.

Excellent contextual examples given.

Answer shows excellent knowledge on the impacts of SingPosts various growth strategies

Excellent elaboration on the positive AND negative impacts on consumers, SingPost AND other firms.

Excellent explanation on the impacts on consumer welfare AND SingPosts AND/OR other firms revenue AND/OR cost advantages and their performances

Excellent rigour of analysis and minimal/no errors in elaboration.

Excellent use of diagrams to support elaboration.

Excellent contextual examples given.

Level 2 (12-14)

Answer shows good knowledge on the impacts of SingPosts growth strategies

Good elaboration on the positive AND negative impacts on consumers, SingPost AND/OR other firms.

Good explanation on the impacts on consumer welfare AND

(10-11)

SingPosts AND/OR other firms revenue AND/OR cost advantages and their performances

Good rigour of analysis and minor errors in elaboration.

Good use of diagrams used to support elaboration but diagram analysis is weak.

Good contextual examples given.

Answer shows good knowledge on the impacts of SingPosts growth strategies

Good elaboration on the positive AND/OR negative impacts on consumers, SingPost AND/OR other firms.

Good explanation on the impacts on consumer welfare AND/OR SingPosts AND/OR other firms revenue AND/OR cost advantages and their performance

Some rigour of analysis but under-developed elaboration.

Some attempt to use diagrams to support elaboration but diagram analysis is weak.

Some attempt to provide contextual examples.

Level 1 (6-9) (1-5)

Answer shows some knowledge on the impacts of SingPosts growth strategies

Some elaboration on the positive AND/OR negative impacts on consumers, SingPost AND/OR other firms.

Some rigour of analysis and minor errors in elaboration.

Minimal or no diagrams used to support elaboration.

Minimal or weak contextual examples given.

Answer is mostly irrelevant

Answer shows some knowledge on the impacts of SingPosts growth strategies but little or no elaboration.

E2 (3-4)

Judgement made with economic justification

E1 (1-2)

Judgment without economic justification.

3 (a)

Explain how market dominance and immobility of factors of production in a country can lead to market failure.

[10]

(b) Discuss the extent to which globalisation has reduced the problems associated with these sources of market failure.

[15]

(a) Suggested Answer: Introduction

Explain that market failure refers to a situation in which markets produce undesirable outcomes. Resources are not allocated efficiently and/or equitably.

Explain market dominance Due to high barriers to entry and unique products, firms may have high market power which allows them to dominate markets, influencing prices. Monopolies and oligopolies tend to have such market dominance.

Explain immobility of factors of production Factor immobility refers to the inability of a factor of production to shift from one use to another, even in response to large changes in remuneration and prices.

Body

Explain why the presence of market dominance can lead to market failure - The presence of market dominance may lead to firms enjoying monopoly

power and hence there is imperfect competition and the presence of firms such as monopolies and oligopolies may result in the 'wrong' quantity being produced at too high a price, and the market outcome being allocatively inefficient. Draw a diagram and use an example.

- Socially optimum level of output is at QPC where total welfare to society is maximised. This is because P=MC.

- In an imperfect market, assuming that the monopolist seeks to maximise profits (where MR=MC), it has the incentive to restrict production at output QM and charge price PM.

- By under-producing output QMQPC, the potential social benefits lost is due to MB > MC for every output between QMQPC. The total loss is also known as the deadweight loss to society due to an allocatively inefficient level of production.

- Firms utilize supernormal profits to erect even higher barriers to entry. Hence, market failure is perpetuated.

- The other problem may be increasing inequality of income between owners and workers. Use analysis above and diagram to explain.

Explain why immobility of factors of production can lead to market failure - Factor immobility may be due to Occupational Immobility. Factor immobility

may be due to Geographical Immobility. Use examples. - Factor immobility prevents the switch to the production of new goods and

services most valued by society, in the quantity required, thereby resulting in allocative inefficiency.

Mark Scheme

Level Descriptors

Level 3 (7-10)

Answer shows excellent knowledge about the market failure arising from market dominance AND immobility of factors of production

Excellent rigour of analysis which includes: - an excellent use of diagram to explain the market failure arising

from market dominance - an explanation of how immobility of factors of production causes

allocative inefficiency.

There are no errors in explanation

Good use of examples

Level 2 (5-6)

Answer shows some knowledge about the market failure arising from market dominance AND/OR immobility of factors of production

Some rigour of analysis which may include - a diagram to explain the market failure arising from market

dominance although it may not be particularly well explained

Level 1 (1-4)

Answer is mostly irrelevant.

Answer may only list points about market dominance and/or factor immobility.

Answer may have multiple concept errors.

(b) Suggested Answer: Introduction:

Globalisation refers to the increasing integration of national economies in terms of financial flows, trade, movement of factors of production, ideas, and changes in information and technology.

As explained in (a), market dominance and immobility of factors of production lead to market failure. Problems associated with market dominance include high prices, low output, allocative inefficiency, lack of dynamic inefficiency and income inequality. Problems associated with immobility of factors of production include allocative inefficiency and structural unemployment.

Thesis: Globalisation has reduced the problems associated with market dominance and immobility of factors of production

Extent of effect on Market Dominance

With falling trade barriers, there is increasing competition in many markets because of the increase in imports. Cheaper imports from developing countries may enter the markets in developed countries, resulting in more competition. Generally price falls and output increases.

There may be a change in market structure from a monopoly to oligopoly or from oligopoly to monopolistic competition as market concentration ratios of top firms fall.

The associated problems of high prices, income inequality and high allocative inefficiency are reduced.

The increasing competition also increases the incentive for firms to differentiate their products through innovation and R&D. This may reduce problems to some extent as firms may have to channel their supernormal profits previously gained from their market dominance, to improving their products instead.

The extent can be wide if trade barriers are reduced extensively. Use an example. However, if the pace of globalization slows or there are significant restriction to foreign firms and imports, the extent will indeed be marginal.

If domestic firms were facing problems of X-inefficiency due to market dominance which resulted in their complacency, increasing competition would also force them to produce on the LRAC and be productively efficient. Extent of effect on immobility of factors of production

With globalisation, there are increasing flows of labour between countries as transport costs are lowered and there are less restrictions on labour flows between countries

Industries may hire foreign workers if their skills match their needs. Similarly, if workers are unable to find jobs which require their skill set, they can move to other countries with a demand for their labour.

With more outsourcing and offshoring, labour may also not have to move overseas as foreign firms might choose to set up factories overseas instead. This helps to solve the problem of geographical immobility where workers were unemployed because of their reluctance to leave their homes.

Thus globalisation reduces the problem of unemployment and thus productive inefficiency to some extent as labour tend to be immobile family ties, friends and difficulty in adjustment. Nevertheless, the biggest barrier are sovereign rules governing employment.

Antithesis: Globalisation has not reduced (but has increased) the problems associated with market dominance and immobility of factors of production

Effect on market dominance

While globalisation may lead to increasing competition and therefore a fall in the problems associated with market dominance, it may also lead to other problems.

If competition is too intense, domestic firms may not be able to compete and may be forced to leave the industry.

Also, in industries with very high barriers to entry, a local monopoly may become a global monopoly, thereby increasing its market power and dominance.

These problems may also lead to income inequality issues.

Increasing competition also may result in an erosion of supernormal profits of firms. Firms have less ability to do substantial R&D which may not be beneficial to consumers. Thus globalisation may not necessarily have only reduced the problems associated with market dominance but it may have reduced the benefits that come with market dominance as well.

The extent can be extensive as firm especially Fortune 500 firms are powerful entities and are able to dominate national markets with relative ease. Give an example. Effect on immobility of factors of production

While globalisation may lead to greater mobility of factors of production across countries and therefore a fall in problems associated with labour immobility, it may also create other problems.

Immobility of factors of production within a country may still be large unresolved. For example, occupational immobility occurs due to a lack of ability to switch between jobs in different industries. This could be due to a mismatch of skills.

For example, in developed countries, as low skilled jobs are lost to outsourcing, there is structural unemployment amongst low skilled workers. These workers may not be able to find a job because the jobs in supply are those which require high skills. Thus structural unemployment worsens in developed countries if these workers cannot relocate to regions which require their skills.

Due to structural shifts in an economy as countries specialise and trade according to comparative advantage, export oriented industries with comparative advantage would see an increase in demand for labour. However industries without comparative advantage would see a fall in demand for their goods and therefore a loss of jobs, resulting in greater structural unemployment.

With increasing specialization as countries focus on their comparative advantage to reap the benefits of specialization and trade, workers may also have increasingly specialized skills. If there are changes in world demand, industries which face a fall in demand might suffer and workers in these industries may not be able to switch jobs if they lack the necessary skills.

All of these worsen the problems associated with occupational immobility. Synthesis: Whether or not globalisation has reduced the problems associated with market dominance and immobility of factors of production depends on

The type of industry In some industries, due to the large number of imports, market dominance has greatly reduced, improving consumer welfare. For example, clothes and shoes made in China, India and Vietnam are being exported to many developed countries, bringing down prices and increasing output and variety. Firms in developed countries are forced to innovate to remain competitive.

The MES of the industry For industries with large MES, global dominance may lead to greater fall in average costs which would not have been achieved if output was produced only for one domestic market. This may lead to lower prices and greater consumer welfare and may not necessarily cause problems.

The government policies in place to manage globalization For example, many developed countries have anti-competitive laws which punish firms that abuse their market power. If firms are found engaging in anti-competitive behaviour, they may face harsh penalties such as hefty fines. This prevents the likelihood of large MNCs abusing their market power and exploiting their consumers or workers. However, if governments impose protectionist policies to protect domestic firms, then these firms may still have high market power and the associated problems that come along with their market dominance may still remain. Similarly, if there are policies in place to help workers upgrade their skills, the problems associated with factor immobility may not be so severe. If workers are able to upgrade their skills and find jobs, structural unemployment may not be a severe problem even with globalisation.

Mark Scheme

Level Descriptors

Level 3 9-11

Answer shows excellent knowledge of the effect of globalisation on market dominance AND immobility of factors of production.

Well-balanced answer to show how problems may or may not be reduced.

Excellent development and rigour in economic analysis throughout.

Good use of real world examples.

Level 2 7-8 6

Answer shows good knowledge of the effect of globalisation on market dominance AND immobility of factors of production.

Some evidence of a balanced answer to show how problems may or may not be reduced.

Good development and rigour in economic analysis. OR

Answer shows good knowledge of the effect of globalisation on market dominance OR immobility of factors of production.

Well-balanced answer to show how problems may or may not be reduced.

Good development and rigour in economic analysis.

Answer shows fair knowledge of the effect of globalisation on market dominance AND/OR immobility of factors of production.

Some evidence of a balanced answer to show how problems may or may not be reduced.

Some development and rigour in economic analysis. OR

Answer shows fair knowledge of the effect of globalisation on market dominance AND immobility of factors of production.

May not be a balanced answer to show how problems may or may not be reduced.

Some development and rigour in economic analysis.

Level 1 4 - 5

Answer shows some knowledge of the effect of globalisation on market dominance AND/OR immobility of factors of production.

May not be a balanced answer to show how problems may or may not be reduced.

Little development and rigour in economic analysis.

Answer may be a mere listing of points.

1 - 3 Answer is mostly irrelevant.

Only a few valid points incidentally in an irrelevant context.

For example, answer may focus on the effects of globalisation on macroeconomic aims rather than on market failure.

Evaluation

E1 (3-4)

For a well-reasoned judgment on whether or not globalisation has reduced problems associated with market dominance and immobility of factors of production.

E2 (1-2)

For a mainly unexplained judgment on whether or not globalisation has reduced problems associated with market dominance and immobility of factors of production.

Essay Question 4 Singapores inflation unexpectedly accelerated to the fastest pace since 2008, with rising housing prices as one of the key drivers, renewing calls for a switch from a regime of managing exchange rates to managing interest rates to control for inflation.

Adapted from Bloomberg, 23rd Sept 2011

Discuss the validity of this view. [25]

Suggested Answer: Introduction :

State that Singapores characteristics of a small open import-reliant export-led economy expose her vulnerability to external shocks. As such imported inflation is a main cause of inflation in Singapore. And a recession in Singapores main trading partners will severely impact the Singapore economy.

However there are other domestic factors contributing to Singapores rising inflation rate.

Body: Thesis : A switch from a regime of managing exchange rates to a regime of managing interest rates to control for inflation is valid.

Explain that domestic causes of inflation have been significant contributors to rising inflation rate in recent years as a result of higher house prices.

The increase in demand for (private) housing is mainly by speculative foreign buyers, foreign monies due to quantitative easing in the US and UK, regional demand and citizens upgrading from HDBs to private condominiums.

While the increase in demand for public housing is in general by genuine home owners. This is due to the rapid increase in demand of housing. Population increase faster than housing starts.

Singapore experience low interest rate as she is an interest rate taker. Due to loose monetary policy in developed countries including QE, global interest rates remained low. This fueled demand for housing.

A switch to a regime of managing interest rates will mean managing the cost of borrowing for buyers and hence consumer expenditure on housing. A rise in interest rates increases the cost of borrowing which can lead to a fall in demand for housing, fall in price of housing and hence reduce inflation rates.

As the inflation rate is driven by rising housing prices, the extent of fall in inflation rates would be significant.

Anti-Thesis: A switch to a regime of managing interest rates to control for inflation is not valid.

Explain why imported inflation is the main external cause of inflation in Singapore. Singapore is small in size and lacking in scarce natural resources. This means

that we are dependent on imports for basic necessities, and raw materials & intermediate goods necessary for the production of goods. Quote M/GDP and explain. As such, using the exchange rate is a better tool than interest rate despite inflation being driven by rising housing prices.

Explain the importance of maintaining a regime in managing exchange rate to control for demand-pull inflation. Quote X/GDP and explain.

Explain that Singapores small size openness to capital flows makes it difficult to target interest rates to control for inflation.

In addition, Singapores role as an international financial centre means that the economy is very open to capital flows. Small changes in relative interest rates would lead to large and quick movements of hot money making it hard to target money supply.

If MAS decides to increase the domestic interest rate by reducing money supply through an open market sale, domestic interest rates would rise above world interest rate and this would lead to short term capital inflows (hot money) due to higher returns on Singapore assets. As a result, due to Singapores managed float regime, there likely be an increase in domestic money supply. This would lead to a fall in interest rate until it becomes on par with the world interest rate again. Hence, Singapore government has no control over domestic money supply and interest rate. (it is also acceptable if the given explanation is based on impossible trinity)

Conclusion/ Evaluation :

Singapores characteristics of a small economy with a lack of scarce resources and openness to trade and capital flows underscores the importance in maintain a regime of managing exchange rate so as to influence the prices of imports and exports and hence control of imported inflation, the main cause of inflation in Singapore.

Although arguably a regime of managing interest rates can control for inflation brought about by rising housing prices. However inflation is also propelled by other factors such as increase in wages and COE prices which may not be tackled effectively with interest rate or exchange rate.

Instead other alternative policies will be more appropriate to address the root cause of these domestic factors such as improving productivity and providing better public transportation.

The view to switch from a regime of managing exchange rates to a regime of managing interest rates is therefore not valid. Singapore must continue maintaining with the regime of managing exchange rates to control for imported inflation, adapting and complementing with alternative appropriate policies to control for other causes of inflation.

Mark Scheme

Level Descriptors

Level 3 18-21

Answer shows excellent knowledge of why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Good attempt distinguishing between external and domestic causes of inflation.

Excellent attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapores inability to deviate from worlds interest rates.

Excellent development and rigour in explaining how both regimes work.

Excellent contextualisation: sound understanding of how characteristics of Singapores economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.

A recognition of effects of interest rates on housing market.

15-17

Answer shows excellent knowledge why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Some attempt at distinguishing between external and domestic causes of inflation.

There may be some attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapores inability to deviate from worlds interest rates.

Good development and rigour in explaining how both regimes work.

Good contextualisation: sound understanding of how characteristics of Singapores economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.

Level 2 12-14

An answer which shows a good discussion of why exchange rate policy AND interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. Some attempt at distinguishing between external and domestic causes of inflation.

There should be some attempt at explaining why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapores inability to deviate from worlds interest rates.

Some development and rigour in explaining how both regimes work.

Some contextualisation: sound understanding of how characteristics of Singapores economy can help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.

10-11 Answer shows good knowledge of why exchange rate policy

AND/OR interest rates (monetary policy) can be used as a measure for Singapore to manage inflation. There may be no or some attempt to explain why interest rates cannot be used in the context of Singapore either using the policy trilemma or through Singapores inability to deviate from worlds interest rates.

Answer may lack / limited development in economic analysis.

Some contextualisation: some attempt at making use of the characteristics of Singapores economy to help explain why exchange rate policy OR interest rates (monetary policy) can help control for inflation in Singapore.

Level 1 6-9

Answer shows some knowledge of why exchange rate policy OR interest rates (monetary policy) can be used as a measure for Singapore to manage inflation.

There may be some conceptual errors in the explanation, showing a lack of understanding of economic concepts.

Limited contextualisation: Theoretical explanation lacking in application to the Singapore context.

1-4 Answer is mostly irrelevant.

A few valid points made incidentally in an irrelevant context.

Major conceptual errors.

Evaluation

E1 (1-2) For an unexplained judgement whether there should be switch from a regime of managing exchange rate to a regime of managing interest rates.

OR evaluation on the use of exchange rate policy AND/OR use of interest rates (monetary policy) to control for inflation.

E2 (3-4) For a well-reasoned explained judgement whether there should be switch from a regime of managing exchange rate to a regime of managing interest rates.

AND evaluation on the use of exchange rate policy AND/OR use of interest rates (monetary policy) to control for inflation.

Essay Question 5

Labour force numbers went up as more Singapore residents joined the workforce. Labour force participation rates in 2012 also reached a record high as older residents and working-age women joined the workforce. (a) Explain the possible conflicts in a governments macroeconomic

objectives. [12]

(b)

Discuss the extent to which the initiative of encouraging older residents and working-age women to join the labour force is effective in helping Singapore achieve its macroeconomic objectives.

[13]

(a) Suggested Answer: Introduction:

Government aims to achieve the following 4 macroeconomic goals: High and sustainable economic growth, low inflation (price stability), low unemployment and healthy balance of payments.

Possible conflicts may arise in achieving the 4 macroeconomic aims. Body: 1. Low inflation vs actual growth/low unemployment

An increase in AD will lead to a multiple increase in real national income by the full multiplier process if the real national income increases at the Keynesian range where there is a lot of spare capacity. However, if the economy is nearing full employment, real national income may not increase by the full multiplier, as there is an increase in general price level. Nevertheless, an increase in real national income indicates that there is an increase in actual growth in the economy.

Conflict arises when the economy aims to achieve low inflation and actual growth/unemployment. As AD increase close to full employment, real national income increases, achieving actual growth and low unemployment, and yet the trade-off is that general price level increases as AD increases close to full employment level, causing demand pull inflation. Demand pull inflation occurs due to the existence of bottlenecks as the economy moves closer to the full employment as those sectors experiencing near-full capacity will find their unit costs rising, and therefore prices charged for their commodities will rise. GPL will therefore increase as real output increases.

Hence, this explains for the conflict in achieving low inflation and actual growth/low unemployment.

2. Economic growth vs low structural unemployment

Economic growth involves changes in production both in terms of the goods produced, and techniques used and the skills required. Hence the more rapid the rate of growth, the more rapid the rate of change in production techniques. People may then find their skills are no longer relevant or their jobs may be replaced by machines. Workers may thus find themselves unemployed as their skills do not match the available jobs.

For instance, when the economy engages in new technology such as invention of new techniques of production, these new machines increases the productive capacity and LRAS of the economy, achieving economic growth. Yet at the same time, workers may not have the relevant skills to operate these new machines and technology, resulting in them being unemployed.

Thus there is a mismatch of skills and opportunities as economic growth brings about a change in the structure of the economy, causing the conflict in achieving economic growth and low unemployment.

3. Economic growth vs healthy balance of payments

Economic growth may cause a BOP current account deficit, if the investment undertaken to achieve growth involves purchasing imported machinery. Furthermore, the rising incomes due to economic growth may lead to increased purchases by households on imported consumer goods, given a relatively high marginal propensity to import. This will worsen the BOT and current account, hence BOP worsens.

4. Low inflation vs healthy balance of payments

The use of exchange rate policy i.e. currency depreciation to improve balance of trade (if Marshall-Lerner condition holds) can lead to demand-pull inflation and cost-push inflation.

Devaluation/depreciation decreases the price of exports in foreign currency and increases the price of imports in home currency. Given Marshall-Learner condition holds, |PEDx + PEDm| > 1, devaluation/depreciation will increase net exports and improve BOT. The increase in net export can lead to demand-pull inflation if there is no spare capacity in the economy. Also, if the economy is open and import-reliant, depreciation will increase the cost of imported raw materials and decrease SRAS, resulting in cost-push inflation.

This explains for the possible conflict in achieving low inflation and healthy BOP. Conclusion: To achieve the 4 macroeconomic objectives, the government is likely to face the possible conflicts: low inflation vs actual growth/low unemployment, economic growth vs low structural unemployment, economic growth vs healthy BOP and low inflation vs healthy BOP. Hence, there is a need for a government to prioritize its goals based on the needs of the economy and implement the relevant/appropriate macroeconomic policies. Mark Scheme

Level Descriptors

Level 3 (9-12)

Answer shows excellent knowledge of at least 3 possible conflicts in a governments macroeconomic objectives

Excellent analysis in considering all 4 macroeconomic objectives

Excellent economic rigour of elaboration

Excellent use of diagrams

Level 2 (7-8)

Answer shows good knowledge of at least 2 possible conflicts in a governments macroeconomic objectives

Good economic rigour in explanation

(5-6)

Good use of diagrams

Answer shows good knowledge of at least 2 possible conflicts in a governments macroeconomic objectives

Some economic rigour in explanation

May not have attempted to use diagram or diagram is not well explained

Level 1 (1-4)

Answer is mostly irrelevant with no evidence of understanding the possible conflicts in achieving low unemployment, low inflation, economic growth and healthy BOP.

Answer shows weak attempt to explain possible conflicts in a governments macroeconomic objectives

(b) Suggested Answer: Introduction:

Identify the following 4 macroeconomic objectives: High and sustainable economic growth, low inflation (price stability), low unemployment and healthy balance of payments

Identify the main problems that the Singapore economy is facing rising cost of production (due to rising domestic labour cost)

The initiative of encouraging older residents and working-age women to join the labour force increases the quantity of labour in Singapore which is an aggregate supply management policy to increase the aggregate supply in the short run and long run, through reducing production cost and increasing productive capacity of the economy.

Body: Thesis: The initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives Explain how increase in quantity of labour will achieve macroeconomic objectives in Singapore.

Economic growth, low unemployment and low inflation - The long run aggregate supply is determined by the quantity and productivity of

factor inputs including labour. Given the initiative of encouraging older residents and working-age women to join the labour force, quantity of labour will increase, leading to an increase in the long run aggregate supply of Singapore and full employment output. Hence potential growth increases.

- The increase in labour supply will also bring about a fall in wage costs, decreasing the cost of production in producing every unit of output. Hence aggregate supply curve shifts downwards and to the right. Real output increase, achieving actual growth and lower cyclical unemployment rate. In addition, general price level decreases, curbing cost-push inflation in the economy.

- The rise in AD from external demand is met with an increase in AS, resulting in price stability and output at the same time.

Healthy BOP

- Increase in the labour supply leads to a fall in cost of production and increases export competitiveness since exports will be relatively cheaper than imports. This leads to a rise in the quantity demanded for exports, this is especially so if demand of exports is relatively price-elastic (e.g. countries such as Korea produce close substitutes for Singapores exports of consumer electronics), as such a more than proportionate increase in quantity demanded of exports leads to an increase in export revenue. Hence Singapores balance of trade and the balance of payments improves.

- At the same time, the increase in labour supply and lower wage costs can attract more foreign direct investment to Singapore, improving the financial and capital account and hence BOP improves.

Anti-Thesis: The initiative of encouraging older residents and working-age women to join the labour force is not effective to help Singapore achieve its macroeconomic objectives Explain how increase in quantity of labour may not necessarily achieve macroeconomic objectives in Singapore.

Economic growth Actual growth:

- Although the increase in quantity of labour can increase LRAS and potential growth of the economy, actual growth may not occur since achieving full employment level of national income requires that AD is sufficiently high to buy the potential output. However, the level of AD depends on many factors, including external demand, business and consumer confidence. A policy focusing on increasing quantity of labour cannot effectively counter such fluctuations in AD because such a policy is a long term supply-side policy aimed primarily at shifting the AS. - Evaluation (Alternative way): The government needs to adopt additional stimulus to boost AD i.e. expansionary fiscal policy and depreciation of domestic currency.

Potential growth:

- While increasing quantity of labour is a desirable and necessary growth direction for Singapore in view of intensified global competition, there are many problems in increasing quantity of labour force. Singapore being a developed country with mainly highly skilled labour and capital intensive industries will demand more highly skilled labour to work in the high-technology industries such as biomedical, pharmaceutical and aerospace. As such, encouraging older residents and working-age women to join the labour force may not be effective in allowing them to work efficiently in the capital intensive and high-technology industries, since they may lack the set of relevant skills required in these industries. As a result, AS may not increase as much since quantity of labour is not the sole factor in determining AS; rather quality of labour is important to increase productive capacity. If the older residents and working-age women are not equipped with the relevant skills, they will still be underemployed. - Evaluation (Alternative way): In order to increase potential growth in Singapore, it is important to increase the skills of the labour force. Singapore government can provide the older residents and working-age women with training so that they acquire the essential skills to work in these expanding industries.

Nevertheless, training takes time and it is also a costly investment and a heavy drain on government finances. The outcome is uncertain depending not only on the workers receptiveness but also the quality of training.

Low unemployment - Although the increase in quantity of labour can increase LRAS and potential

growth of the economy, actual growth may not occur since achieving full employment level of national income requires that AD is sufficiently high to buy the potential output (mentioned under the anti-thesis point on economic growth). If growth of AD does not keep pace with potential growth, cyclical unemployment rate will rise.

- Furthermore, there is a possibility of a mismatch of skills between the old residents/ working-age women and the jobs available (i.e. jobs that demand skills to work in the high-technology industries such as biomedical, pharmaceutical and aerospace) in the market, giving rise to structural unemployment. Structural unemployment is evident as Singapore undergoes changes in the structure of the economy.

- As Singapore moves from a labour intensive industry to a capital intensive industry, industrial innovations and new techniques to produce goods and services are emphasized, hence hiring surplus workers raise costs and can hasten the decline of an industry that is threatened by competitive products. An industry that is declining due to economic changes becomes an increasingly large burden to the government which may find itself withdrawing its support to encourage old residents and working-age women to join the labour force.

Low inflation Demand-pull inflation

- If Singapore is currently experiencing demand pull inflation, the initiative of encouraging old residents/working-age women to join the workforce may not be sufficient to improve the situation if the increase in AS is not quick enough to counter the effect of an increase in GPL brought about by the increase in AD close to or at full employment. For instance, world economic recovery can lead to an increase investment due to investors optimism on the economy, resulting in an increase in AD and cause Singapore to experience demand-pull inflation. Given this situation, an increase in labour supply will not be appropriate in curbing demand-pull inflation, and help Singapore achieve low inflation rate.

- Evaluation (Alternative way): Hence, there is a need to use contractionary AD management policies to tackle demand pull inflation to achieve low inflation. Cost Push Inflation

- Encouraging old residents and working-age women to join the workforce increases the labour supply and decreases the wage costs. Curbing cost-push inflation is appropriate in the given economic conditions in Singapore as there are cost-push inflationary pressures. However, the cause of Singapores cost-push inflation is mainly due to import price-push inflation, given that a large proportion of Singapores imports are raw materials since Singapores resources are scarce. An increase in the cost of imported inputs due to inflation in foreign countries leads to a fall in Singapores SRAS and an increase in the general price level. Hence, decreasing wage costs via increasing labour supply will not tackle the root cause of Singapore cost-push inflation problem.

- Evaluation (Alternative way): As such, it is important for Singapore to appreciate its domestic currency so that imported necessities become cheaper in terms of domestic currency, this would also lower GPL as price of final goods & services are lower, leading to lower imported inflation.

Mark Scheme Level Descriptors

Level 3 (7-9)

Answer shows an excellent explanation of the effectiveness AND ineffectiveness of encouraging older residents and working-age women to join the labour force to help Singapore achieve its macroeconomic objectives.

Answer shows an excellent explanation on the impact on at least 3 macro goals with an excellent theoretical framework, showing a balanced analysis with scope & depth.

Answer makes excellent reference to real world examples

Level 2 (5-6)

Answer shows a good explanation of the effectiveness AND/OR ineffectiveness of encouraging older residents and working-age women to join the labour force to help Singapore achieve its macroeconomic objectives.

Answer shows a good explanation on the impact on at least 2 macro goals with a good theoretical framework, showing a balanced analysis.

Answer makes good reference to some real world examples.

Level 1 (1-4)

Answer is mostly irrelevant

General remarks on the impact of the initiative with or without reference to the macro goals

Only few points made in with little reference to the question and with no economic basis

No evidence of theoretical framework Evaluation E2 (3-4)

Well explained judgment on whether the initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives.

E1 (1-2)

Mainly unexplained judgment on whether the initiative of encouraging older residents and working-age women to join the labour force is effective to help Singapore achieve its macroeconomic objectives

Essay Question 6

The North-American Free Trade Area (NAFTA) agreement, linking trade and facilitating investment between the United States, Canada and Mexico, was considered a major accomplishment by President Bill Clinton in 1994. However, many Americans now blame the agreement for the loss of thousands of U.S. manufacturing jobs. (a) Explain how Free Trade Agreements such as NAFTA might lead to

unemployment and income inequality within a country.

[10]

(b) Discuss whether protectionism is the best solution for tackling unemployment and income inequality in a developed country like the USA.

[15]

(a) Suggested Answer: Introduction

Define Free Trade Agreements: A Free Trade Agreement is a legally binding agreement between 2 or more countries that agree to remove some trade barriers between the signatories.

Provide example/s of Free Trade Agreements (NAFTA, ASEAN)

Define unemployment and income inequality

Unemployment refers to the number of people of the legal age who are willing to and are able to work but are unable to find suitable employment.

Income Inequality: Differences in terms of income distribution within the population

Body Explain the effects of signings of FTAs

- FTAs will affect trade patterns of a country, allowing trade volumes to increase where the country will now specialise in the production of goods which it has a comparative advantage in.

- Define and Explain the Theory of Comparative Advantage: A country has a comparative advantage over another country in the production of a good if it can produce it at a lower opportunity cost, i.e. it has to forgo less of other goods in order to produce it.

- For developed countries such as the USA, they tend to be relatively well-endowed with capital and thus have a comparative advantage in capital-intensive industries and will specialise in these industries (e.g. green technology).

- With the reduction of tariffs, this would enable the exports of a country to be more price-competitive, hence increasing quantity demanded of exports and increasing export revenue.

- FTAs increase the pace of specialisation and globalisation and may result in the collapse of domestic industries that might not be able to compete with the influx of imports, in industries where the country does not have a comparative advantage in. On the other hand, exports might not rise substantially compared to the rise in imports due to the lower level of national income in other signatories, such as Mexico that are developing countries. This would lead to a lower ability to purchase imports from other countries.

- Net exports may fall as a result of the influx of imports being greater than the increase in exports lead to a fall in Aggregate Demand

- FTAs (with lower tariffs and removal of restrictions on FDI) will foster an increase in overseas FDI and offshoring, which will result in hollowing out of domestic industries, especially manufacturing and in industries that the country does not have a comparative advantage in (e.g. clothes industry).

Effects on unemployment Cyclical unemployment

- Due to a fall in Aggregate Demand, there will be a fall in national income. Since labour is a factor of production and is a derived demand for goods and services, there will be an increase in unemployed labour. There will be an increase in demand-deficient unemployment.

Structural unemployment - Possibility of collapse of domestic industries that might not be able to

compete with the influx of imports, especially in industries (sunset industries) where the country does not have a comparative advantage in e.g. textile industries in the US has lost their comparative advantage due to lower wages in other countries such as Mexico, therefore enabling these countries to have lower opportunity costs in producing a good.

- Structural unemployment as workers does not have the necessary skills to transit to new industries. (Mismatch of industries and skills of workers). This is especially so with the transfer of knowledge and skills between countries that might easily render workers existing skills easily obsolete and make it difficult for the workers to find new employment.

- For example, with the signing of NAFTA, the US lost many manufacturing jobs (esp. textile) to Mexico, which has a relative comparative advantage in labour-intensive industries. Workers in the textile sector are unable to find jobs in other sunrise sectors in the US (e.g. green technology) due to lack of specific skills. Therefore, these workers are structurally unemployed.

Effects on Income Inequality

- Income inequality might be exacerbated within a country as workers in sunrise industries (e.g. capital-intensive industries) in the country will be able to increase their factor incomes at the expense of workers in sunset industries (e.g. labour-intensive industries).

- This is especially so if workers in the disadvantaged industries are not able to transit into new industries and suffer from structural unemployment as a result. This is especially difficult for workers in developed countries, especially as the new emerging industries (sunrise industries) tend to be capital and knowledge-intensive, which will be difficult for the workers to make the transition. Therefore these workers in sunset industries would suffer from a greater fall in wages while the workers in industries with comparative advantage would benefit from a faster increase in wages, leading to greater income inequality between low skilled and high skilled workers.

Conclusion The signing of FTAs, such as NAFTA, which increases the pace of globalisation, will have detrimental effects on unemployment, cyclical and structural

unemployment, as well as on income inequality that are difficult to eradicate. Mark Scheme

Level Description Marks

L3 For an answer that demonstrates excellent development of analysis for effects of FTAs on unemployment (both cyclical and structural) AND income inequality Answer demonstrates excellent examples of relevant FTA/s for illustration

7-10

L2 For an answer that is accurate with excellent development of analysis for effects of FTAs on unemployment (either cyclical or structural) AND income inequality Answer demonstrates good examples of relevant FTA/s for illustration

5-6

L1 For an answer that shows limited knowledge on the effects of FTAs on unemployment OR income inequality Answer demonstrates a lack of or limited use of examples of illustration There are conceptual errors and/or inconsistencies in explanation.

1-4

(b) Suggested Answer: Introduction Define Protectionism: enacting of trade barriers to restrict trade between countries Examine the context of developed countries like the USA where unemployment, especially structural unemployment and income inequality have been prevalent due to the effects of specialisation (based on comparative advantage) and offshoring which have increased the gap between the different segments of the population, especially between the low-skilled and high-skilled workers. Body Thesis: Protectionism is the best solution for tackling unemployment and income inequality Explain how protectionism deals with unemployment and income inequality

- Protectionism, through the enactment of barriers to free trade will reduce the amount of imports that a country imports

- This can be carried out through measures such as the use of tariffs and import quotas.

- For example, tariffs, a tax levied on imports will increase the price of imports and reduce the quantity demanded for imports.

- US consumers would switch from purchasing imports to domestically-produced goods.

- Illustrate using a diagram - This will result in a net increase in net exports (X-M) and thus increasing AD

and national output and reduces cyclical unemployment - Protectionism, with the protection of domestic industries will also reduce the

extent of structural unemployment that may happen as a result of the signing of FTAs, through the slowing of adoption of new technologies and the reduction in foreign competition in the domestic market.

- This will also reduce the extent of income inequality that is a result of income losses from factor owners and workers from comparatively disadvantaged industries (though at the expense of slower/negative income growth for the industries with comparative advantage).

- Protectionism can be particularly useful for a developed country who has a huge domestic market and do not have a comparative advantage in labour-intensive industries (which hires a lot of labour), where protectionism may prevent a huge fall in employment (especially structural unemployment) and a subsequent rise in income inequality.

Anti-Thesis: Protectionism is not the best solution for tackling unemployment and income inequality Examine limitations of Protectionism

- Problem of inefficiency on society (explain using tariff diagram) - Protectionism is a beggar-thy-neighbour policy that benefits the home

country at the expense of the trading partners becoming worse off. If incomes of trading partners of the US fall because of a fall in their export revenue, then they in turn would import less, adversely affecting US exports. Therefore, this could potentially lead to a fall in export revenue fall in AD Greater demand-deficient unemployment

- Developed countries generally have more FTAs signed and it is difficult to pursue protectionism without breaking the provisions in the FTAs and this may also invite possible retaliation by trading partners. If trade partners retaliate and impose tariffs on US exports entering their countries, this would adversely affect the price competitiveness of US exports Fall in export revenue Fall in AD Greater demand-deficient unemployment

- Protectionism is a temporary solution that does not deal with the underlying root causes of unemployment and income inequality arising from factors such as loss of export competitiveness due to increasing pace of globalisation. There is a need to implement policies to address the root cause of the problem such as supply-side policies to improve the competitiveness of US exports.

- Protectionism would restrict foreign competition and potentially lead to complacency among domestic producers. The problem of unemployment may also worsen with the fall in export competitiveness of our exports due to the lack of competition and incentive to innovate will also lead to the eventual fall in exports (X) and a fall in investor confidence (I), leading to a fall in net export revenue and investment that will reduce actual economic growth and cause an increase in cyclical unemployment as a result of the fall in demand for factors of production.

- The decrease in income inequality will be achieved but at the expense of making everyone poorer through a fall in actual economic growth.

- This is in contrast with the use of trade liberalisation policies to encourage free trade and make the country a more popular place for investment, where

this will result in economic growth, albeit at the expense of income inequality. Other policies that tackle unemployment and income inequality Examine the policy options available to a developed country and explain how these policies would work to resolve unemployment and 1. Supply-side policy

- Supply-side policies can be implemented to improve the competitiveness of exports, such as through improving cost competitiveness of exports and investing in new niche areas as long run measures

- With an lower cost of production and an increase in productive capacity Increase in SRAS and LRAS Sustained growth Fall in demand-deficient unemployment

- The US government can also implement programmes to train workers and to help them upgrade their skills. Higher productivity Fall in cost of production Increase in SRAS and LRAS (better quality of resources) actual and potential growth. This would enable workers to take on jobs in the sunrise sectors, which require specific skills and knowledge and the ability to handle capital-intensive production. This would help to reduce structural unemployment.

- If low-skilled workers participate in such training programmes, this would enable them to fetch higher wages reduce income inequality

2. Income re-distribution policies - The government can implement policies for income redistribution. For

example, increasing income tax rates to increase tax revenue. With higher tax revenue, this would enable the government to increase the amount of transfer payments to the low skilled workers, such as through unemployment benefits and welfare payments. This would help to reduce income inequality.

Synthesis/Conclusion Possible synthesis: Given the severity of unemployment and income inequality, a policy mix is needed. Comparing between the policies, it is unlikely that protectionism is the best policy considering the inability of the policy to deal with the underlying root causes of unemployment and income inequality brought about by globalisation and increasing competition from trading partners. Protectionism and the use of income redistribution policies offers only a temporary solution while other policies such as supply-side policy to be implemented, which are better able to deal with the root causes. Supply-side policies would take time to take effect, therefore protectionism could be implemented in the short-term to cushion the impact on the domestic industries. Synthesis should consider the nature of developed countries when evaluating the different policies and taking a stand regarding the best policy to be adopted.

Mark Scheme

Level Description Marks

L3 For an answer that shows excellent knowledge in explaining how protectionism deals with the problem

9-11

of unemployment and income inequality

Excellent explanation of other policies that deals with both unemployment and income inequality with excellent discussion of the adoption of the policies in the context of developed countries.

At least 2 other policies should be discussed in-depth with clear reference to context of developed countries (supported by examples of policies)

Excellent development and rigour in economic analysis.

L2 For an answer that shows some knowledge in explaining how protectionism deals with the problem of unemployment and income inequality

Limited explanation of other policies that deals with both unemployment and income inequality with some/limited discussion of the adoption of the policies in the context of developed countries.

Some conceptual errors in the explanation of policies

5-8

L1 For an answer is mostly irrelevant with discussion of policies that do not deal with the problems of unemployment and income inequality

1-4

Evaluation Marks

E2 For a well-reasoned judgment on the best choice of policy in dealing with the problems of unemployment and income inequality

3-4

E1 For a mainly unexplained judgment 1-2