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 S
0
to S
1
results in a
less than proportionate fall in quantity demanded from Q
0
to Q
1
to the increase in its
price from P
0
to P
1
, 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 D
0
, a rightward shift of the supply
curve from S
0
to S
1
will see a more than proportionate rise in quantity
demanded from Q
0
to Q
1
to the fall in price from P
0
to P
1
, 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
D
0

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 D
0
to D
2.










Figure 2 Market for e-
cigarettes

Q0
Price
Quantity
S1
D0
S0

Q1
P0
P1
D1
A
B

























With 0 <Eab< 1, this means that the shift in demand for e-cigarettes is to a relatively
smaller extent as compared to the increase in price of conventional cigarettes.

Explain the importance of considering the values of Ep and Eab, and the
rightward shift in supply due to the increase in the number of new firms in order
to analyse the effect on revenue earned in the market for e- cigarettes.

Explain that the overall effect on revenue earned in the e-cigarettes market is
dependent on the extent of the shifts its demand and supply curves. Thus, this
gives rise to a resultant equilibrium price that is uncertain although the quantity
transacted of e-cigarettes will increase.

Note: Candidates are not required to draw the many different permutations of the
differing extent of shifts in demand and supply curves to illustrate the effect of
changes on revenue earned in the e-cigarette market. A well-reasoned
explanation(s) with at least one diagram to illustrate understanding is sufficient.










Figure 3: Eab > 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

P
0

Q
1

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 P
2
and equilibrium quantity at Q
2
.
Revenue earned in the e-cigarettes market increases and is given by the area
OP
2
E
2
Q
2
.

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
S
1

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 Q
PC
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
Q
M
and charge price P
M
.
- By under-producing output Q
M
Q
PC
, the potential social benefits lost is due to
MB > MC for every output between Q
M
Q
PC
. 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