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2013


1

ECONOMICS
Higher 2
(Syllabus 9732)
Suggested Answer Outlines Year 6 Preliminary Examinations 2013

Year 6 Preliminary_9732 ? RI 2013

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2 Case Study Question 1: Education
(a) (i) With reference to Tables 1 and 2, compare the government expenditure on education between Singapore and USA. [2] Both the Singapore and USA?s government expenditure per student on education as a percentage of GDP per capita increased from 2008 to 2010. [1m] However, the Spore government?s expenditure per primary student is consis tently lower than that of USA OR the Singapore government?s expenditure per tertiary student is higher than that of USA [1m] Note: Though the examiners have accepted some significant differences which did not point to the difference in the expenditure of primary versus tertiary education between the 2 countries, those are considered as second tier answers. The question made specific references to the 2 tables with data only on primary and tertiary expenditure of the 2 countries and it is fair to expect Economics trained candidates to point out the relevant difference. (a) (ii) Explain 2 possible reasons for the difference observed in (a)(i). [4]

Possible reasons (any 2): 1. The US govt may place a larger value on the external benefits of primary school education than the Spore govt. It may be of the opinion that primary school education has a greater impact on society than tertiary education. The US government thus spends more for each primary school student. [2m] 2. The US govt may find it more equitable to provide greater subsidy (per student) on a larger cohort of primary students as compared to a relatively smaller cohort of university graduates. The graduates are the ones who are likely to be able to command a higher wage and it may not be equitable to provide larger subsidy (per student) for this smaller group. [2m]

3. (Secondary point which examiners accepted - The cost of providing primary school education may be higher in USA than in Spore. In USA, class sizes are smaller and the primary school teachers are mainly graduates as compared to Spore.)
(b) Explain the possible relationships between monthly wages and work experience. [4] Fig 1 shows that monthly wages and work experience are positively related in the earlier years of work of a worker. (1m for identification of relationship). As work experience increases, learning on the job increases and this will increase labour productivity. With higher output per worker, the demand for such workers will rise, ceteris paribus, and thus they are likely to be rewarded with higher wages. (explanation of relationship 1m) Figure 1 also shows that the wages of workers with only primary school education decline after 30 years of work experience. (1m for identification of negative relationship). Their value-add to productivity tend to taper off and decline. Such workers are low-skilled and work is mainly manual. As physical activity declines with the workers? age, so will their productivity, that is, the monthly wages fall as their years of work increase beyond 30 years. (Explanation of negative relationship 1m) (c) To what extent does an increase in education levels improve the standard of living in an economy? [8] SOL refers to the welfare level of the average person in an economy. It encompasses both the material and the non-material aspects. Material SOL can be measured by real GDP per capita while non-material SOL is measured in terms of healthcare & education standards, stress level, externalities, etc.

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Thesis: Higher education levels lead to higher SOL ? Higher education → skills level ↑→quality of labour force↑ → potential EG↑ ? With rising demand for a country?s goods & services → AD↑ → actual EG↑ → real GDP per capita↑, ceteris paribus→ material SOL↑ ? With higher GDP, government tax revenue↑ →GE on healthcare, education, etc↑ →nonmaterial SOL↑ An increase in education level implies a greater level of skills acquired or at least a greater ability to acquire new skills because of higher levels of numeracy and literacy. This is likely to lead to greater labour productivity and that means greater employability and higher pay (refer Fig 1). Employment level is likely to rise, leading to greater economic growth and higher national income per capita. Ability to buy goods and services increases and thus the material aspect of SOL increases. Also, the nonmaterial aspect of SOL may improve due to reduced deviant behaviour and lower crime rates. Anti-thesis: Higher education levels may not lead to higher SOL If higher education levels do not lead to economic growth and real GDP per capita does not increase, SOL will not rise. As shown in Extract 3, many American university graduates are unemployed, with unemployment standing at 8%. The 8% unemployment rate of graduates is close to that of the overall unemployment rate of 8.1 to 7.5%. It is likely that there is weak economic growth in USA during that period and therefore reduced job creation. Recruitment is low and fresh graduates have difficulty getting employment especially if their expectation of pay is relatively higher than non-graduates. Therefore education level does not necessarily mean greater employability over a lower education school leaver if the economy is weak. High unemployment → stress levels & crime rates↑ → non-material SOL↓ In the US, higher education increases the supply of skills that are not required by industry, the rate of unemployed graduates↑ (Extract 1). In the course of choosing fields of studies which do not align with the manpower needs of the nation, graduates have difficulty looking for employment in the relevant fields. On the whole, higher level of education does not guarantee employment in the economy and therefore does not ensure a higher SOL for the average person. Conclusion/Evaluation: So higher levels of education of residents do not necessarily lead to increases in a country?s GDP. It must be coupled with greater job opportunities in an economy so that SOL may rise. Also, if the Gini coefficient increase, income gap widens, the average person in the economy may not be better off. Level Descriptors Marks L1 1-3 A theoretical regurgitation of SOL with no reference to case study at all. Answer that is one-sided EITHER on how education does or does not lead to improvement in SOL. L2 Answer shows balance and sufficient breadth in the discussion of how education may increase SOL. Points are somewhat developed with reference to case study evidence. L3 Points are well-developed with strong use of case study material. Answer must show awareness that material SOL is measured by real GDP/capita and must make macro-economic links to employment and AD/AS framework. Answer must include both material aspect and non-material aspect (at least a mention) of SOL. Answer must have a reasoned conclusion to score max of 8m. 7-8 4-6

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(d) (i) Explain the term positive externality. [2]

Positive externality is generated when some of the benefits associated with the production or consumption of a good ?spills over? to third parties, that is, to parties other than the immediate buyer or seller (1m for definition). For example, when one receives education, he will benefit in terms of job satisfaction and higher wage earned. However, there is also the external benefit to society when he is also likely to contribute to a greater productivity rate in the economy and this helps to increase investments (including FDIs) to benefit all (1m for an explanation of external benefits using an example). (d) (ii) Discuss whether education subsidies in the USA and Singapore should be adjusted to better achieve the governments’ micro-economic objectives. [10] Introduction Clarify “micro-economic objectives” ? Efficiency in the usage and allocation of a country?s limited resources ? Equity in the distribution of a country?s goods and servi ces Thesis : Explain how education subsidies are used in both countries to achieve micro-economic objectives. ? To correct market failure (due to the existence of positive externalities in education) in order to achieve allocative efficiency. Diagram and explanation positive externality and market failure in education Subsidizing an amount equivalent to MEB will bring consumption to a socially optimal level. Subsidy →COP↓→SS↑→P↓→QDD ↑ Use data in Tables 1 & 2, Extract 1 “government funds about 75% of the total cost” in Singapore and Extract 4 “government provides subsidies directly to institutions” in the USA. To establish a more equitable distribution of a merit good by keeping costs low to allow the poor access to primary, secondary and tertiary education. Education subsidies are also used in both countries to help talented but poor children to succeed. This helps to foster a more equal society.

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Antithesis: However, the subsidy schemes in both countries can be adjusted to reduce adverse outcomes and apparent inequities. ? Tertiary education is currently over-subsidised in both countries. In Singapore, tertiary education is more highly subsidized compared to primary education. But the gap between private and external benefits is wider for primary education ( because, even though the private returns of primary education is low, literacy is essential to the functioning of society and ought to be accessible to all. The main beneficiary is the population at large). This gap is far narrower for tertiary education as the returns to individuals with higher education are substantial and often sustained through their working lives (See Figure 1). The premium on higher education is strong enough an incentive for people to want to pursue university qualifications, thus, from an Equity standpoint, there is no need for large government subsidies to encourage greater consumption. Moreover, only a minority (less than 25%, as seen in Table 3) in each cohort receives university education and should therefore not receive more subsidy than the majority that receives only basic education. This therefore represents a lack of equity in the way education subsidy is being distributed. In light of the relatively high Gini coefficient (Table 4), more should be done about primary education in Singapore. As seen in a(ii), the lower government expenditure on primary education could be due to lower costs per student. This in turn is due to the large size of each class (large number of students per teacher). Perhaps more should be spent on reducing class sizes and improving the quality of primary education. This will better prepare every child to succeed in life, reducing poverty & income inequality in

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the future. According to findings of an Edinburgh University Study, (Extract 2) “bas ic childhood skills – literacy and numeracy – proved important throughout life”. Extract 2 also points to the importance of pre-school education in reducing income inequalities. Singapore should therefore increase the direct and indirect subsidies going to pre-school education to ensure that every child receives quality pre-school education. The relatively low literacy rate among people aged 15 and above (Table 4) accounting for the low income of low skilled workers, could also have been a factor for the high Gini Coefficient. In light of this, more should also be done about adult education. The government should increase subsidies and funding to make adult education, training & upgrading more accessible to all workers. In the US, tertiary education appears to be over-consumed, resulting in the over-supply of college graduates. Extract 4: “tertiary enrolment rate of close to 80%”. Diagram and explanation Americans already have a high MPB for college education. Government subsidy therefore pushes consumption to a level beyond social optimum. There is overallocation of resources into higher education resulting in allocative inefficiency. For greater efficiency, the US government should therefore reduce or remove acrossthe-board subsidies for higher education and divert resources into other areas or simply use the subsidy cut to reduce the US government Budget Deficit. In view of the possible mismatch between the supply of college graduates and the demands of industry (Extract 1) and as discussed in part (c), the US government should remove subsidies going into “impacted programs” (Extract 4) and increase the rate of subsidy for industry-relevant courses in order to encourage more students to opt for such courses. To ensure equitable access to “high quality tertiary education” (Extract 4), government financial aid and interest-free study loans should still be available to poorer students.

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Conclusion/synthesis From the data given, it appears that Singapore?s education subsidy should be adjusted for greater equity, while the US should adjust for greater economic efficiency. However, there are other factors which could have caused the problems identified. In the US, the high rate of unemployment among college graduates is also caused by the slow rate of economic growth. In Singapore, the high Gini Coefficient may not have anything to do with the lack of subsidies for lower level education. The significant number of elderly citizens (especially among the women) who did not receive formal education plus the influx of cheap foreign labour are possible causes. In the final analysis, whether or not the education subsidy schemes in the two countries should be adjusted depends on whether the root causes of the adverse outcomes and apparent inequities can be reduced by the adjustment. Addressing the root causes with appropriate measures would more effectively move both countries towards achieving their micro-economic goals. Mark Scheme Level Descriptors L1 Answer contains no economic framework. An answer that does not address the question asked L2 Answer is lacking in some aspect: ? Does not explain how education subsidies are used to achieve microeconomic objectives ? Discusses only one microeconomic objective ? Makes no reference to case material ? Discusses only with respect to one country ? Addresses the question but has tendency to be superficial and lacks depth

Marks 1-3 4-6

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L3 There is both scope and depth in the answer: ? Answer is balanced (examines why and how education subsidies are used and the extent to which microeconomic aims are achieved) ? Discusses at least one aspect of education subsidy in each country that may need adjustment ? Uses relevant economic framework and diagrams ? Rigorous development of economic framework ? Good reference to case data ? Minor inaccuracies / Antithesis that is not adequately developed ? For an evaluative conclusion on the differences in outcomes in the two countries and therefore the need for different treatments of education subsidies. ? Any other evaluation, for example, that the suggested adjustments to subsidies may be at the expense of other economic objectives of government. 7-8

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7 Case Study Question 2
(a) (i) In which year were consumer prices highest in Greece? 2012. (a) (ii) Calculate UK’s real interest rate in 2012. Real interest rate = Nominal interest rate – Inflation rate = 0.5% - 2.8% = - 2.3% No calculation: 0 m Correct formula but incorrect numbers substituted = 0m No % = OK (b) To what extent were the changes in UK exchange rates affected by changes in its interest rates? Thesis: UK interest rates fell in 2009 and remained low thereafter. If interest rates are lower than other countries, it leads to an outflow of ?hot? money. The increased supply of UK pound in the foreign exchange market may cause the exchange rate to depreciate. If they say fall in demand for UK pound, it must be linked to ?less inflow of hot money? Anti-thesis: However, Figure 2 shows an appreciation of the UK exchange rate generally. OR In 2009, the exchange rate first appreciated, then depreciated – thus no definite relationship between exchange rate and interest rate. Possible reason for appreciation: capital account surplus exceeded current account deficit ? From data: huge surge in FDI in 2010 ? any other theoretical reason: inflow of hot money (must explain reason) Conclusion: Simple summation [1] [1]

[5]

2 m – thesis 1 m – identify correctly direction of exchange rate i.e. appreciated 1 m – explain briefly antithesis 1 m – simple summarised conclusion (c) (i) Compare the change in the balance on current account for Greece and UK from 2009 to 2012. [2] Similarity: Both experienced deficits Difference: But Greece?s current account deficit reduced, while UK?s cur rent account deficit worsened No link word: max 1 m Award full credit if similarity is implicit (c) (ii) Identify and explain one reason for the difference observed. Greece
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Factor 1: Reason: With the recession, the demand for imports fell. Explain: As demand for imports may be income-elastic, the significant fall in import spending assuming unchanged export revenue- may have caused the deficit to reduce Factor 2: Reason: Cut in minimum wage (Extract 2) Explain: It led to a fall in labour costs, thus increasing AS. With the lower inflation, Greece?s exports were made more competitive while imports became less attractive. As demand for exports rose and demand for imports fell, the respective rise in export revenue and fall in import spending caused the deficit to reduce [1m]. [not the best answer since Greece?s labour productivity was lower but give full credit] UK Factor 3: Reason: The UK pound appreciated (marginally). Explain: Assuming ML condition fulfilled (PEDx + PEDm) > 1, current account worsens Other Acceptable Factors: ? Greece lower inflation ? Greece rise in productivity ? Greece – “2/3 of competitiveness regained” with ?theoretical? explanation Any 1 reason: ? reason stated (?Identify?) [1m] ? explanation of reason provided [2m] Candidate attempted 1 reason each for UK and Greece, and as a result, analysis slightly diluted compared to candidate who discussed only 1 reason per se, still award full 3 m No ML condition: award max 2

(d) Given their current economic conditions, assess wheth er ‘exports can restore growth’ in Greece and UK. [8] Introduction Objective is to increase economic growth and employment through increased X Thesis: Exports can restore growth 1. Theoretically, an increase in X increases AD and works through multiplier to increase GDP by more than proportionate For UK: Table 1 shows that UK?s inflation rate has slowed from 4.5% to 2.8% from 2011 to 2012. If her inflation rate is lower than other countries, this might enhance UK?s export price competitiveness i n the global market For Greece Steps had been undertaken by government to increase X Examples: ? 22% cut in minimum wage ? lower labour cost may translate into lower Px
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?Export procedures simplified halving the no. of days that goods are stuck at ports? (e xt 3 para 2) ? can export more now for a given time ? Table 1 shows improvement in labour productivity in 2012 ? suggests lower unit costs ? Inflation rate also declines steadily from Table 1 ? if inflation rate is lower than that of other countries, Greece?s exports would be more competitive in global mkt ? As such, Greece had regained ?two-thirds of competitiveness lost in the decade? (Ext 3 para12); X might rise ? boost AD ? 2. It may be increasingly difficult to rely on other components of AD. ? ? Both countries may be over-reliant on C (Table 1: 74% of Greece?s GDP and 66% of UK?s GDP). The high unemployment rates especially in Greece may make reliance on C unsustainable. Problem further compounded by Greece?s cut in minimum wages. As government debt is significantly high for both countries, any further increase in G may also be unsustainable. ? can also link to need to borrow from public and crowding out of C and I ? adverse impact on future government spending and future growth or future increase in taxes

Antithesis: Exports cannot restore growth For UK: 1. Main export markets are weak Ext 1 para 2 stated that top 10 export destinations are ?depressingly familiar? - mainly Euro-zone which experience slow or negative NY growth ? slow rise or even fall in DD for UK?s exports ? slowdown or negative NY growth for UK (as shown in Table 1). Further corroborated by UK?s worsening current a/c deficit from 2011 to 2012 (fall in X or ↑X<↑M) 2. UK?s appreciating pound (Fig 2) might also reduce X, assuming PEDx>1 3. Moreover, UK may lack CA in goods it is producing or goods not competitive enough ? thus not exporting enough to ?vast and fast-growing? China which has higher NY growth & large population ? conditions not in place: Ext 1 para 3 mentioned that for UK to shift focus from ?a spe ndthrift, consumer-led economy to an exporting powerhouse? was ?always going to take time?. Need for supply-side measures to boost competitiveness

For Greece: 1. weak EU export mkts 2. Compared to UK, Greece might face more problems. Though some level of competitiveness had been regained via cut in min wage, Greece is constrained by her lack of ability to devalue her own currency to gain greater price advantage (Ext 1 para 4) 3. Moreover, Greece lacked ?medium and large export-oriented enterprises? ? may suggest a lack of IEOS and insufficient export price competitiveness Synthesis: The possibility of exports restoring growth may be more pessimistic for Greece largely due to inability to devalue currency and also other ?deep seated problems? such as public finance mismanagement & ?weak administrative capacity? which might hamper development of helpful policies to increase X. Level 1 (1-3 m) Descriptors Largely irrelevant Smattering of few valid points

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2 (4-6 m) T-A approach with evidence of theoretical framework and some use of case ? ? ? ? 3 (7-8m) h/r insuff scope and depth minor conceptual inconsistencies answer tends to be skewed reference to case material can be better

T-A-S approach with sound use of theoretical framework and ample use of case ? some attempt to synthesise (egg make comparison btw UK and Greece) showing some awareness of possibly differing problems

(e) To what extent does the evidence show a need for increased government involvement in both economies? [10] Thesis: Evidence shows a need for increased govt involvement Data: weak economic performance especially negative or weak GDP growth and higher unemployment rates for both UK and Greece. ? should explain the repercussions of prolonged recession and higher UN if govt doesn?t intervene more ? pessimism, hysteresis, inefficient use of resources 1. Need for More Policies/Different Policies ? For UK, expansionary MP or QE since 2009 seemed to have limited effect to boost UK?s econ growth (?little sign in the hard data that the economy has turned the corner?, Ext 1 par a 2). ? Theoretically, QE, along with very low r/i should boost C+I+X to boost NY and reduce UN. ? Evidence suggested that UK?s X didn?t grow. ? UK?s widening current a/c deficit might imply ↓X. Ext 1 para 2 stated that companies were not ?making rapid inroads into profitable new markets?. ? Fig 2 also showed pound appreciating for some time btw mid Jan 2011 – 2012. ? All these suggest that UK govt might need to do more to boost NY growth and reduce UN and therefore make further adjustments to current policies/growth strategies. ? More QE or maintain low/lower r/i to further raise C+I. Also helps to exert downward pressure on pound to help ↑X. ? Evidence suggested that UK govt aimed to adopt a more export-oriented growth strategy (Ext 1: ?from a spendthrift consumer-led economy to an exporting powerhouse?) o Egg: target more export markets (non-EU). Perhaps UK govt needs to aggressively export to emerging economies such as China to capitalize on her fast growing economy with large population, rather than to concentrate on the weak (& smaller?) EU export market ? Higher X, and higher % of X of GDP. ?might ?help build up a more sustainable business model for the country? o More sustainable because the current low r/i policy which had been prolonged for 3 years (Fig 1) might bring abt detrimental effects on UK?s LT growth by punishing savers and encouraging (indiscriminate?) borrowing For Greece, falling real GDP might have been due to fall in C, I and X ? calls for more govt involvement to help ↑ these components ? In particular, her low net FDI inflow (Table 1) poses a cause for concern. Gross fixed K formation also forms a very low% (only 14%) of her GDP. ? Greek govt cannot really rely on C to drive econ growth. Cut in min wage is ?squeezed? by higher taxes, in view of austerity drive? reduce C. Currently, C forms a large (74) % of her GDP. Like UK, Greece govt might need to do more to adjust growth strategies ? switch to more export-oriented and investment-driven growth strategy ? Extract 3 also stated that Greece regained 2/3 of competitiveness that was lost in the past. Govt might need to do more as her X+I is still not rising enough to bring about ↑ in real GDP and ↓ in UN.

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o To boost X+I: Greek govt might consider doing more to cut inefficiencies associated with bureaucracy (?negotiating Greek bureaucracy is a headache, though some failings are already being tackled.? Ext 3 para 2). o ?With more simplified procedures, more investors such as export-oriented enterprises would be willing to set up their businesses Higher X+I means more chance of sustained econ growth as both AD and AS can grow. UN can fall too. Like UK, Greek govt should target more export markets: cannot depend on weak Euro area. o If successful, may help ↑(X+I)?s share of GDP too

o o

Antithesis: Evidence shows less need for increased government involvement 1. For UK?s exp MP: increased govt involvement may not be needed. There is a limit to how much lower r/i can be cut. Fig 1 shows r/i is already very low at 0.5%. ? Moreover, cutting r/i further ? fear of un-sustainability ?may create more problems in future: ? rock-bottom interest rates not without risks…punishing savers and encourage (indiscriminate) borrowing? (Ext 1 para 4) due to possible negative real r/i ? may have detrimental impact on LR growth

2. For both UK and Greece, increased govt involvement via exp FP to boost NY may not help. ? Table 1 showed high and generally rising govt debt to GDP ratios btw 2009-2012 ? more G and lowering T to boost economy only result in budget deficit ? borrowing ? crowding out, higher debt 3. For Greece: evidence reflected ?deep-seated? problems of govt sector such as ?weak admin capacity, public finance mismanagement?, bureaucracy ?Suggests that there is less need for increased govt involvement ? More government involvement might bring about more costs than benefits ? greater inefficiency (govt failure) ? For example, if Greek govt nationalize the export enterprises, the above weaknesses of govt management might result in greater inefficiency which won?t help increase X Instead evidence hinted at the Greek govt reducing govt involvement ?had adopted or looking into more market-oriented policies. Egg: ? Reduced min wage (ext 1 para 1) ? Wages allowed to be flexible in accordance to mkt forces; helped lower COP ? Considering privatization programme (ext 3 last para) ? Previously govt-owned enterprises now privately-owned ? aim: profit-motivated ? firms driven to be productive efficient (lower AC) and improve on quality of g/s to increase DD ? Usually accompanied with deregulation? lower BTE to inject more competition ? enhance efficiency ? may improve labour productivity further (Table 1) Harness the free market forces/signals/incentives to drive economy to achieve efficiency instead of relying more on weak & incapable govt management Synthesis/Conclusion Some ideas ? Perhaps need for tweak in polices or changes in policies ? ? Might also be too premature to tell if austerity measures are working or not working to restore confidence Increasing govt involvement poses more challenge for Greece than for UK. Being part of EU means Greece is incapable of adopting its own ER policy and independent exp MP. Even exp FP & interventionist SS-side policies might be difficult due to its very high govt debt (Table 1). As such, Greece govt might turn to more ?market-based? solutions egg privatization.

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Level 1 (1-3 m)

Descriptors Smattering of few points Irrelevant answer No theoretical framework nor use of economic concepts Balanced answer but limited scope in terms of economic aims, issues and policies Sensible, clear, balanced and well-elaborated discussion with respect to whether case evidence & data shows govt should increase involvement for both countries Good scope on economic aims & issues as well as policies (egg QE, austerity, privatization etc) Able to relate to a full range of data & evidence to develop answer

2 (4-6 m) 3 (7-8m)

E1 (1 m) E2 (2 m)

Mainly unexplained judgment Judgment based on analysis; good effort at substantiation

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13 Essay Questions
1. Globalisation and technological advancement have caused rising income inequality in many countries. Minimum wage policy is implemented in many countries to improve the welfare of low skilled workers and narrow the income gap. (a) Account for the increasing income gap between skilled and unskilled labour in Singapore. [10] (b) Is minimum wage the best policy to narrow the income gap in Singapore? [15]

(a) Introduction - Increasing income gap between skilled and unskilled labour is caused by widening wage gap. - Wages of workers are determined by free market forces of demand and supply of labour. - Labour market is assumed to be perfectly competitive. Body ? ? Increasing wages of skilled workers coupled with falling wages of unskilled workers result in increasing income gap between skilled and unskilled workers. Wages of skilled labour are increasing significantly due to globalization and technological advancement o Globalisation has increased the demand for skilled labour in Singapore. Freer movement of goods and services across international boundaries is a characteristic of globalisation. Countries will specialize in industries which they possess comparative advantage [CA]. Singapore possesses CA in knowledge intensive industries. The expansion of knowledge intensive industries such as pharmaceutical, bio-medical and financial industries increases the demand for skilled labour. o Technological advancement has increased the demand for skilled labour. Skilled labour is required to operate machineries, computers and other mechanized equipment brought about by technological advancement. o Ceteris paribus, an increase in demand for skilled labour will result in an increase in equilibrium wages of skilled labour. ? Demand for skilled labour increases from D0 to D1. ? At prevailing wage, W 0, there is a shortage of workers, Q1Q2. ? The shortage of workers will cause firms to offer higher wages. ? As wages increase, Qd of workers decreases and Qs of workers increases. ? This increase in wages will continue till Qd=Qs at W 1.

Wages

S

W1 W0

D1 D0 Q0
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o

For a given increase in demand for skilled labour, wages of skilled labour likely to increase more than proportionate (to quantity) as the supply of skilled labour is price inelastic. PES of skilled labour is relatively low as the process required to educate and train skilled workers is lengthy. This significant increase in wages for a given increase in demand for skilled labour worsens income gap between skilled and unskilled labour.

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Wages of unskilled labour are falling due to globalization and technological advancement o Globalisation has increased the supply of unskilled labour in Singapore. Freer movement of labour is a characteristic of globalization. Singapore augments its supply of unskilled labour by allowing foreign workers to work in Singapore. Unskilled labour is deployed in various labour intensive industries such as cleaning services industry. o Technological advancement has decreased the demand for unskilled labour. Innovations such as labour-saving machines in cleaning industries have substituted unskilled labour. o With a decrease in demand for unskilled labour and an increase in supply of unskilled labour, will result in a fall in the wages of unskilled labour. o [Diagram, with accompanying explanation to illustrate decrease in demand for unskilled labour and increase in supply of skilled labour required.]

Conclusion ? Free market forces acting in the labour market will cause the income gap between skilled and unskilled workers to increase in the face of globalisation and technological advancement. Knowledge, Application, Understanding, Analysis L1 ? ? ? L2 ? ? ? Lack of theoretical framework to analyse increasing income gap. Glaring errors in analysis Superficial analysis Use of appropriate theoretical framework to analyse increasing income gap. Some explanation of how increasing income gap comes about. Some gaps/errors in analysis. 1-4

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[Max 5 marks. Only analysed increase in wages of skilled labour or fall in wages of unskilled labour.] [Max 6 marks. Only SS or DD factors are included in analysis.] L3 ? Detailed analysis of how increasing income gap comes about. o Step-by-step explanation o Appropriate diagram/s which are explained, used in analysis Only 3 shifts – max 8m No adjustment process – max 8m No mention of PED/PES concepts – max 9m 7 – 10

? ? ?

(b) Introduction ? Income distribution can be measured using the Gini Coefficient which ranges between 0 and 1. A larger Gini coefficient represents more unequal income distribution. ? Increasing income gap can represent an inequitable distribution of income.
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? ? It can cause problems such as such as material hardship for lower income groups, increasing tension between the different income groups and social instability. Hence, policies to narrow income gap should be pursued if it is perceived to be inequitable. There are various policies to narrow the income gap, among which is the minimum wage policy.

Body ? Minimum wage policy can narrow income gap by lifting the minimum wages earned by unskilled labour. o For minimum wage policy to be effective, it has to be set at W MIN which is above W FM, the free market equilibrium wage. o Workers who are able to find jobs which pay W min become better-off o Income gap is narrowed as unskilled labour earns W MIN which is more than W FM. o Minimum wage policy can be effectively implemented as long as monitoring is carried out and enforcement actions are taken against errant employers. However, minimum wage policy have the following limitations: o Minimum wage policy can cause an increase in the level of unemployment among unskilled workers. Employers cut back on number of workers employed as these workers are now more expensive to hire. Under the minimum wage policy, only QMIN number of workers are employed. This is less than QFM number of workers employed before the policy is implemented. o On one hand, QMIN workers who are able to secure jobs at wages of W MIN are betteroff. However, QMINQFM workers who are unable to find jobs are worse-off. Consequently, it is unclear if unskilled labour, as a group, becomes better-off under the minimum wage policy.

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Wages

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WMIN

WFM

D No. of Worker s o Minimum wage policy causes wage-push inflation in the economy which results in other macroeconomic objective trade-offs. This can result in a loss of competitiveness of the Singapore economy as its goods and services become more expensive relative to its trade competitors. Firms will also experience a reduction in profits as labour costs increase. Unprofitable firms will shut down further contributing to unemployment. Other policies which can narrow the income gap include: o More progressive income tax system will reduce the after-tax income gap ? To increase the progressivity of Singapore?s income tax system, the proportion of taxes paid by higher income earners should be increased. The QFM QMIN

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highest marginal tax rate of 20% for individuals earning more than $320,000 can be increased. ? This will reduce the after-tax income of high income earners and hence reduce the after-tax income gap. ? Moreover, the increase in tax revenue raised can be used to finance transfers to the lower income earners. ? However, limitations of this policy include: ? Higher tax rates could dis-incentivise work effort as workers choose to consume more leisure as the monetary rewards of work have decreased. ? Higher tax rates work against Singapore?s efforts to attract the global talents to re-locate to Singapore to work and live. More targeted transfers from government to low income earners will reduce the income gap ? For example, under the Workfare Income Supplement scheme, low income earners are eligible for wage top-ups of up to $700 per quarter from the government as long as they remain employed for at least 2 of 3 months. This effectively increases the after-transfer income of low income earners and reduces income gap. ? For example, under the Wage Credit Scheme, the government will co-fund 40% of up to $200 wage increment given to workers who earn less than $4,000 a month. This scheme runs for a duration of 3 years from 2013 to 2015. Employers are more likely to increase low income earners wages as it is co-funded by the government. This will increase the wages of low income earners and reduce the income gap. ? However, limitations of policies that involve government transfers include: ? Burden of financing transfers. ? Low income workers and their employers may become reliant on these transfers. Tightening of Singapore?s unskilled foreign worker policy will reduce the income gap: ? For example, a reduction in the number of employment passes issued to unskilled foreign workers will reduce the supply of unskilled labour, increasing wages. As such, low income earners will earn higher wages resulting in a reduction in income gap. ? For example, government could increase the foreign worker levy to be paid by employers. Unskilled foreign workers become more expensive to hire. This will cause an increase in the demand for local unskilled workers, resulting in higher wages and consequently a reduction in income gap. ? However, limitations of such policies include: ? Wage-push inflation. (covered previously) ? Some jobs will remain unfilled as locals shun jobs in certain industries such as construction and ship-building. Key industries in Singapore could be negatively affected by this shortage of workers. Skills upgrading policies will reduce the income gap: ? For example, under the Workfare Training Support Scheme, the Singapore government subsidies employers up to 95% of fees incurred in sending low income earners for approve upgrading courses. In addition, workers are provided cash incentives for completing upgrading courses. By upgrading the skills of workers, they become more productive. Firms will be able to pay higher wages to these better-skilled workers. This helps to reduce the income gap. ? However, limitations of skills upgrading policies are: ? Burden of financing course subsidies. ? Mindset and receptivity of workers ? Loss of productivity during training ? Policy takes time to take effect ? Quality and relevancy of skills upgrading courses

o

o

o

Conclusion
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? ? ? ? ? Policies are required to address increasing income gap if it is perceived to be inequitable. Income gap can be narrowed by paring the top income earners and/or leveling up the low income earners. The competitiveness and vibrancy of the Singapore economy should not be compromised in the attempt to close the income gap. Ideally, policies that level up low income earners should be preferred. While minimum wage policy and targeted government transfers can help level up low income earners, significant trade-offs are incurred. Skills upgrading policy is the long term solution to closing the income gap in Singapore as it addresses the root of the problem. Knowledge, Application, Understanding, Analysis Lack of theoretical framework. One-sided answer. o Limitations of policies not discussed. Narrow scope. o Only minimum wage policy was analysed. Superficial analysis. Glaring conceptual errors. Use of appropriate theoretical framework. Balanced answer. o How policies work / Limitations of policies discussed. Sufficient scope. o Minimum wage policy. o At least 1 other policy. Some explanation of how policies work and their limitations. Some gaps/errors in analysis. Some application to Singapore context. Good scope. o Minimum wage policy. o At least 2 other policies. Detailed explanation of how policies work and their limitations. Application to Singapore context Evaluation Evaluative remarks/Insightful comments. Judgment made. Unsupported judgment, position. Evaluative remarks/Insightful comments. Well-reasoned and substantiated judgment that suits Singapore?s context.

L1

? ? ? ? ?

1-5

L2

? ? ? ? ? ?

6-8

L3

? ? ? ? ? ? ? ? ?

9 - 11

E1

1-2

E2

3-4

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2. The UK Rail industry is split into franchises, in which companies are invited to bid for the rights to operate individual rail routes for a specified time period. Train operators typically sell their tickets at a lower price if they are bought in advance on the internet, and they offer both first class and economy class tickets. (a) Explain whether the above pricing policies could be considered to be examples of price discrimination. [10] (b) Discuss whether the UK government should regulate prices in the rail industry to protect society’s interests. [15] (a) Introduction: Define Price Discrimination - Charging different prices for the same good for reasons not associated with cost differences. Body: 1) Train operator selling tickets at a lower price if they are bought in advance rd Identify that this is 3 degree price discrimination - Charging different prices for the same good to different groups of consumers for reasons not associated with cost differences Explain why the pricing policy is can be classified as 3 degree PD by appealing to the conditions for PD - Train operators are price setters o Each train operator acts as a monopoly for its own individual rail routes - Impossibility of resale o Train tickets if bought in advance can only be collected with the credit card used for purchase - Market can be segmented due to differences in PED o Time of purchase can be used by the train operator to segment consumers o Lower ticket prices for consumers who buy their train tickets earlier as they have a more price elastic demand. This is because they have not fixed their travel plans yet and so they have more substitutes (other travel alternatives such as coach services) to choose from. Hence, the train operator will earn higher revenue by charging these consumers a lower price as the fall in price leads to a more than proportionate increase in quantity demanded. o Consumers who buy tickets nearer the travel dates are usually business travellers. They have a more price inelastic demand as they are unable to change their business appointments and so there?s a high degree of necessity for them to travel at a particular date/on a particular route. This enables the train operator to charge higher prices as an increase in price leads to a less than proportionate decrease in quantity demanded, so total revenue will increase. - No significant difference in costs o Cost of providing the train ticket is the same regardless of time of purchase o Cost of train travel is constant as well 2) First class tickets and economy class tickets First class tickets are typically sold at a higher price than economy class tickets
rd

Highlight that this is not a case of price discrimination - Difference in cost of production for the train operator for first class and economy class seats o First class seats incur higher costs due to food/beverage provided or better seats/amenities o Given the difference in cost, it is justified for the train operator to charge higher prices for the seats.

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OR Different type of good (and so demand is different) o First class seats and economy class seats are considered to be different products by customers o First class seats provide more leg space/provide a different degree of comfort/include food and beverage o As a different product with a higher demand, the train operator is simply just selling a different product at a higher price and so not practising price discrimination (it is not the same good)

Conclusion: The train operators are practising price discrimination but only with regards to the advance sale of tickets. NOTE: The act of the train operator offering multiple classes of seats on flights at different prices can be nd nd considered to be a form of 2 degree price discrimination. Traditional 2 degree price discrimination is when price varies with quantity demanded. This works as a form of price discrimination as firms use rd quantity to differentiate themselves according to their preference (this is unlike 3 degree price discrimination where the firms are able to identify and segment the market). In reality, different pricing may apply to differences in product quality as well as quantity. For example, when the train operators offer first class and economy class seats, this allows them to differentiate consumers based on preference, and therefore allows the train operators to capture more consumer surplus. The cost of providing a first class seat is actually not significantly more than the cost of providing an economy class seat (once the seat is in place, the only difference in marginal cost will be just the cost of food and drinks). Knowledge, Application, Understanding, Analysis Descriptive answer which contains little if any economics Substantial/ lots of glaring conceptual errors throughout Listing of points with little/no economic analysis An incomplete/underdeveloped explanation of whether the above pricing policies practised by the train operator are a form of price discrimination. A clear and thorough explanation of whether the above pricing policies practised by the train operators are a form of price discrimination. Good use of economic concepts and examples pertinent to the rail industry. 1–4

L1

-

L2

5-7

L3

-

8 - 10

-

(b) Introduction: Explain that price regulation in this context refers to setting a maximum price on ticket prices. In this context, the government should practise either MC or AC pricing to protect society?s interests. Body: Thesis: The UK government should regulate prices in the rail industry to protect society?s interest. 1) Each train operator is a monopoly for the particular train route that they are operating. This leads to allocative inefficiency. a. Explain with the aid of a diagram how market dominance leads to allocative inefficiency. 2) Explain how MC pricing will help to protect society?s interest. a. Explain with the aid of a diagram how MC pricing leads to allocative efficiency. 3) Explain how because of market dominance/price discrimination, the monopolist will earn supernormal profits. This leads to inequity. a. There is a transfer of consumer surplus from consumers (poor) to the monopoly (rich).
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4) Explain how AC pricing will help to protect society?s interest. a. Explain how AC pricing helps to achieve equity/reduce allocative inefficiency. Anti-thesis: The UK government should not regulate prices in the rail industry to protect society?s interest. 1) Explain the limitations of price regulation. a. Failure to achieve AE. If the maximum prices set are too high (due to imperfect information), the train operator will be guaranteed high prices and high profits and so may not have an incentive to minimise costs of production (productive inefficiency). If the maximum prices set are too low, the firm may shut down and leave the industry if it is unable to earn at least normal profits. b. Shutdown of firm. MC pricing may cause the firm to shut down and leave the industry (for the context of a natural monopoly which is applicable to the context of the UK rail industry). This leads to allocative inefficiency as an essential service is not provided. c. Lack of dynamic efficiency. AC pricing will lead to normal profits in the LR (or price regulation will reduce the profits of the monopoly) and so the train operator will not be able to conduct R&D and hence there will not be improvement in quality of rail travel in future. d. Government failure. Government bureaucracy and inefficiency of government intervention (red tape). The government may also not be able to respond quickly to changes in market conditions, and so may lead to allocative inefficiency in the rail industry. 2) A price discriminating monopolist is beneficial to society?s interests (application to UK rail industry). rd a. Equity. Explain how a 3 degree price discriminating monopoly is able to allow consumers from lower income groups to consume more of the rail service at a lower price because the firm is charging a higher price to consumers in higher income groups (business travellers) and using the additional profits earned to subsidise the lower income consumers. Contrast with the case of monopolist that charges a uniform price. b. Increase R&D. The price-discriminating rail operator enjoys higher revenue and thus profits. Higher profits may benefit society if these profits are re-invested into research and development which leads to product improvement and cost reductions. c. Survival of firm. Price discriminating may be necessary for the train operator to earn the necessary profits to survive in the industry. Diagram to illustrate. d. Efficiency. Explain how a first degree price discriminating train operator (although this is highly unrealistic given the real world) is able to achieve allocative efficiency. Conclusion: Make a justified stand of whether the UK government should regulate prices in the rail industry based on the criteria of efficiency and equity, bearing in mind the costs of price regulation. The student can also bring in alternative forms of government policy to solve the problem of market dominance. 1) Taxes. Explain how a lump sum tax (profits tax) is able to solve the problem of inequity in the railway industry. a. Evaluation: This will lead to a fall in profits for the monopolist and so hinder R&D in the rail industry. 2) Subsidies. Explain how a subsidy when given to the monopolist will shift its MC and lead to the monopolist producing at the allocative efficient output level. Consumers will also benefit as they enjoy lower prices. a. Evaluation: This will lead to a drain on the government budget. It is also inequitable as the monopolist now ends up with higher profits. 3) Nationalisation. Explain how a nationalised monopoly will benefit society?s interests as the government will produce the socially optimal output level (efficiency) as well as setting prices low (equity). a. Evaluation: Explain how a nationalised monopoly will not have a profit maximising motive and so may end up to be productive inefficient. 4) Introduction of competition. Explain how the current bid system used by the UK government ensures that society?s interests are protected. The UK government invites train operators to
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bid for licenses to operate the rail routes. This introduces competition as the bidding is competitive in terms of both price as well as the quality of service. There is an incentive for rail operators to keep prices low and standards high so as to win the bid. a. Evaluation: Even though competition is introduced, the market is still imperfectly competitive (oligopolistic). Firms still have an interest to exploit consumers. Knowledge, Application, Understanding, Analysis An answer without a clear economic framework and lack balance. Points are not well developed to show an understanding of the issue. Glaring conceptual error. For an underdeveloped discussion. For a two sided answer with limited scope on whether the UK government should regulate prices in the rail industry. For a good analytical and balanced answer. There is sufficient scope (efficiency and equity are well considered) and depth in discussion with well labelled diagrams to enhance analysis. Good application to the UK rail industry (price discriminating firm). Evaluation E1 E2 An unexplained judgement ? An unexplained evaluative conclusion/comment Evaluative assessment supported by economic analysis ? Substantiation of an evaluative comment and/or conclusion 1-2 3-4

L1

-

1–5

L2

-

6-8

L3

-

9 - 11

-

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3. How far can efficiency in resource allocation be achieved by encouraging competition in Singapore? [25] Introduction: ? Identify that “encouraging competition” is a form of government intervention undertaken to resolve market failure that arises from market dominance. ? Explain market failure - failure of the unregulated free market to allocate resources fully and efficiently. ? Explain key sources of market failure – market dominance, presence of externalities, imperfect information and failure of the free market to provide public goods. ? Explain the objective of government intervention in the markets for goods and services ? In the event of the failure of the free market, the government?s intervention aims to achieve the microeconomic aim of allocative efficiency ? Explain concept of allocative efficiency o Net social benefit or maximum total surpluses occurs at an output level where the valuation of (or benefits to) consumers for the additional unit of the good produced (P) is equal to the opportunity costs incurred in using resources to produce that additional unit (MC) (i.e. Price = Marginal Cost) o The optimum output for the society is at QC where the price, PC is determined by the point of intersection of the market demand curve (AR) with the supply curve or the MC in the case where there is no market dominance (i.e. in a perfectly competitive market). o At output QC and price PC, total societal surpluses (consumers? and producers?) could be maximized, where P = MC. Body: 1. Brief explanation of how market dominance causes market failure. ? Explain what is meant by ?market dominance? – ability of the firm to control price and exclude competition o Monopoly – sole firm in the industry ? capture total market DD o Oligopoly – a few dominant firms in the industry ? few firms each having a significant/large market power o Examples of monopolistic or oligopolistic markets : Oligopolies include telecommunication industry in Singapore, Integrated Resorts (MBS and RWS), Banking industry in Singapore (explain wrt characteristics above) while a Natural Monopoly would be that of Public Transport (egg. MRT) Industry/ Media ? Explain how market dominance leads to market failure (with the aid of a diagram) o Identify the objective of the firm ? to profit maximize o The high market share implies firm?s demand curve (AR) is rather price inelastic. Hence there is a fairly large degree of exploitation for every unit of output produced when there is market dominance by a firm. o So when firms choose to restrict /set output at the level where the additional revenue gained for an additional unit produced (MR) equals the additional costs incurred for that additional unit produced (MC) i.e. at Qm where MR=MC (profit-max condition) and MC is rising o Setting output where profits are maximized (MR=MC) results in an equilibrium price, P m, set above marginal cost (P>MC) at Qm. o At Qm ,the valuation of (or benefits to) consumers for the additional unit of the good produced (P) is greater than the opportunity costs incurred in using resources to produce that additional unit (MC) – the vertical distance of the divergence represents a degree of consumer or monopolistic exploitation, representing the extent of allocative inefficiency caused by market dominance.

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Price/Revenue/Cost

MC = SS PC Industry A

Pm Pc MC

B C

D

MR o

AR = DD PC Industry

0 Qc Qm Quantity Hence so long as the output produced and sold is where P>MC, the output produced will be less than the socially optimum level, at Qc (underproduction of goods and services by the amount QcQm) ? consumers? and producers? surpluses (total surpluses or societal welfare) are not maximized ? there is market failure and an inefficient allocation of resources ? Deadweight loss on the society of area BCD.

2. Thesis: Efficiency in resource allocation be achieved by encouraging competition in Singapore ? Highlight the role of the Competition Commission of Singapore (CCS) in the case of market dominance: o Increasing competition in markets ? include pro-market government policy such as liberalization, deregulation o Singapore Competition Act: legislation / regulation ? anti-competitive laws Explain rationale for Intervention (Use economic framework): o The introduction of greater competition into the Singapore markets ? reduces market power amongst firms ? DD falls (AR1 and MR1 shifts left to AR2 and MR2) and price elasticity of demand increases (potential weakening of market power due to availability of substitutes) ? lower prices from P1 to P2 ? decreasing the divergence between P and MC ? reducing the extent of allocative inefficiency. Also, because total level of output increases in the entire industry due to the increase in number of producers ? move the equilibrium level of output closer to allocatively efficient level. o The introduction of greater competition ? increase dynamic efficiency and responsive to consumers? needs ? better, more innovative services, more promotional offers ? consumers enjoying a wider variety and quality of products or services egg. Telcos provision of cable TV include on demand TC, type of programs etc.

?

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Price MC P1

P2 MC1 MC2 MR1 MR2 0 Q2 o Q1 Quantity AR1 AR2

The introduction of greater competition ? reduces cost-inefficiency (X-inefficiency) of a firm with market dominance due to the lowering of supernormal profits that can be used to cushion unnecessary increase in costs ? forcing firms to be more productively efficient from the firm?s point of view.

3. Anti-thesis: Efficiency in resource allocation may not necessarily be achieved by encouraging competition in Singapore (i) Explain that encouraging competition need not necessarily help achieve allocative efficiency in the case of a natural monopoly (market dominance that arises due to natural BTE) ? Briefly explain the case of a natural monopoly & how it is inevitable but may still result in the failure to achieve allocative efficiency.

AR(1/2)

? As shown above, a natural monopoly possesses the distinct characteristic in which the LRAC of the firm falls continuously as output expands as the MES is large and there is room for only one firm to fully exploit all of the available economies of scale, hence being able to supply the entire market at a lower price than two or more smaller one.
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? The key point is that a natural monopoly exists when there is scope for economies of scale to be exploited over a very large range of output relative to the entire market demand. ? In such industries where there is a high ratio of fixed to variable costs. The high fixed costs of building a national or regional infrastructure distribution network for a product might be enormous, but the marginal (variable) cost of supplying extra units of output may be very small. In this case, the ATC will continue to decline as the scale of production increase, because fixed (overhead) costs are being spread over high and higher levels of output. Examples include the national grid for electricity transmission, gas transmission; the building and maintaining a country?s telecommunications network for broadband industry; etc. ? Explain that in the case of a natural monopoly, introducing competition is detrimental to its existence since it is not possible for 2 or more firms to exist, each charging the same price and supplying half of the industry?s output as there is no price that would allow them to cover cost. Introducing competition in this case will only result in firms leaving the industry due to subnormal profits reaped ? non-provision of the good ? allocative inefficiency rises ? Instead, for natural monopolies, there are other better ways of government intervention such as engaging in price regulation i.e. MC pricing in order to achieve allocative efficiency. ? Briefly explain how MC pricing works to achieve AE in natural monopolies, with reference to the diagram. (ii) Explain that there are other significant sources of market failure in Singapore that are not necessarily resolved by encouraging competition . (Provide real life examples for each of them) Market failure arising from the presence of externalities , in particular negative externalities in Singapore from the usage of motor vehicles, is a major source of market failure due to the longterm impact of prolonged damage of environment because of pollution as well as the immediate negative impact such as traffic congestion. o Explain how market failure arises from the use of motor vehicles (use a diagram) o Briefly explain why such a source of market failure cannot be resolved by introducing or encouraging competition. (failure in addressing the root cause of over-consumption) o Instead, in order to achieve allocative efficiency, the government has to employ market based (ERP charges that work like a tax) as well as non-market based policies (COE that is a quota on purchases of new cars) to resolve the market failure problem of over-consumption of motor vehicles. (Briefly explain how these policies work) Market failure arising from positive externalities and imperfection of information manifests itself in the form of the under-consumption of merit goods that are deemed by the government to be socially desirable, such as basic healthcare, education and public housing. o Using a diagram, explain how market failure arises from the consumption of merit goods. rd (failure to take into account of external benefits on 3 parties in the case of positive externality associated with consumption of merit goods as well as ignorance of potential private benefits associated with consumption of the good, hence underestimating the private benefits in the case of imperfect knowledge) o Briefly explain that the allocative inefficiency that has resulted from under-consumption cannot be resolved through the introduction of competition. o Instead, in order to achieve allocative efficiency, the government has to intervene in the provision or subsidization of merit goods through market based policies such as subsidies (targeting the internalization of external benefits) or non-market based policies such as launching mass public education programmes to raise awareness of the importance of consuming such services, hence resolving imperfection of information. (briefly explain how these policies work) Market failure arising from the non-provision of public goods by the free market , in the form of provision of national defence and street lighting etc. o Explain how the twin characteristics of non-rivalry and non-excludability of public goods present a case of market failure (missing market)

?

?

?

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o o Briefly explain that in the case of the non-provision of the public good by the free market, introducing competition does not resolve the allocative inefficiency problem since the free market chooses not to produce the good in the first place. Instead, in order to achieve allocative efficiency, the Singapore government has to intervene through non-market based policy to directly provide public goods like national defence though MINDEF, police services (SPF) and civil defence (SCDF) in order to achieve domestic stability, and at the same time ensuring there is positive business confidence in Singapore.

?

Any other potential sources of market failure (explain using economic framework and accompanied with real life examples within the Singapore context)

Conclusion: ? Make a stand regarding the effectiveness of encouraging competition in correcting market failure and achieving allocative efficiency in Singapore. More specifically, encouraging competition can only be applied to market failure arising from market dominance and only in non-natural monopolies. ? There are other forms of market failure in Singapore that cannot be corrected with the encouragement of competition. ? As Singapore is an open economy, Singapore firms would be exposed to foreign firms? penetration and hence, increased international competition, making the case for control of market domination less important for Singapore, hence introduction of competition by the CCS is not the main and most significant form of government intervention to achieve allocative efficiency in Singapore. ? On the other hand, direct provision of public goods and subsidies in merit goods market failure could be argued to be more effective at achieving allocative efficiency. For egg. Public goods such as National Defence and merit goods such as education, healthcare and public housing provision takes up a sig. proportion of Singapore?s budget either through direct provision or subsidies. ? The intervention in public and merit goods also serves as a building block in which the government can achieve internal stability and create a more business-friendly environment to continue to encourage foreign direct investment (FDI) into Singapore. Mark Scheme: Level L1 Descriptors Answer fails to address the question. Answer is mainly irrelevant. Answer that shows some knowledge of the concepts but does not show that the meaning of the question is grasped. Attempt to show a balanced answer i.e. whether AE can be achieved through encouragement of competition but explanation may not be sufficiently developed. Egg. Explanation of why government intervenes for reasons other than market dominance (i.e. other sources of market failure), but analysis lacks rigour. Some reference to Singapore context is provided. L3 Well-developed two-sided argument that is able to examine the extent to which introduction of competition achieves AE in Singapore?s context. Candidates are also able to analyse the different causes for government intervention in the Singapore context as well as the use of alternative policies to resolve these other sources of market failure. Good use of economic framework and supported with relevant examples and clearly illustrated diagrams. Unexplained judgement or not supported by economic analysis. Evaluative discussion based on economic analysis. 17 - 21 Marks 1-9

L2

10 - 16

E1 E2

1-2 3-4

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4. Singapore’s Consumer Price Index (CPI) rose at a moderate rate of 5.5% in 2011. A shortage of completed dwellings will cause accommodation prices to rise further in the near term. Private road transport cost is expected to remain firm in view of the tight COE supply. However, inflationary pressures from abroad should ease, given the moderation of oil prices. (a) Distinguish between the sources of inflation in Singapore. [10]

(b) Discuss the extent to which inflation in Singapore would cause a worsening of the other macroeconomic indicators. [15]

(a) Identify sources of inflation from preamble: Increase in price of accommodation, transport, imported oil Distinguish according to clearly-defined criteria Accommodation Transport Demand-pull Demand-pull: Shortage of homes Demand-pull: Shortage of cars vs. cost-pull and hence increase in home and hence increase in car prices prices is due to an increase is due to an increase demand for demand in for homes. This cars. This represents an represents an increase in C. increase in C. Increase in C ? Increase in C ? increase in AD increase in AD ? increase in ? increase in GPL GPL Internal vs. Internal: Increase in GPL is due to Internal: Increase in GPL is due External increase in domestic spending to increase in domestic spending

Imported Oil Cost-push: Increase in price of oil ? increase in cost of production since oil is a factor of production ? AS shifts up (decreases) ? increase in GPL

External: Increase in GPL is due to increase in price of an imported factor of production Less significant magnitude (?moderation of oil prices?)

Magnitude

Significant magnitude

Significant magnitude

Level L3

L2

L1

Descriptor Scope: Recognises at least two distinct sources of inflation and distinguishes between them (accurately) according to at least two criteria AND Depth: Makes good use of the AD-AS framework to explain how some sources cause demand-pull inflation and others cause cost-push inflation AND Context: Sources of inflation and significance of each source relatable to Singapore Scope: Recognises at least two distinct sources of inflation and distinguishes between them (accurately) according to whether they cause demand-pull or cost-push inflation AND Depth: Makes good use of the AD-AS framework to explain how some sources cause demand-pull inflation and others cause cost-push inflation AND Context: Sources of inflation relatable to Singapore Lacks scope: Unable to distinguish between the sources of inflation using any criteria (i.e. just identified/explained the sources of inflation without it being beyond reasonable doubt that a comparison is being made) OR Lacks depth: Did not make use of the AD-AS framework (e.g. using only demand and supply framework)

Marks 8-10

5-7

1-4

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(b) Approach 1 Identify and define the other macroeconomic indicators -Indicator for economic growth = real GDP growth rate: Percentage change in the total value of the final goods and services produced within the geographical boundary of a country in a given time period -Indicator for unemployment = Unemployment rate: Proportion of population that is willing and able to work [i.e. the labour force] that is unable to find jobs -Indicator for external balance = Balance of Payments (BoP): Record of net monetary flows into a country arising from cross-border transactions. It?s the sum of the current account balance (trade, income, and transfer balances) and financial account (long and short term capital) balance. Explain how inflation in Singapore may or may not cause a worsening of the other macroeconomic indicators Thesis: Inflation will cause a worsening of other Anti-thesis: Inflation will not cause a worsening of macroeconomic indicators other macroeconomic indicators -If inflation is demand-pull: -If inflation is demand-pull: >Inflation may now be higher relative to foreign >Increase in AD ? increase in real NY via the countries ? loss of export price competitiveness multiplier process ? improvement in real GDP and imports becoming relatively cheaper ? growth rate worsening of Balance of Trade (BoT) ? >(From above) Increase in real NY ? increase in worsening of BoP position derived demand for labour as labour is a factor of production ? reduction in cyclical unemployment ? fall in unemployment rates

-If inflation is cost-push: >Similar to above, worsening of BoP position >Upward shift of AS ? fall in real NY ? worsening of real GDP growth rate >(From above) Decrease in real NY ? decrease in derived demand for labour as labour is a factor of production ? increased unemployment ? rise in unemployment rates

Conclusion -Inflation in Singapore definitely has a deleterious effect on the health of the BoT and hence the BoP. With regards to the other indicators, the net effect depends on whether inflation in Singapore was more due to demand-pull or cost-push factors. Demand-pull inflation is more likely to have a salutary effect on real GDP growth and unemployment while cost-push inflation is more likely to be accompanied by a reduction in real GDP and an increase in unemployment rates. Since inflation in Singapore (according to the preamble) is more due to an increase in AD than a reduction in AS, the net effect on real GDP growth and unemployment is likely to be positive. Approach 2 Identify and define the other macroeconomic indicators -Indicator for economic growth = real GDP growth rate: Percentage change in the total value of the final goods and services produced within the geographical boundary of a country in a given time period -Indicator for unemployment = Unemployment rate: Proportion of population that is willing and able to work [i.e. the labour force] that is unable to find jobs -Indicator for external balance = Balance of Payments (BoP): Record of net monetary flows into a country arising from cross-border transactions. It?s the sum of the current account balance (trade, income, and transfer balances) and financial account (long and short term capital) balance.

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Explain how inflation in Singapore may or may not cause a worsening of the other macroeconomic indicators Thesis: Inflation will cause a worsening of other Anti-thesis: Inflation will not cause a worsening of macroeconomic indicators other macroeconomic indicators Growth: Growth and Unemployment: Inflation ? uncertainty ? loss of biz confidence Small size of k (high MPS and MPM due to CPF ? fall in I ? fall in AD ? fall in real NY via k and lack of natural resources) process ? worsening of real GDP growth rates 5.5% is high, but may not be high enough to UnE: warrant a significant loss of investor confidence From above, fall in output ? fall in demand for labour as labour is an FoP which has its demand BoP: derived from the demand for goods and services For BoT, it?s relative inflation that matters. 5.5% ? rise in unemployment rates may be lower than inflation in other countries. BoP: Inflation may now be higher relative to foreign countries ? loss of export price competitiveness and imports becoming relatively cheaper ? worsening of Balance of Trade (BoT) ? worsening of BoP position Also, from above, lower FDI inflow will worsen the FA and BoP position

Conclusion -Whether inflation will cause a worsening of Singapore?s other macroeconomic indicators depends on the kind of expectations it creates, as well as whether it exceeds the inflation rates in Singapore?s major trading partners. While 5.5% sounds high, it should also be noted that the underlying core inflation was still low and stable (i.e. the headline inflation was primarily driven by increases in the prices of housing and cars) and as such, business expectations are unlikely to be significantly affected. With regards to the relative inflation rates, our major trading partners US and EU faced inflation rates of approximately 4% and 3% in 2011 respectively. As such, it is very likely that our Balance of Trade and hence Balance of Payments position worsened.

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Level L3

Descriptor Balance: Discussion shows how inflation may both worsen and not worsen the other macroeconomic indicators AND Scope: Discussion covers growth, unemployment, external balance and their indicators AND Depth: Makes good use of the AD-AS framework and/or relevant concepts to explain the effects on the other macroeconomic aims AND Context: Explanations are applicable to Singapore Balance: Discussion shows how inflation may both worsen and not worsen the other macroeconomic indicators AND Scope: Discussion covers at least two of the other three macroeconomic indicators AND Depth: Makes good use of the AD-AS framework and/or relevant concepts to explain the effects on the other macroeconomic aims AND Context: Explanations are applicable to Singapore Lacks balance: One-sided argument. Either explained how the other macroeconomic indicators will be worsened OR how they will not be OR Lacks depth: No/Very limited use of economics frameworks and concepts OR Lacks scope and context: Only discussed one other macroeconomic indicator with no reference to Singapore whatsoever. Judgement that answers the question with well-elaborated and insightful justification. Judgement that answers the question with some attempt at justification. Justification is incomplete or weak.

Marks 9-11

L2

6-8

L1

1-5

E2 E1

3-4 1-2

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5. In response to their current economic climates, the US government posted its third consecutive annual budget deficit in excess of US$1 trillion (8.7% of GDP) in 2011. On the other hand, the Singapore government posted an overall budget surplus of S$2.3 billion (0.7% of GDP). To what extent is the choice of government budget positions the best way for these countries to achieve macroeconomic stability? [25] Suggested Outline Students were required to analyse the effects of the choice of government budget position (deficit – expansionary fiscal policy or surplus – contractionary fiscal policy) on the economy and discuss its effectiveness/desirability in achieving the macroeconomic objectives of a country. Students are also required to compare between using the government budget to manage the economy and other alternative policies to see which policy is the most effective &/or desirable given the economic climate in Singapore and the US. Introduction Establish what is meant by macroeconomic stability: o Macroeconomic aims: Internal stability: stable and positive economic growth, low inflation rate (price stability) & low unemployment rate. External stability: Healthy BOP and stable exchange rate Current economic climate in the two countries: o US: weak EG/Recession, high unemployment rate, low inflation rate, BOT deficit o Singapore: Stable EG, low unemployment, high inflation rate, healthy BOP. Interpret the choice of government budget positions o US: Budget deficit – expansionary fiscal policy o Singapore: Budget surplus – contractionary fiscal policy Define the scope of the question o Explain FP – achieve macroeconomic stability – limitations – alternative policies – strength/weaknesses of policies – evaluate and make judgement “best way” o “the best way” - There must be comparisons between policy suggestions to achieve macroeconomic objectives (given the different contexts in countries). Yardsticks that can be used for comparison include the extent to which the policy can/will impact NY, EU, and inflation rate, direct VS indirect measure, SR vs. LR effects, limitations etc.

-

-

-

Body Thesis: The choice of budget position is the best way for these countries to achieve macroeconomic stability 1. Explain how the US uses the budget to achieve macroeconomic stability. ? Context: Slow EG/recession & high unemployment rate ? Policy: budget deficit – increase G or reduce T – expansionary FP ? Explain how increase G/increase in T will achieve macroeconomic stability. - If government increases expenditure on public works (e.g. building of roads), and reduce taxes to increase C and I, this will lead to an increase in AD (total demand on domestically produced goods by households, firms, government and foreign sector) as government expenditure, C & I are components of AD. - The initial increase in C, I & G, through the multiplier process will cause a more than proportionate increase in AD from AD0 to AD1. This will cause an increase in national income from Y0 to Y1 and reduce cyclical unemployment as the economy moves towards full employment level of national income. - The k- effect is due to the k-principle which states that expenditure creates income and income generates greater expenditure. Thus, the initial increase in C, I and G will lead to an increase in demand for firm?s output. As firms increase output, they hire more FOP and factor incomes increase, NY increase. As NY increase, this will stimulate increases in induced C which will
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cause further increases in AD and NY. The process will stop when the initial increase in AD is equal to the increase in total withdrawals. Illustrate diagrammatically. General Price Level (GPL) AS1

-

AD1 = C+I+G1+(X-M)
PE

AD0 = C+I+G0+(X-M) YE Y2 YF Real National Income

0

?

Advantages of using the budget: - direct effect on AD (if G rather than through T) - if spending is targeted, it will effectively increase aggregate supply and national income. E.g. increase spending on infrastructure, education or retraining and can help to achieve stability over the long term.

2. Explain how Singapore uses the budget to achieve macroeconomic stability. ? ? ? Context: recovery, strong EG, low unemployment, inflation rate is rising Policy: budget surplus – decrease G or increase T – contractionary FP Explain how increase G/increase in T will achieve macroeconomic stability. - Fall in G, C and I will lead to a more than proportionate fall in AD due to the reverse k-effect. This will dampen EG and will put a downward pressure on GPL and inflation rate. - The policy will be effective in preventing overheating, prevent wage-price spiral, and achieve price stability, which is important as a foundation for sustained EG (as Singapore is reliant on FDI and X). - The budget surplus will help Singapore government to accumulate surpluses and reserves, which can help in achieving confidence in the economy and increase its ability to manage any crisis in the future.

Note: Students need not need re-explain the whole k-process if they have done so in the case of the US. Anti-thesis: The choice of budget position is not the best way for these countries to achieve macroeconomic stability 1. Explain the limitations of the budget in managing the economy. ? US: ? Effectiveness of the policy may be dampened by crowding out effect – borrowing leads to competition for funds and may crowd out investments and consumption. Evaluate that this can be overcome by monetary policy. ? Time Lag – admin lag given that the deficit needs to be approved by congress. ? the budget deficit position may not be effective in achieving stronger growth and lower unemployment rate –“third annual consecutive deficit”. ? The policy is not sustainable – “third annual consecutive deficit” – high public debt will lead to macroeconomic instability in the long run. Higher taxes and spending cuts in future. Ideas of fiscal cliff, susceptibility to international crisis in future, reliance on foreign creditors should be accepted and considered.

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? ? ? ? Singapore: Small multiplier – the effects on AD and GPL will not be significant. G is a small % of GDP. May not affect AD and GPL significantly. May not be effective in managing the root cause of inflation in Singapore – imported cost-push inflation, domestic cost-push inflation (wage increase, transport costs increase), dd-pull inflation (increase in C, I & X – economic recovery). ? Conflict with other aims of EG and low unemployment. Evaluate that is it not a big problem because the private sector is spending, and the budget surplus is a small % of GDP). 2. Explain alternative policies and its limitations and compare to using the budget in achieving macroeconomic stability ? US: expansionary monetary policy (traditional MP or quantitative easing) ? Increase money supply ? fall in interest rate. - The fall in interest rate will lead to an increase in consumption & investment. If the fall interest rates lead to hot money outflow, the depreciation of US$ will also cause NX to increase. - Increase in C, I and NX will lead to a more than proportionate increase in AD due to the k-effect. This will lead to EG and lower UE rate.

? Comparison of MP to adopting a budget deficit - Advantages: shorter time lags in the implementation of policy, greater flexibility, do not require government financing - Disadvantages: indirectly approach to increasing AD, will not work as effectively during times of recession. - Synthesis: increasing G is more direct than MP and will be more effective in a recession. But MP may be more effective if government needs to borrow to fund its expenditure. In the case of US, need both policies. ? Singapore: gradual appreciation of ER - The appreciation of S$ will lead to an increase in Px (in f.c) ? fall in quantity traded of exports, a fall in Pm (in d.c) ? increase in quantity traded of imports. - PEDx and PEDm determines the extent of change in X and M. - Assuming M-L condition holds (PEDx + PEDm >1), this will lead to a fall in NX and a fall in AD. Which helps to dampen dd-pull inflation. - Due to reliance on imported FOP, appreciation of S$ will also lead to a fall in COP, increase in AS and dampen cost-push inflation.

? Comparison of ER policy to adopting a budget surplus - Advantages: targets the root cause of inflation – imported inflation in Singapore. - Disadvantages: limit to how much S$ can appreciate due to fall in Xcompetitiveness. Does not address domestic causes of inflation (which in recent years seems to be more serious contributors to inflation) - Synthesis: Exchange rate policy will be most effective to dampen inflation due to Singapore?s susceptibility to imported inflation. But because of the trade-off with export competitiveness, the policy should be used together with budget surplus to prevent overheating, and inflationary pressures in Singapore . ? Both Singapore and US can use SS-side policies. - Explain the workings of supply side policies (in the contexts of US and Singapore). - Students may discuss any of the measures below: - Retraining schemes, education ? increase productivity and potential capacity ? increase AS - wage policies ? flexible wages allow wages to fall in times of recession ? reduces the firms? COP ? this reduces the extent the firms retrench workers - any other ss-side measures.
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?

Limitations and Comparison of Supply-side policies to using the budget: - Some supply side policies take time to take effect - Require firms to respond to the government?s initiatives - Advantages: tackles the root cause of problems if macroeconomic instability is caused SS-side factors, can lead to long term economic growth, not just getting out of recession for the US, and prevent trade-offs in the SR for Singapore. - Disadvantages: does not tackle deficiency in demand directly (in the case of US)

Note: Accept any other sound points by students and be open to different approaches to the question. Conclusion & Overall Evaluation ? ? ? ? ? The choice of budget positions and fiscal policy is effective in helping the countries to achieve macroeconomic stability through EG, job creation and lower inflation rate. The position/policy can definitely be sustained in Singapore. While it may be effective in the SR for US, the long run cost may make the policy undesirable (financing of debt) and other policies should be the primary policy – monetary policy in the US. Combination of policies – the government may want to undertake a combination of policies so that the recession can be tackled more effectively in the US and inflation/overeheating can be managed more effectively in Singapore and can also prevent conflicting policies. Any other judgement about effectiveness/desirability/comparison of policies. A sound judgement if it is the “best way” to deal with the current problems.

Mark Scheme ? ? Knowledge, Application, Understanding, Analysis Answer lacks use of economics framework / concepts in analysis. ? No AD/AD framework. No application to the question ? Did not link it to macroeconomic stability. ? Did not address the current economic climate in these countries. A one sided answer: ? Only explained workings of fiscal policy without limitations. ? Only explained alternative policies without explaining the budget as a tool. Glaring conceptual errors. 10 - 14

L1

1-9

? ?

? L2

? A balanced answer with use of appropriate framework / concepts in analysis. ? T-A structure ? Limited scope of analysis: ? Alternative policies suggested did not include SS-side policies. ? Suggestion of only 1 limitation of budget as a tool. ? Focused on only 1 country – US or Singapore. ? Limited depth of analysis: ? lack elaboration ? no mention of k-process ? lack elaboration of k-process

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? Some conceptual errors. L3 ? ? A well balanced answer ? T-A-S Structure Good scope and depth of analysis: ? Good range of alternative policies suggested. At least 1 alternative for each country. ? At least 2 limitation of using the budget as a tool (e.g. size of k, crowding out effect, drain on govt resources, time lags etc) ? No SS-side policies (MAX 18m) Good application to macroeconomic stability o Policies must have links back to tackling recession. o Specific examples of public spending and how it can affect AD and AS. Evaluation E1 ? ? ? ? ? An unexplained judgement, one that is not supported by analysis Any sound evaluative point made in the body of essay No conclusion: Max 2 marks No overall synthesis: Max 2 marks Evaluative assessment supported by economic analysis ? Excellent synthesis in which the student is able to justify and arrive at a convincing stand 1-2 15 - 21

?

E2

3-4

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6. In 2012, Singapore ranked second on Ernst and Young’s Globalisation Index, a measure of a country’s openness to trade, capital and labour. It is projected that Singapore’s globalisation score will continue rising. However, increases in trade and capital flows are likely to be partially offset by a decrease in labour flows. Discuss how the projected changes above will affect Singapore’s economy. Introduction Define Globalisation ? Globalisation refers to the growing economic interdependence of countries worldwide through increased flows of goods and services, capital, labour and technology across international borders. Clarify Key Terms ? Singapore imports and exports heavily but is an overall net exporter ? Singapore is a net recipient country for both international capital and labour flows ? “Projected changes” refers to an increase in trade and capital flows but a decrease in labour flows. ? Both Micro (efficiency and equity) and Macro (4 macro goals) effects on the economy will be examined. Body Increased Flow of Goods and Services Key Driver (Optional): Projected increase in trade possibly due to an increase in the number of countries Singapore is signing Free Trade Agreements with. For example, negotiations for FTAs with countries like Canada and the European Union are on-going. Thesis (positive effects) 1. Higher output and Increased Consumption (theory of comparative advantage) ? Theory of Comparative Advantage (CA) can explain how Singapore will gain from increased trade ? Different countries have different opportunity costs of producing different types of goods and services due to difference in factor endowments ? For example, Singapore has an abundance of capital and thus has a comparative advantage in capital intensive goods like pharmaceuticals. ? China, our major trade partner has an abundance of labour thus has a comparative advantage in labour intensive goods like clothing. ? According to the theory of CA, if each country specialises in what they have a comparative advantage in, total output for both countries would increase. Both countries can then trade to obtain goods and services which they do not produce ? CA theory predicts that after trade, Singapore will be able to consume a higher quantity of goods and services 2. Reaping Internal Economies of Scale (IEOS) ? Increased trade → larger export market → firms in Singapore will have to increase output → reap IEOS → lowers unit cost of production ? These cost savings can then be passed on to Singaporeans in the form of lower prices. Example: Computer parts like Hard disk drives, one of Singapore?s major exports, are very cheap. ? Also since export oriented firms increase output → produce at an output closer to their Minimum Efficient Scale (MES) → ↑ productive efficiency from society?s perspective ? Especially important for Singapore since firms would find it difficult to reap IEOS given the small size of our domestic market 3. Increased Actual Economic Growth [25]

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? Increase trade → larger export market → Singaporean exports ↑ → ↑ in aggregate demand (AD) → more than proportionate ↑ in real national output (NY) via the multiplier effect → ↑ real national output

4. Lower unemployment Rate ? Increase in real national output → ↑ demand for labour (derived DD) → ↑ employment → ↓ unemployment rate Anti-thesis (negative) 1. Increased susceptibility to external shocks on the demand side ? If a major trade partner experiences recession → demand for our exports ↓ → ↓ in Singapore?s AD → more than proportionate ↓ in real NY via the multiplier effect → reduced / negative actual economic growth for Singapore ? Effect likely to be significant given the size of the (X-M) component in our AD ? Example: Singapore experienced a severe recession during the 2008-2009 Global Financial Crisis. Other risk factors on the horizon such as slowing growth in China and the debt ceiling in the USA.

2. Increased susceptibility to external shocks on the supply side ? Singapore highly dependent on imported raw materials. ? Supply-side shocks abroad → sharp increases in commodity prices → ↑ cost of production → horizontal portion of the AS curve to shift upwards → general price levels ↑ → leading to a higher inflation rate. ? Examples: Drought in the USA in 2012 led to rising food prices. More recently, threat of war in Middle-east (Syria) and its effect on oil prices. Evaluation ? Total trade volume = exports + imports. Cannot assume that increased trade entails ↑ exports. It could be imports that ↑. ? There needs to be an ↑ in exports in order for Singapore to fully reap the benefits discussed above. ? To do so exports need to be competitive in terms of both price and quality ? Singapore will have to accept the new reality of higher but more volatile economic growth Increased Flow of Capital Key Driver (optional): Signing of more FTAs, pro-business environment, EDB?s continued push to attract more MNCs into Singapore. Thesis (positive effects) 1. Actual economic growth ? Increased inflow of foreign direct investment (FDI) → ↑ I → ↑ AD → more than proportionate ↑ in real NY via the multiplier effect → actual economic growth. 2. Potential economic growth ? Increased inflow of FDI → ↑ in Singapore?s capital stock → ↑ productive capacity ? Increased inflow of FDI → spill-over of technology, management skills and technical skills → ↑ productivity → ↑ productive capacity & ↓ COP ? Entire AS curve shifts to the right → ↑ potential economic growth. 3. Lower unemployment rate ? When MNCs locate some of their operations here, jobs are created for Singaporeans ? Increase in real national output → ↑ demand for labour (derived DD) → ↑ employment → ↓ unemployment rate Anti-thesis (negative effects) 1. Stifling of domestic firms ? MNCs larger thus enjoy huge IEOS → able to charge low prices → Singaporean companies who are unable to match their low prices leave the market or don?t even
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enter in the first place → ↑ market power of foreign MNCs →worsening of allocative efficiency (AE) Resource & Talent crowding out: MNCs might crowd out domestic firms by competing with them for factors such as labour and land. This bids up the price of factor inputs which increases the cost of production for domestic firms Possible reason why there are relatively few large global Singaporean firms

? ?

2. Footloose nature of MNCs ? Should Singapore lose its comparative advantage, MNCs will uproot and shift their operations to other more attractive locations ? The resulting loss in exports would ↓ AD lead reduced economic growth and higher unemployment. Evaluation ? MNCs need not be viewed as competitors to domestic firms. They can instead be viewed as complements. In fact, many Singaporean Small and Medium Enterprises (SMEs) have been formed to serve the business needs of the many MNCs located in Singapore. ? While there remains the risk of MNCs shifting the operations to other countries, Singapore has been able to mitigate this by developing new areas of comparative advantage. ? Example: MNCs have chosen shift their manufacturing operations to China which has lower labour costs but choose to locate regional headquarters in Singapore due to our highly skilled and highly educated labour force. **Full credit to be given to students who view Singapore as a source country for capital flows. While we are still a net recipient of capital flows, we have begun investing more overseas in recent years. The ratio of outward versus inward investment currently stands at approximately 2:3** Decreased Flow of Labour Key Driver (optional): Tightening of foreign worker policy – higher foreign worker levies and more stringent employment pass requirements. Thesis (positive effects) 1. Decrease in income inequality ? Reduced inflow of lower skilled foreign workers → ↓ supply of low skilled workers → wages for low skilled workers increase → reduces income inequality between low skilled and high skilled workers 2. Decreased inflation ? ↓ Foreigners → ↓ demand for housing and transport → ↓ prices of housing and transport → ↓ inflation ? Especially important for Singapore since her inflation is primarily driven by high housing and transport costs 3. Increased productivity ? ↓ inflow of foreign workers → gives firms an incentive to increase productivity → if successful entire AS curve would shift to the right → ↑ economic growth (both actual and potential) and ↓ inflation Anti-Thesis (negative effects) 1. Slower economic growth in the SR ? ↓ foreign worker inflow → ↓ quantity of labour → ↓in productive capacity of the Singapore economy ? Tighter labour market and hike in foreign worker levies → ↑ cost of production (COP) ? Therefore entire AS curve shifts to the left → real NY ↓ → ↓ actual and potential economic growth ? Higher COP might also reduce Singapore?s attractiveness as a destination for FDI → I ↓ → ↓in AD → ↓ actual and potential economic growth 2. Higher inflation rate in the SR ? Since AS shifts to the left → ↑ GPL → higher inflation rate
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Evaluation ? Singapore will definitely have to accept slower growth in the SR as she restructures her economy to reduce its reliance on foreign labour. ? Whether or not she experiences economics growth over the LR depends on whether companies are successful in increasing productivity. Overall Evaluation ? The government is the main driving force behind the projected changes in Singapore?s globalisation pattern ? In order for these changes to be beneficial to the Singapore economy, the government will have to play the additional role of minimising the costs and maximising the benefits ? They have actively taken up this role ? For example there have been a slew of measures to help companies cope with the reduced supply of foreign workers such as a Productivity Innovation Credit (PIC) cash bonus which was given to companies to help defray rising labour costs and encourage spending on innovation and productivity improvements Knowledge, Application, Understanding, Analysis Descriptive answer that lacks use of economic theory Glaring conceptual errors One-sided answer which only considers the benefits OR the costs An answer that only discusses one flow (either goods & services, capital or labour) No application to the Singapore economy Sufficient use of economic theory: AD-AS model / CA theory Depth lacking in some areas and some conceptual errors Balanced answer which considers both the benefits and the costs Sufficient application to the Singapore economy Excellent use of economic theory: AD-AS model / CA theory Sufficient depth and no conceptual errors Balanced answer which considers both the benefits and the costs. Discusses all 3 flows Discusses both micro and macro effects Good application to the Singapore economy Evaluation An unexplained judgement that is not supported by economic analysis Evaluative judgement that is supported by economic analysis

L1

1-9

L2

10 - 16

L3

17 - 21

E1 E2

1-2 3-4

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