Y6 H2 CT2 2011 - Examiner's Report

7/30/2019 Y6 H2 CT2 2011 - Examiner's Report

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ECONOMICS

Higher 2Syllabus 9732

Examiners Report

Year 6 Common Test 2 2011

R a f f l e s I n s t i t u t i o n N u r t u r i n g t h e T h i n k e r , L e a d e r & P i o n e e r

TEL: 65 6419 9888 FAX: 65 6419 9898

http://www.ri.edu.sg One Raffles Institution Lane, SINGAPORE 575954


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ECONOMICS

Y6 H2 Common Test 2 2011

Paper 9732/02Essay Paper

Question 1

1 The unrest in the Middle East had helped to push crude oil prices up to their highest levels

since September 2008. The International Monetary Fund (IMF) warned that high oil prices

were a key risk to global economic recovery.

(The Strai ts Times, 13 Apri l 2011)

(a) Explain the factors which might have caused the oil prices to rise [8]

(b) Discuss what determines whether consumers or producers are more likely to bear thecost of the oil price rise. [17]

(a) Introduction:

Explain how oil prices are determined in the free market for crude oil.

Body:

Explain reasons for increase (rightward shift) in demand for crude oil:

- Rapid industrialization, especially of China and India

- Economic recovery and growth in many countries

- Population growth

- Any other credible reason

Students must offerat least 2 DD-side reasons.

Explain reasons causing decrease (leftward shift) in supply of crude oil:

- Bad weather conditions

- Oil wells drying up (note the difference between stock and supply)

- Middle east (major source of crude oil supply) riots and political unrest

- Any other credible reason

Students must offerat least 2 SS-side reasons.

Explain the adjustment process using a clearly drawn and labeled SS/DD diagram.

- The combination of demand and supply side changes results in a large shortage in the oil

market. This creates upward pressure on price.

Conclusion:

- Oil prices will rise whenever there is an increase in demand (as long as the demand increase

is more than supply increase) or a decrease in supply. In this case it is likely to have been

caused by both demand increasing and supply decreasing.


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Mark Scheme:

Know ledge, Appl icat ion, Understanding, Analys is

L1 - An answer that lacks economic frameworkMax L1 (1-2 marks)- Insufficient scope of explanation: Answer only gives only demand o r

supply-side factorsMax 3 marks

1 3

L2 - An answer that gives both SS & DD factors but has poor orunexplainedDiagrams Max 4 marks

- Where factors are linked to diagrammatic analysis but theres noexplanation of how price is determined in the first place Max 6marks

4 - 6

L3 - A good balanced answer which includes an appropriate introductionbut does not conclude on the analysis Max 7 marks

- An answer showing good analysis with a good introduction and a goodconclusion.

7 - 8

Examiners Comments:

- Majority of the candidates failed to recognize the need to explicitly identify and explain the

workings behind the determination of equilibrium oil prices, ie. the price mechanism, in their

essay, hence resulting in a lack of a clear economic framework/ underlying principles that

determine equilibrium oil prices in the world.

- While a large majority of the candidates have identified the need to relate to demand and

supply factors that have influenced the rise in oil prices, most were unable to provide a clear

and detailed analysis of these demand and supply factors and how they led to either an

increase in demand or a fall in supply of oil.

- Most candidates were unable to score a high L2 or even an L3 grade due to the lack of

detailed analysis that is explicitly referenced to a diagram. Many answers were merely

fleeting and skimpy, reflecting a superficial understanding and hence coverage of the

demand and supply factors that led to the oil price increase.

- Some candidates had demonstrated a lack of maturity in their analysis of demand and supply

side factors for example, the identification of an increase in demand for cars in a particular

country, say, Singapore, leading to an increase in demand for oil in the world, hence causing

the increase in world oil prices failing to recognize the need for more compelling reasons

that explain the rise of oil prices globally. It is also disappointing to find out that a significant

number of candidates have failed to make ample use of the preamble in identifying

compelling reasons for the increase in world oil prices.

- A significant number of candidates have failed to achieve a good L2 grade due to the lack of

a detailed analysis of the price adjustment process, showing how an increase in demand and

a fall in supply have resulted in the rise in equilibrium oil prices. This is a pity as the price

adjustment process is a major requirement that forms part of the core analysis in accounting

for the rise in global oil prices.


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(b) Introduction:

Identify that consumers include

- Consumers of crude oil (oil-importing countries/producers of final products)

- Consumers of final goods and services

Identify that producers include

- Producers of crude oil (oil-exporting countries)

- Producers of final goods and services

The factors determining whether it is consumers or producers who will bear the cost of the oil price

increase are PED and PES.

Body:

Thesis: Explain factors affecting the determination of burden of cost of oil price increase

- In the final product market, when crude oil price increased, the cost of producing goods

and services rose because oil is a factor input (the SS curve of final products shifts upwards).

- Where the demand for final goods and services is price inelastic, such as the demands forbasic essentials like foodstuff and fuel, producers can more easily pass on the cost increase

to consumers. So consumers will have to bear the bulk of the cost of the oil price hike (ab)

while producers bear a smaller percentage (bc) of the cost increase. Explain with diagram.

- On the other hand, most final products, especially manufactured goods, have price elastic

demands. Consumers adjust to price increase by cutting down their consumption of such

goods or turning to substitutes. Where PED>1, producers will thus have to bear the bigger

part (ef in the diagram) of the cost of the oil price rise.- Evaluation: Not all production processes rely greatly on oil as a factor input. In some service

industries, for example, the cost of oil is not a significant part of total cost. Therefore the oil

price rise will have little impact on both consumers and producers.

- In the crude oil market, the distribution of cost between producers and consumers depends

on the cause of the oil price rise.

P1 d

P0 e

f

c

b

Q1 Q2 Q0

Elastic DD

Inelastic DD

Original SS

Price

Qty of final product

P2

New SS with oil P increase


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- If it is due to SS decreasing, the effect depends on PED, similar to that analysed in the final

product market. The demand for oil is likely to be price inelastic. This is because of the lack of

available oil substitutes and the high dependency on oil as a factor of production.

- For a given fall in the supply of crude oil, the more price inelastic the demand for crude oil,

the greater the extent of oil price increase, and therefore consumers bear a greater burden

(cost).

- Evaluation: However, PED becomes more elastic in the long-run as consumers adjust to the

high oil prices. New substitute fuels are found, technological changes allow for reduced oil

usage, etc. When PED>1, producers of oil will bear the bigger burden of the price increase.

- If the crude oil price rise is due to rising demands, consumers will bear the entire burden, the

more price inelastic the supply of oil, the greater the burden on the consumers.

- The supply of oil is likely to be price inelastic. This is because the rate at which oil can be

pumped out of the oil wells, the capacity of the plants, the number of existing oil wells, all

these are more or less fixed in the short-run.

Antithesis: Explain limitations of suggest factors & other factors affecting burden

- The analyses are based on the ceteris paribus assumption. For example, PED can only be

analysed when only SS falls, holding DD constant. PES can only be analysed when only DD

changes, SS is held constant.

- What has really happened in the real world is a series of simultaneous changes. The SS

shocks, population and income changes, all took place at the same time. (Both DD and SS

shifted). It is hard to ascertain, at any point of time, whether consumers or producers will bear

the greater cost of the oil price rise.

- Government intervention will also alter the distribution of the burden of the oil price increase.

Eg., if the govt chooses to keep oil price affordable by subsidizing oil sales, consumers willenjoy lower prices, producers costs are lowered. However, subsidies will use up public funds,

tax rates may have to be raised or less funds become available for subsidizing merit goods.

Depending on the change in the tax structure or the sectors neglected by the lack of public

funds, the final burden will have to be borne by consumers and / or producers.

- Or any other sensible evaluation of the analyses

Q0 Q1 Q2

Price

Qty of crude oil

Original DD

New DD

Elastic SS

Inelastic SS

P2

P1

P0

0


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Conclusion & Overall Evaluation

- The short and medium term impact of the oil price rise may be to cause a slowdown or even

recessions in several economies, as the warning by the IMF in the preamble of the question

indicates. If this occurs, all producers and consumers will have to bear the cost of lower

demands (of both crude oil and final products) and the loss of jobs. However, if this price

increase persists over the long term, producers and consumers will adjust to the new reality

and will take steps to protect their self-interests by turning to the development, production

and consumption of substitutes. This will generate economic activity and will serve to benefit

all consumers and producers, except for crude oil producers whose sales and revenue will

fall.

- Any other sensible conclusion based on the evaluative discussion of the question.

Mark Scheme:


L1 - If answer lacks economic framework, or has obvious conceptualerrors or where concepts used are not relevant.Max 2 marks

- If answer lacks substance/content, analyses are weak but conceptsused (DD/SS analysis, elasticity concepts) are relevant. Max 4marks

1 4

L2 - A one-sided answer that analyses costs from the point of view of theconsumer orthe producer in the crude oil market only. Max 6marks

- Good analysis showing costs borne by both producers & consumers,but confined only to the crude oil market oran answer with goodanalyses of both crude oil and final product markets but the answer isone-sided. Max L2 (9 marks)

5 - 9

L3 - A balanced answer with a good TAS structure and clearly illustrateddiagrams that cover both the crude oil and the final product market,

and showing an attempt at making a judgment about who really bearsthe cost of the oil price rise.

10 - 13

Evaluation

E1 An unexplained judgement An unexplained evaluative

conclusion/comment

1 2

E2Evaluative assessment supported by economic analysis Substantiation of

an evaluative comment and/or conclusion3 - 4


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Examiners Comments:

- It Is disappointing to see that a large number of candidates have failed to obtain a decent L2

grade for this part of the question, owing to failure in recognizing the correct economic

framework as well as important underlying concepts that frame the question.

- Candidates who had correctly identified the need to make use of demand as well as supply

elasticity concepts in their answers have however, failed to recognize the requirements of the

question ie. an explicit comparison of the relative incidence of an increase in oil price on

consumers and producers of oil as well as goods and services in general, since oil is an

important factor of production in all production processes and that a rise in oil prices will

result in an increase in COP among producers of gds/svcs in general.

- Gross errors include the use of consumer and producer surpluses in analyzing the relative

incidence of an increase in oil prices on consumers and producers.

- Many candidates have also erroneously analysed the effect of changes in supply of crude oil

together with the use of price elasticity of supply and the same applies to demand. Forexample, candidates claim that with an increase in demand for oil, shifting the demand curve

rightwards diagrammatically, the extent of the increase in equilibrium oil price (and hence the

incidence borne by the consumer) is affected by the price elasticity of demand for oil. Since

demand for crude oil is price inelastic due to the lack of close substitutes, the extent of the

increase in oil price is larger than proportionate to the extent of the fall in equilibrium output.

As a result, consumers tend to bear a larger incidence of the rise in oil price compared to the

producer

- Many candidates also focused on the market structures in various product markets in

analyzing the effect of an oil price rise on consumers and producers, stressing on how, in

imperfect markets such as monopoly or oligopoly, the price-setting ability of producers will

allow them to pass more of the incidence of the rise in price to consumers, failing to

recognize that the market structure in which these firms belong to actually has direct

influences on the price elasticity of demand for their products, hence, resulting in differences

in the incidence on consumers and producers. In other words, PED remains an important

underlying concept in determining the respective consumer and producer incidences.

- In terms of evaluation, many candidates recognize the significance of government

intervention as an additional factor in determining the relative size of consumer and producer

incidence. However, they failed to elaborate on how government intervention, for example, in

the form of subsidies (and the funding of it) will affect the relative incidences on consumers

and producers.


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Question 2

2 A fast ageing population will put pressure on the governments budget. Health MinisterKhaw Boon Wan said that the key to a sustainable healthcare system is to minimise marketdistortions and to allow healthcare to function as normally as other economic activities.

(Adapted from Economis t Conferences, Healthcare in As ia, 30 March 2010)

Evaluate the extent to which the government should intervene in the market for healthcare inSingapore. [25]

Suggested Outline:

Introduction:- Define market failure

o Failure of the free market to allocated limited resources in the production ofgoods/services such that societys welfare is maximized and achieve social aims suchas equity

- State that there is market failure in the healthcare sector due too Presence of positive externalities in the consumption of healthcare serviceso Imperfect information of the full private benefits of consuming healthcare serviceso Nature of free market where resources are allocated to the production of healthcare for

consumers whose need/want for healthcare is backed by the ability to pay, i.e. theconcept of effective demand.

o Oligopolistic market structure of the healthcare sector[Choose at least 2 out of 4 sources of market failure to develop in Body of answer.]

- As a result of significant market failure in the healthcare sector, government intervention tocorrect this market failure is required.

Body:- In-depth analysis of market failure in the healthcare sector

o Presence of positive externalities in the consumption of healthcare services

MPB of consuming healthcare services is the treatment of individuals illness andupkeeping of owns health

MEB of consuming healthcare is the spill-over benefits on 3rd parties. For

example, 3rd parties benefit from an individual seeking treatment from commonflu as it reduces the spread of sickness to the 3 rd parties. Other MEB alsoincludes a healthier workforce and greater productivity that benefits theemployers as individuals consume healthcare services.

Quantit0

MPC = MSC

MPB

Y Z

A

C

B

MSB

Costs/Benefits


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MSB = MPB + MEB MPC of consuming healthcare is the costs associated in producing healthcare

services, like doctors charges and prescription drugs fees. MSC = MPC, assuming no negative externalities in the production of healthcare Free market level of consumption is at MPC=MPB where individuals net private

benefit is maximized Allocative efficient level of consumption is at MSC=MSB where net social benefit

is maximized. Due to under-consumption of YZ units of healthcare, DWL is incurred. DWL

represents the net social benefits forgone when YZ units of healthcare are notconsumed.

o Imperfect information of the full private benefits of consuming healthcare services Individuals may underestimate the full private benefits of certain healthcare

services. For example, individuals tend to underestimate the private benefits ofannual health screenings, thinking that they are in good physical condition.

DD1 represents demand for healthcare services when its private benefits areunderestimated due to the lack of perfect information of private benefits ofconsuming healthcare.

DD2 represents demand for healthcare services assuming the private benefitsare fully appreciated by individuals.

Y is the level of healthcare consumed by individuals assuming imperfectinformation

Z is the level of healthcare consumed by individuals assuming perfect information.This is also the allocatively efficient level of healthcare consumption to beconsumed by society.

Hence, there is under-consumption of YZ in the free market resulting in DWL ofshaded triangle.

o Nature of free market where resources are allocated to the production of healthcare forconsumers whose need/want for healthcare is backed by the ability to pay, i.e. theconcept of effective demand.

Free market responds to effective demand. However, there could be sick individuals who have a need/want for healthcareservices, but would not receive any due to the inability to pay.

This is deemed socially unfair (i.e. there is an inequitable outcome in theproduction/distribution of healthcare)

o Oligopolistic market structure of the healthcare sector Healthcare sector could be dominated by a few large firms due to high entry

barriers

Quantit0

MPC = MSC

DD1 with Im erfect information

Y Z

A

C

B

Costs/Benefits

DD2 with Perfect information


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High start-up cost due to need for specialized equipment Need for specialized labour such as doctors, nurses

Dominant firms in oligopolistic markets with significant market power couldpractice monopoly pricing where

Qm < Qfm P > MC, resulting in allocative inefficiency

*Note: In the next section of this answer, the following is required:- Identification of appropriate intervention methods- Cite Singapore-specific intervention programme relevant to intervention methods

identified- Explain how the intervention works using economics framework- Evaluate strengths/limitations of intervention methods

o In terms of aging population and government budgetary pressureso In terms of distortion to the free market (in line with preamble)o In terms of sustainability of intervention (in line with preamble)

- Should government pursue intervention more or less (to address requirement of question,. the extent to which thegovernment should intervene.

- In-depth discussion of the extent to which the government should intervene in the healthcaremarket.

o Subsidy Singapore examples

Class C and B hospital wards in Restructured hospitals are subsidized

Polyclinic medical services are subsidized Medifund subsidy is provided to low-income individuals

How subsidy works? An Indirect Subsidy = MEB will bring consumption to Z, eliminating DWL

and achieving allocative efficient outcome Subsidies also reduce inequity so that lower income individuals are more

able to consume healthcare that they need/want. Strengths

Subsidies do not displace price mechanism. Market remains responsiveto forces of demand and supply.

Limitations

Difficult to attach monetary value to MEB, that is a healthier and moreproductive work force.

o If under-estimate MEB, under-consumption of healthcarepersists. Though DWL and extent of allocative inefficiency isreduced.

o If over-estimate MEB, over-consumption of healthcare will occur.This results in DWL and allocative inefficiency.

Opportunity cost incurred in providing healthcare subsidy. Spending onpublic goods and other merit goods which improves societys welfare isforgone.

In view of aging population, subsidy on healthcare likely to increase.Hence, sustainability is an issue.

Should government provide more/less healthcare subsidies? To reduce subsidy expenditure, means-testing subsidy should be

implemented. Currently, means-testing for hospitalization subsidy isbeing practiced. 60% to 80% subsidy is provided for Class C ward.More differentiated subsidies for different income groups should be


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considered. Means-tested subsidies should also be implemented forpolyclinics.

Different levels of subsidies should be provided for different types ofhealthcare services. Preventative healthcare services which generatesignificant MEB such as vaccinations should be heavily subsidized whilecurative healthcare services such as treatment non-infectious diseases

should be subsidized to a lesser extent. However, subsidies for lowerincome individuals should continue to be provided regardless of type ofhealthcare consumed as these subsidies are provided to reduce inequity.

Subsidies cannot form the core of government intervention policies. InSingapore, subsidy is one part of a multi-pronged healthcare interventionplan which includes Medisave a compulsory self-financing healthcareprogramme, as well as Medishield a healthcare insurance planavailable to all Singapore citizens.

o Direct Provision Singapore examples

Public hospitals and polyclinics How direct provision works?

The public hospitals and polyclinics seek to provide socially optimal levelof healthcare services at affordable prices. Profit-maximization is not theprimary objective.

Strengths Ensures affordable h/c is made accessible to all (eg polyclinics are

located in neighbourhoods) Limitations

As profit maximization is not the primary objective, provision ofhealthcare services might not be at lowest possible cost, resulting inproductive inefficiency.

Given limited supply of doctors, nurses and medical professionals, publichospitals and polyclinics may face difficulties in trying to provide sociallyoptimal level of healthcare services at affordable prices. Patients mayhave to endure long queues, and lower standards of healthcare services.

It is difficult to determine the socially optimal level of healthcare services,as this is dependent of the MEB of consuming healthcare services.

Should the government build more public hospitals and polyclinics?

Government should not directly provide all healthcare services as thatwould result in significant productive inefficiency.

At this time, public hospitals provide 80% of costly hospitalizationservices while private hospitals provide 20%. Polyclinics provide 20% ofprimary healthcare services while private clinics provide 80%. This mixof public-private healthcare providers is beneficial as

o It provides consumers with choiceso Private hospitals and clinics provide quality benchmark for public

hospitals and polyclinicso Public hospitals and polyclinics (charging subsidized rates)

provide pricing benchmark for private hospitals and polyclinics.[Note that benchmark does not mean, equal. For example, itis unrealistic to expect private clinic quality at polyclinic pricing.Rather, the presence of polyclinics helps to influence/moderateprivate clinic charges, bearing in mind the difference in quality tobe expected.]


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Conclusion & Overall Evaluation:- In view of the aging population, the use of subsidies as an intervention method should be

targeted and specific.- Subsidies for preventive healthcare that generates significant positive externalities should

continue while subsidies for healthcare services that generate little/positive externalitiesshould be eliminated/reduced.

- Subsidies for the lower income groups should continue for equity reasons. Givengrowing income inequality in Singapore, means-tested subsidies should be the norm sothat no individual requiring healthcare services is denied access for financial reasons.

- Medisave contributions should be stepped up so that individuals take up responsibility forfinancing their healthcare expenditure as much as possible. Extensive efforts to persuadeindividuals to take up medical insurance should also be made. Collectively, these measures willsignificantly ease the government in providing healthcare for its aging population.

- A mix of public-private healthcare providers is optimal as it offers choices to consumers and alsoallows pricing and quality benchmarks to be set. This will contribute towards a healthcare sectorthat can provide quality healthcare at reasonable prices.

[This suggested outline is by no means the best or only response to this question. For example,students can choose other intervention methods instead of direct provision for their answers.However, it is important that they bring their choice of intervention method through the process

outlined in *.]

Mark Scheme:

Know ledge, App l ication, Understanding, Analys is

L1 - No/inappropriate use of economics framework.

- Glaring conceptual errors.

- Superficial analysis.

1 9

L2 - Use of appropriate economics framework.- Some analysis and evaluation of at least 2 intervention measures

undertaken by government to solve market failure problem.

10 - 14

L3 - In-depth analysis of at least 2 intervention measures undertaken by

government to address market failure.

- Evaluation of intervention measures in Singapores context and in

terms of sustainability and degree of distortion to the free market.

- Discussion of the issue to what extent should the Singapore

government intervene.

- Good awareness of measures adopted in Singapore.

15 - 21

Evaluation

E1 An unexplained judgementMade judgment on whether government shouldintervene more or less with no/little substantiation.

1 - 2

E2Evaluative assessment supported by economic analysis Made judgment on

whether government should intervene more or less with substantiation.3 - 4


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Examiners Comments:

- Average mark for this question is about 11.5/25.

- The question is rather clearly delineated in 2 parts. The first require candidates to analyze at least

2 sources of market failure for the Singapore Healthcare market. Most candidates analyzed

positive externalities and imperfect information.

- For positive externalities and imperfect information, majority of students managed to provide

sound analysis using MB-MC framework. This section is necessary to set the premises that

market fails to efficiently allocate resources (under-consumption) and government intervention is

justified.

- However, some candidates used the MSB-MSC graph to explain with respect to imperfect

information. This graph (which shows divergence between MSB and MPB) seeks to illustrate the

presence of positive externalities rather than imperfect information. For the part on imperfect

information, candidates should show a separate graph showing that individuals DD is less than

social optimal level. This helps make analysis clearer.

- Quite a number of students also lumped the analysis of market failure due to imperfect

information and positive externalities. These students make the claim that consumers have

imperfect information of the positive externalities associated with consuming healthcare, hence

causing market failure. While not entirely incorrect, it missed the key issue that it is the self-

interested nature of consumers that result in market failure when positive externalities are present.

- Quite a number of candidates fail to define terms such as MPB and MEB clearly. In particular,

examples given to explain positive externality are often not clear! One common example includes

external benefit of h/c involves a more productive society. Candidates should avoid being so

vague about the 3rd

parties by harping on society. It is essential that they identify the 3rd

parties

clearly- i.e. employers that benefit from greater productivity of his firm from an individuals

consumption of h/c. Students should also clearly explain self-interested nature of individualsconsume to the point where MPC=MPB to maximize net private benefits, while allocative efficient

level of consumption is at MSB=MSC. Quite a number simply asserted that there was under-

consumption of healthcare. Students should also explain the concept of deadweight loss and

how it arises from under-consumption of healthcare, instead of merely stating that some shaded

area in the diagram represented deadweight loss.

- A few candidates analyzed other sources of market failure such as imperfect competition and

inequity. For the former, many candidates did not justify clearly why Singapores h/c market

suffers from market dominance. Examples to show presence of large entities in the private sector

were scant.

- As for the latter, an explanation of the price mechanism through the dollar-vote system isnecessary to explain how resources are allocated towards those who have the ability and

willingness to pay. However, this portion was often sweepingly covered.

- For the 2nd part of this question, candidates should expound on the measures to deal with the

market failure above, and provide analysis and deep evaluation. To obtain the highest mark

range, candidates should evaluate with respect to the Singapore context presented in the


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preamble - consider issues related to population ageing, budget pressure and sustainability of the

Singapores h/c system.

- Most candidates provided rehearsed answers from lecture notes on the effectiveness and

limitations of measures such as subsidy, education & campaign and direct provision. In order to

score the full range of marks, your evaluation needs to relate to the preamble on the issues listed

above. Quite a number of students provided answers without a single reference to anySingapore-specific healthcare intervention measure. This definitely inhibited their answers from

scoring higher-end marks too.

- For instance, in evaluating subsidy, one common point of evaluation would be that imposition of

subsidy exerts a great strain on governments budget. Better scripts would go on to comment on

the sustainability of this measure. With ageing population, government expend on subsidy is

expected to rise; government might resort to raising tax rates. With the workforce growing less

than proportionately (or falling) with respect to the proportion of aged, candidates should note the

difficulty in raising sufficient income tax revenue.

- Students need to specify whether the subsidy is given to the producer or consumer. This must be

clearly stated because the effects on the graph are different for both cases.

- Students are to note that Medisave and Medishield are not examples of h/c subsidies. Medisave

account is part of an individuals CPF account, which comprise of compulsory savings.

Hospitalization charges can be partly paid through the patients Medisave account. Medishield is

a medical insurance scheme that is tied to the Medisave account. The premiums for Medishield

can be financed through the Medisave account. The purpose of Medisave and Medishield is to

make sure that the majority of Singapore citizens are able to back their need/want for healthcare

with the ability to pay.

- For education and campaign, examples should be provided. Again, evaluation on this lacked

depth of thought for many scripts. Better evaluation discussed the possibility of a better-informed

public who would gain from better health, and thus contribute to the long-run benefits of reducingthe strain on governments budget to finance their health needs, resulting in a more sustainable

h/c system in view of population ageing.

- Candidates should discuss direct provision as a possible measure in order to gain a holistic

discussion. They should provide examples (government hospitals, polyclinics) and discuss the

case for more or less direct provision from the current level. The best scripts examined this part

by comparing with the case for promoting greater competition (i.e. privatization, deregulation).

These responses showed good awareness of the lack of profit motive of public hospitals and the

tendency to become productive inefficiency which might result in possibly higher government

expenditure to run them. Concurrently, allowing more private providers might spur greater

productive efficiency and higher quality of services in a bid to compete for more profits.

- In general, a good awareness of the current measures in the Singapore h/c system is required to

do well. With these measures, candidates can better make a stand on whether more intervention

is needed or not, for whichever aspect. For example, in the intervention measure of subsidy,

given the distribution of subsidies awarded for different classes of hospital wards, a candidate

may evaluate on the inequitable distribution of resources and thereafter bring in the subject of

means-testing.


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Question 3

3 The Monetary Authority of Singapore will continue with the policy of a modest and gradual

appreciation of the S$ foreign exchange rate to ensure medium-term price stability.

(MAS Pol icy Statement, 14 October 2010)

(a) Explain how exchange rates are determined in Singapore. [10]

(b) How far do you agree with the proposition that an appreciating Singapore dollar will

lead to price stability? [15]

(a) Introduction:

- Define exchange rate exchange rate is the value of ones currency in terms of another

currency.

- Context of Singapore: Singapore dollar is managed against a trade-weighted basket of

currencies of our major trading partners and competitors. The trade weighted Singapore

dollar is allowed to float within an undisclosed band. The band allows short term,

temporary movements in response to crisis; as buffer to external shocks.

Body:

Explain Singapores managed float regime in exchange rate determination

- Explain how free forces of demand and supply of S$ affect the S$ exchange rate.o Explain factors affecting demand and supply of S$ Any 2 ideas (1 each for current

account and capital account show changes both in the demand and supply of S$) Current account relative inflation rates, changes in income levels of trading

partnersEg. Increase in the demand of Singapores goods and services by foreigners increase the DD for S$ Appreciation of the S$.

Capital account inflow-outflow of FDI/Hot money flowsE.g. Fall in interest rates in other countries Relative interest rates rise inSingapore Fall in hot money outflow Fall in DD for foreign currency Fall in the SS of S$ in the foreign exchange market Appreciation of S$

- Explain how MAS manages exchange rate within target bando When S$ appreciates beyond the target band set by MAS, the central bank will

increase the supply of S$ in the foreign exchange market by increasing the demandfor foreign currency, and selling S$. Increase in SS of S$ will decrease in externalvalue of S$ in the foreign exchange market.

o When the $$ depreciates below the target band set by MAS, the central bank willincrease the DD for S$ in the foreign exchange market by selling foreign currency(foreign reserves). Increase in DD will lead to an appreciation of the S$ within theband.

- Illustrate the effects diagrammatically.- Explain the market mechanism how a change in DD/SS will affect the external value of

S$.


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Conclusion:

- The interaction of demand and supply for Singapore currency in the foreign exchangemarket determines the external value of S$.

- The change (appreciation / depreciation) of S$ can be due to a change in DD or SS or acombination of DD and SS changes.

Mark Scheme:

Know ledge, App l icat ion, Understanding, An alys is

L1 - Lack of economic framework in explanation

- Irrelevancies in explanation.

- Substantial and glaring conceptual errors.

- Listing of points.

1 4

L2 - Some lapses in explanation:- Limited scope of explanation:

Did not look at the role of government intervention in

the foreign exchange marketMAX 6m Answer looked at only government intervention

influencing ER without factors affecting DD/SS in thefree marketMAX 6m

Answer focused on only DD side factors OR supplyside factors Max 6m

- Limited depth of analysis: Lack of diagrammatic analysis MAX 6m

5 - 6

L3 - A comprehensive explanation of the determination of S$.

Good use the relevant economic framework in theexplanation of determination of exchange rates inSingapore.

Good scope of explanation DD/SS for S$,explanation of factors include changes inimport/exports and Hot$ flows/FDI, and the role ofgovernment intervention.

Good depth of elaboration factors arecomprehensively explained and elaboration of themarket mechanism.

- If answer explains only DD side factors OR SS side factors(both imports/exports AND hot$ flows/FDI) AND governmentintervention, WITHOUT SS OR DD side factors MAX 8m

- If answer explains BOTH DD side factors and SS side factors(due to changes in imports/exports OR hot$ flows/FDI) ANDgovernment intervention MAX 8m

-

7 - 10

Examiners Comments:

- Most students were able to achieve a L2 mark for this part of the question.

- Students who were able to achieve a L3 mark were able to identify both free market

forces and government intervention as factors determining exchange rate in Singapore.


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- Common errors which prevented students from gaining high marks for this question

include lack of application to the question and the context, insufficient scope of

explanation and limited depth of elaboration.

- Lack of application to the question:

Inappropriate examples used not linked to the context of Singapore and no

mention of Singapore.

Some students focused their answer on the rationale behind the managed float

exchange rate looking at the nature of the Singapore economy and why we

appreciate the S$, instead of explaining how the exchange rate is determined.

These students missed the point of the question, and their answer also

overlapped part (b) to a certain extent. These students were only able to get L1

marks.

- Insufficient scope of explanation:

There were mainly two groups of students who achieved L2 marks and low L3

marks - those who explained factors affecting DD and SS of S$ without looking at

the effects of government intervention and those who elaborated on MASintervention in the foreign exchange market, without explaining free market

forces in determining exchange rates. Students need to be aware that to do well

and gain higher L3 marks, they need to have a good scope of answer one that

strikes a balance between DD and SS factors, and that of government

intervention.

There another group of students who did address DD and SS factors, as well as

government intervention in determining value of the S$. However, the DD and SS

side factors included only the demand for exports and demand for imports in

affecting DD and SS of S$ in the foreign exchange market. These students did

not look at the other factors such as hot $ flows and capital flows. As a result,

they could not achieve a high L3 mark. Of course, students are NOT expected to

explain ALL the factors affecting DD and SS of S$ in the FX market. Rather, a

good answer is one that strikes a good balance in the type of factors explained

e.g. increase in DD for imports affecting DD for S$, and increase in Hot $ outflow

affecting the SS of S$.

- Limited depth of elaboration:

While most students were able to identify factors affecting demand and supply of

S$ in the foreign exchange market, these factors were not explained. E.g.

increase in DD for exports will increase in the DD for S$. The linkages were not

made. Students are required to establish the link between DD for exports and

increase in DD for S$. Also, many did not elaborate on why there is an increase

in DD for exports. While that is not the focus of the question, there is still a needfor students to be able to substantiate points made with examples. There was the

other extreme where students spent too much time explaining at all the factors

affecting DD for exports (relative inflation rates, global incomes and even

exchange rates) that they missed out on the crux of the question.

Majority of students also did not elaborate on how the changes in DD and SS will

affect the value of the S$ through the market mechanism they simply stated

that increase in DD/fall in SS will lead to an appreciation of the S$.


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- Conceptual errors:

Quite a worrying number of students wrote that in order to appreciate the S$ to

within the band set by MAS, MAS will have to buy up the S$, to reduce the SS of

S$ in the foreign exchange market. This idea is flawed. If MAS buys S$, it will

lead to an increase in the DD for S$, rather than cause a fall in the SS of S$.

Some students were confused between hot money and investment.

(b) Introduction:

- Explain what is meant by price stability low and stable inflation rate

- Appreciating Singapore dollars rise in the external value of the S$ against her trading

partners and competitors.

Body:Thesis: An appreciating Singapore dollar can lead to price stability

- Explain how an appreciating S$ will dampen demand-pull inflation Illustrate a case ofdemand-pull inflation diagrammatically (AD0 to AD1 P0 to P1).

Appreciation of S$ rise in Px in terms of foreign currency fall in quantitydemanded for exports

Appreciation of S$ fall in Pm in terms of domestic currency rise in quantitydemand for imports

Assuming the Marshall-Lerner condition holds, where PEDx + PEDm > 1 Netexports falls AD falls (AD1 to AD2) dampening demand-pull inflation (P1 to P2).

- Explain how an appreciating S$ will dampen cost-push inflation Illustrate a case ofcost-push inflation (AS0 to AS1 P0 to P1).

Appreciation of S$ makes imports cheaper in S$ this will dampen the price ofimported factors of production fall in cost of producing of goods increase AS(AS

1to AS

2) dampen cost-push inflation in Singapore (P

1to P

2).

This is especially important for Singapore, as she relies heavily on the imports

- Illustrate the effects diagrammatically.

GPL

Real NY

AS0

AD0

Y0 Y2 Y1

P2

P1

P0

0

AD2AD1

GPL

Real NY

AS1

AS2

AS0

AD0

Y0Y2Y1

P2

P1

P0

0


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Anti-thesis: An appreciating Singapore dollar may not lead to price stability

- Explain limitations of appreciating the S$ to manage inflation Marshall-Lerner condition may not hold in the very short-run appreciation of the

S$ will lead to an increase in NX worsen demand-pull inflation. Does not tackle the root cause of inflation

Domestic inflation: caused by structural rigidities, rise in wages/rent, housing,COE, etc. Appreciation may not be effective in reducing inflationarypressure.

Modest and gradual appreciation will limited the extent to which price stability can beachieved.

Appreciation of S$ will reduce short run export price-competitiveness. In theshort run, there is a trade-off between policy objectives price stability &economic growth, employment level in the export-oriented industries.

Extent to which strong S$ can manage inflation is limited as the extent towhich the S$ can appreciate is limited due to the tradeoff.

Limits the extent to which a stronger S$ will mitigate external factors causinginflation.

Overall Evaluation & Conclusion:

- Judgement: A strong S$ will lead to price-stability to the extent that it can dampendemand-pull inflation and imported inflation.

- Seems to be effective given Singapores low and stable inflation rate. (in recent years,inflation is high due to domestic factors)

- The extent to which it will lead to price stability depends on: The root cause of inflation: will be effective if due to imported inflation and rising

DDx. M-L condition Short run vs long run effects

- Other evaluative comments: LR: need other policies e.g. SS-side policies to achieve price stability over the

long term. Costs of appreciating S$ may be high in the SR limiting the extent to which

S$ can appreciate.


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Mark Scheme:

Know ledge, App l ication, Understanding, Analys is

L1 - Lack of use of relevant economic framework in analysis:

Did not link to AD/AS framework

- A one-sided answer: did not look the limitations of

appreciating S$ in achieving price stability.- Poor application to the Singapore context. no mention of a

small and open economy.

- Glaring conceptual errors

1 5

L2 - A balanced answer with use of appropriate framework /

concepts in analysis. T-A structure

- Limited scope of analysis:

answer addressed DD-pull inflation OR cost-push inflation

MAX L2

Anti-thesis lacks scope: answer only listed M-L condition as alimitation.

- Limited depth of analysis: Answer lacks elaboration Lack of diagrammatic analysis MAX L2

6 - 8

L3 - A well balanced answerT-A-S Structure

- Good scope and depth of analysis:

Discussion of both DD-pull and Cost-push inflation

Answer is well-elaborated

- Good application to the Singapore economy.

9 - 11

Evaluation

E1 An unexplained judgementAn unexplained evaluative

conclusion/comment

1 - 2

E2Evaluative assessment supported by economic analysis

Substantiation of an evaluative comment and/or conclusion3 - 4

Examiners Comments:

- In the main, this part of the question was poorly attempted, with majority of studentsachieving L1 or low L2 marks. This was disappointing as the question was considered to

be straightforward, and issues which students should be familiar with. Of course, there

were a minority of students who produced a well-balanced answer with good elaboration

of ideas, and were thus able to achieve L3 marks.


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- Limited scope of discussion:

While most students looked at the effectiveness of appreciating the S$ in keeping

out import-induced inflation due to the reliance of imports in Singapore, some

students neglected to look at the effects on AD, and how it dampens demand-pull

inflation.

For those students who wrote an anti-thesis argument, it usually pertains only to

questioning the assumption of the M-L condition, and how it may not hold in the

short run. This point alone is insufficient to achieve a L3 mark.

- Insufficient discussion of the question:

Students who obtained L1 marks usually had a one-sided answer, and did not

look at the limitations of appreciating the S$ to achieve price stability. Instead,

they gave alternative policies in solving inflation as an anti-thesis point but that

was not required by the question.

- Lack of depth of elaboration:

Lack of theoretical framework in analysis. While most students get it by now that

they have to use diagrams to illustrate and explain effects on the economy, thereare students who still insist on not using diagrams in their analysis. As a result,these students will not be able to get beyond low L2 marks.

- Poor application to the question:

While most students know the effects of an appreciation of S$ on AD, a worryingnumber of students failed to address the question, ie, they explained the effectsof an appreciation of S$ => leading to a fall in net export => a fall In AD, showinga fall in the general price level; BUT did not address how an appreciation ofS$ leads to price stability.

- Weak evaluation:

Majority of students were not able to achieve E2 marks for evaluation. Generally,

evaluation was weak, with many, not making a judgment on the effectiveness ofexchange rate policy on achieving price stability. Instead, they went on to look at

how other policies should be used as well.

- Other errors:

A small number of students stated the M-L condition to be PEDx + PEDm < 1.Hopefully, its more of a careless mistake, than one that is conceptually flawed.

When looking at why the M-L condition may not hold in the SR, some studentsreferred to the J-curve effect and the reverse J-curve effect (or the n-curve coined by some students).This was flawed as the J-curve looked the depreciationof the currency in impacting the Balance of trade, and not an appreciation. Thereis also no such framework as an n-curve. So students should just state that

PEDx + PEDm may be < 1 in the SR, and provide reasons why that may be so,and link it back the question on price stability. Quite group of students analysed that appreciation of S$ will worsen price

stability, as it will lead to a fall in AD, and result in a deflation. This argument isflawed because the implicit assumption behind the effectiveness of appreciationin solving inflation, is inflation!

Instead of analyzing the direct effects of appreciation of S$ on price stability(through fall in AD and rise in AS), some students explained that appreciating theS$ will lead to hot $ inflow and increase in FDI. This will cause a rise in


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productive capacity and dampen inflationary pressure and achieve price stability.This is a secondary effect of a policy. And in the first place, why will theappreciation of S$ lead to increase in FDI (some linked to fall in COP which is aweak point)? Students need to understand that there is no obvious correlationbetween value of S$ and FDI, and that many factors affect level of I.


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Question 4

4 To help Singapore achieve sustainable economic growth, the government has beenreducing income taxes and corporate taxes over the years. It also increased its reliance onindirect taxes - raising the rate of Goods and Services Tax (GST) from 5% to 7% in 2007.

Discuss whether the changing tax structure will improve current and future living standardsin Singapore. [25]

Candidates are expected to examine how the change in tax structure may affect

actual growth and potential growth,

equity given the regressive nature of GST and as the income tax system gets less progressive

non-material indicators such as pollution and stress level

tax revenue and tax base, and how that may impact on government ability to spend in areas to

improve livings standards, and

and how these points above may have an effect on current and future living standards

Suggested Outline:

Introduction:

- Living standard refers to the material and non-material welfare of each citizen in the country.

- Increase in current material SOL arises largely from a rise in actual growth and possible

increases in future SOL arises from the increase in AS due to raised productive capacity.

- Rationale for increased reliance on indirect taxes:

It is a trend amongst DCs to rely more on indirect taxes especially with a rapidly ageing

population that reduces the revenue from income taxes.

For Singapore, income taxes are less progressive (being capped at 20% at the highest tier

and at 15% for foreign workers) than most other developed countries as the government

wants to prevent brain drain and attract foreign talent. Corporate taxes were reduced to 17%with the objective of attracting FDI and encouraging entrepreneurship. The loss in tax revenue

thus has to be compensated by an increase in GST.

Thus, the under-lying objectives are more to affect AS than AD, though the effect on AD

cannot be ignored.

Body: Explain impact of changing tax structure on standard of living

Thesis: SOL may rise Anti-thesis: SOL may not rise/or may not rise

that significantly

A. Effect on Actual Economic Growth

1. Effect of fall in direct taxes:

households disposable income rises firms post-tax profits rise,

entrepreneurship is encouraged andincreased influx of FDI

as a result, AE rises - through multiplier

1. Effect of fall in direct taxes:

rising AD can cause over-heating, thuscausing real GDP to rise by less

more importantly, it may worsen inequitysince the % rise nominal wages of the lowerincome group may be rise less than that of


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process real GDP increases link to impact on material SOL

increases ability to consume more goodsand services

Note that there mus t be at least an expl ici trecognit ion that real GDP per head,

instead of GDP, is the measure of m aterial

SOL

Example:

Thus real GDP per head may rise,assuming popn size relatively stable

In line with governments long-term planto increase the population size, a more

conducive income tax can attract moreforeigners to set up home in Singapore,thus population size may also rise in theLR link to effect on real GDP per head

inflation rate , causing their real wages to fall

effect depends on size of k

C as small % of GDP due to small domesticmarket

unpredictable effects of taxes

2. Effect of rise in GST

With rise in GST which falls on firms: AS decreases (upward shift in horizontal

segment of AS curve) Ceteris paribus, this may lead to cost-push

inflation and a fall in real GDP

Synthesis

evaluate the relative impact on SOL due to rise in GST vs fall in direct taxes effect of rise in AE possibly greater than fall in AS since the last GST increase was in

2007 while income taxes and corporate taxes have been reduced more significantly with income taxes capped at 20% and corporate taxes reduced to 17%.

Over LT, increased population size due to more immigrants may increase C as % of GDP,

and could reduce Singapores dependence on X?


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B. Effect on Future Living Standards

Future SOL may rise due to potential growth

and possible future realized growth

effect of reduced income taxes: may increase incentive to work increase in quality and quantity of

labour as Singapore retains andattracts foreign talent

increased I (on plants and machines)due to lowered corporate taxes

the above effects serve to raise

productive capacity and thus AS, with apositive impact on future SOL full employment frontier shifted

outwards, thus allowing for furtherincreases in AD

reduces inflationary pressuresbrought about by increases in AD

Whether SOL rises depends on the extent towhich the corporate tax cut can attract FDI- theoretically, one can look at MEI which

itself is affected by business prospects- applied to the Singapore context, we face

competition from the region in terms ofattracting FDI

also issue of whether investment can belabour-displacing

Synthesis:

That the effect on AS may be more pronounced than the effects on AD, given Si ngaporessmall k and small domestic market

C. Effect on Equity

The change in tax structure may worsen inequity

regressive nature of GST worsens inequityas it takes a larger % of the poors income

furthermore, GST is broad-based andnecessities are not exempted since demand is price inelastic, again

more adverse impact on the lower-incomegroup as their purchasing power isreduced

compounded by the fact that Singaporesincome tax is relatively less progressive, andcuts in tax rates are more likely to benefit

those at the higher income brackets

Evaluation: that inequity can be reduced as government has in place transfer payments tohelp the needy such as Workfare Supplement Bonus, GST and utilities rebates etc.


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D. Effect on Tax Base and Tax Revenue

GST widens tax base and may be moreconducive for government efforts insustaining living standards ageing population reduces size of

labour force and may reduce directincome tax revenue a switch to reliance on indirect tax

allows government to sustain its taxrevenue to finance spending in areasto increase living standards

While there may be may be a temporaryfall in direct tax revenue due to the taxcuts, this could be more than offset bythe rise in revenue as real nationalincome rises

E. Effect on Non-Material Welfare

1. Stress level

income effect: preference for leisure sincedisposable income has increased

substitution effect: reduced income taxesmay increase incentive to work. Longerworking hours may reduce quality of life

increased stressed level due to competitionfor jobs with influx of foreign labour

strain on infrastructure eg. public transportand amenities with more foreign labour

Synthesis:

Recent studies have shown that Singaporeans have over-taken the Japanese and Koreans in

terms of the number of working hours. This could be due to factors like competition for jobs

which in itself may be a result of the change in tax structure.

The impact on environment may not beadverse

type of investment Singapore attractsare more the technology-intensivetypes and service-oriented eg.biotechnology, biomedical,pharmaceutical and integratedresorts

if there is an increase in manufacturinginvestment which is still vital to any economyincluding Singapores, there may be morenegative externalities generated due topollution

or how increased growth and spendingpower leads to increased car usage andmore pollution


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Conclusion & Overall Evaluation:

- Recognize that sustainable growth and resultant impact on SOL may not be broughtabout by a changing tax structure alone

- Whether SOL rises for everyone still depends on government efforts to trickle fruits ofmasses down to the masses eg. through subsidies in education and healthcare

- Looking forward: how impact can be affected if GST rises further and some brief

suggestion on how system can be tweaked eg. exempting necessities from GST

Mark Scheme:


L1 Content:

- Weak and incomplete understanding of the question and context:

Mainlyirrelevancies

OR substantial glaring conceptual errors

OR Gross inadequate devt of analysis

- mostly irrelevant and contains only a few valid points made

incidentally in an irrelevant context1-5 marks- shows some knowledge but does not indicate that the meaning of

the question has been properly grasped. Basic errors of theoryevident. 6 9 marks

max 9 m:

- no theoretical framework (AD-AS or Keynesian Cross)

- one-sided answer

1 9

L2 - Content (arguments & counter-arguments) placed in given context(explanation may have some lapses)

- Well-labelled and explained diagrams

- Structure & linking sentences are present (may have some lapses)

- Attempt at a balanced answer

12-14 m: Answer has a more thorough relevance to question, but theoryincompletely explained

10-11 m: answer shows ability to identify facts, some ability at graphs, fairability to apply know laws to new situations. Evidence of elementary

judgements, but lack ability to organize ideas into a new unity.

max Level 2:

- If answer lacks scope eg. areas like equity, stress level andpollution cursorily treated without application to the context

max 14 m:

- no reference to multiplier principle

- AD-AS analysis in detailed prose, but without appropriate diagrams

- no discussion of non-material SOL

- no theoretical framework on effect of GST (ie. effect on AS)

10 - 14


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max 11 m:

- focuses only on effect on actual and potential growth, without anydiscussion on other indicators of SOL

- answer more about impact on economic growth, with no/cursory linkto impact on SOL

- addresses only current or only future SOL

max 10 m:

- no mention on effect of GST

L3 - Content (arguments & counter-arguments) placed in given context.

- Depth of explanation provided/rigour in analysis

- Effective use of diagrams

o Provides technical definition(s) to key terms inpreamble/question.

- Structure & linking sentences

- Candidate clear about important issues involved and the context

o Balanced analysis on both current and future SOLo Scope extends to effect on

non-material indicators equity

o good contextual application the best answers will attemptto address the underlying objectives of a reduced relianceon direct taxes such as the need to keep/attract talent andFDI and the intended effect on productive capacity - AS

- 18-21 m : thorough knowledge of facts and theory with excellentability to explain this in a precise, logical and reasoned manner.

- max 15 m:- A very good and balanced answer. However, no explicit recognition

ofreal GDP per head(ie. effect of inflation and popn size) as an

indicator in measuring SOL

15 - 21

Evaluation

E1 An unexplained judgement, one that is not supported by analysis

No conclusion: Max 2 marks

1 - 2

E2

Evaluative assessment supported by economic analysis Excellent

synthesis in which the student is able to justify and arrive at a convincing

stand (based on earlier arguments and counter arguments).

3 - 4

Examiners Comments:

- The mean score of this question is 11.2 marks. This question clearly discriminated between

answers that lacked a theoretical framework and simply responded to the issue of impact on

standard of living in a journalistic manner. These responses were not awarded beyond an L1

mark. The better candidates clearly applied AD-AS or AE-Y analysis to examine the impact

of the changing tax structure on the standard of living. The best scripts, which were few and


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far between, were those that used AD-AS analysis, and adequately discussed the issues of

equity and non-material welfare.

- While candidates were mostly able to examine the effects of changes in direct taxes on AD

and AS, the majority of candidates did not examine the effect of a rise in GST on AS. A

handful of scripts incorrectly explained that a rise in GST leads to a fall in consumption and

thus a leftward shift of the AD curve

- However, candidates need to bear in mind that the question is not about the effect on

economic growth per se, but how the change in real GDP can affect living standards. The

question was phrased in such a way that candidates were expected to respond to effects on

both currentand fu tureliving standards. Disappointingly, the effects were not clearly

differentiated.

- A worrying observation from some scripts is the over-focus on secondary effects. One

example would be the discussion of how more disposable income raises the level of savings

and pool of loanable funds. As interest rates fall, consumption and investment then increase.

The effects on living standards were then examined from this perspective. While the analysis

is not wrong, such answers did not score as well as those that started by examining the directeffects of changes in tax structures on consumption and investment. For this point about

savings per se, the impact might also be more on future rather than current living standards

since savings become investment in the long run. Another script began by asserting tax

revenue rises as a result of the changing tax structure. This allows the government to invest

in education and training as well as infrastructure. As a result, AD and AS rise with a

resultant impact on current and future living standards. Candidates need to bear in mind that

in any essay, the primary effects should be discussed first before moving to secondary

effects.

Areas for Improvement:

- Students failed to:

- clearly explain the differing effects on current living standards (due to changes in actual

growth) and future living standards (due to rise in productive capacity).

- recognise that while the tax incentives have an effect on AD, the objectives of the

government are more to raise AS through keeping and attracting talents as well as FDI.

As a result, discussion on the effects on AS often lacked depth.

- link AD-AS analysis to how the rise in GDP can increase living standards; nor make

explicit reference to effect on real GDPper head

- assess limitations to the increase in AD and/or AS egs. size of k, small domestic market,

expectations of state of economy

- apply to the context especially in the discussion of non-material indicators ie. how the

changing tax structure can affect working hours/leisure time and pollution. Thus, the

discussion of non-material welfare was more regurgitation than application.

- clearly explain why tax revenue rose or fell


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Question 5

5 Many advanced countries like USA and UK have been adversely affected by the recent

financial crisis and increasing competition from emerging economies such as China and

India.

(a) Explain the causes of unemployment in these advanced countries in recent years. [8]

(b) Discuss whether a change in interest rates is the best policy to reduce unemployment

in these countries. [17]

(a) Introduction:

- Define unemployment and identify types of unemployment.

Body:

- Explain how the recent financial crisis in US and UK caused a recession by causing an

autonomous fall in Aggregate Demand and rise in unemployment:

Banking crisis:

credit crunch banks unwilling to lend money high risk of default => difficult

for firms to get bank loans I falls

negative wealth effect fall in value of assets (financial and physical) => feel

poorer fall in C

Aggravated by bleak economic outlook C falls, I falls.

- Use of AD-AS framework to explain how this leads to cyclical unemployment. If diagrams

are used, they must be integrated into the explanation.

- C, I and X components of AD => AD falls fall in national income / output fall in

demand for labour (derived demand) demand-deficient /cycl ica lemployment in

these economies.

- Explain how increasing competition from caused unemployment.

Increasing competition from emerging economies loss of comparative advantage:

Greater competition in the global market exports of emerging economies

more competitive given lower cost of production due to cheaper inputs (relatively

more abundant supply) fall in labour-intensive X, increase in M => C of

domestically produced goods and services falls AD falls

Collapse of labour-intensive import-substituting industries in the US and UK as

consumers switched to cheaper imports from China and India.

Emerging economies China & India huge domestic market => proximity to

such markets is an important consideration and response to changing market

conditions => Possible exodus of foreign direct investment from advanced

economies as firms relocate to take advantage of the cheaper resources too I

falls.

Influx of foreign workers (cheaper source of labour) in advanced economies

increase in unemployment in advanced economies.

Outsourcing of jobs to China and India give examples of jobs that are

outsourced e.g IT-related jobs to India


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Advanced economies in the face of such competition need to restructure shift

in production mismatch of skills => structural unemployment.

Mark Scheme:


L1 - A brief general description of types of unemployment without any / withscant reference to the given situation in the preamble.Incorrect identification / explanation of type of unemployment.

1 3

L2 - Correct identification and explanation of both types of unemployment,shows an ability to relate these to the preamble by relating these to thegiven situation.

- Both financial crisis and emerging economies are taken into accountAnswers show some elaboration and understand, depth is somewhatlacking.

- Use of appropriate theoretical framework in answer.Limited scope i.e only one type of unemployment is identified butsufficient depth in its explanation and shows connection to the given

situation in the preamble.

4 - 6

L3 - A well-developed and articulated explanation of the causes of theunemployment with reference to the preamble. Shows an ability todraw knowledge to answer the question.

7 - 8

Examiners Comments:

- While most students are aware of the different types of unemployment, there were some

candidates who wrote about these without making any reference or paying attention to the 2

situations given in the preamble. The result is a random rambling that has little contextual

application. An example of such random rambling: farmers in US and UK are unable to takeup jobs in factories (structural unemployment) when US and UK decide to industrialize,

fishermen are unemployed during the monsoon season (seasonal unemployment).

- In identifying the causes of unemployment, candidates must apply economic concepts to their

explanation; otherwise, what is written is very much a laymans view on unemployment.

- Candidates did not show an understanding that a recession such as the one associated with

the financial crisis was caused by an autonomous fall in AD. Hence it is incorrect to say that

the fall in AD and its consequent cyclical unemployment was due to a recession when

household disposable income went down and consumption fell. Such an explanation still had

not explained how the financial crisis caused the recession in the first place.


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(b) Introduction:

- Identify expansionary monetary policy: to reduce unemployment in these countries

expand money supply reduce interest rates

- Define scope of analysis: Reduce cyclical unemployment and structural unemployment.

Body:

Thesis: Interest rate policy is the best policy to solve unemployment

- Explain how the policy works to solve unemployment

o Explain the transmission mechanism of fall in interest rate

o Explain how a fall in interest rate can help to boost employment through job creation

Interest rate = price of loans.

Fall in interest rate => cheaper loans increase in investment, ceteris

paribus explain with reference to MEI function. Increase in volume of

investment job creation income generation increase in demand for

goods and services i.e multiplier effect)

Fall in interest rate => lower returns on savings / lower opportunity cost of

consumption increase in household expenditure, ceteris paribus

increase in demand for goods and services job creation boostingemployment.

Fall in interest rate => lower reward for saving => save less, consume more

=> C increases.

o Is it the best policy to reduce unemployment?

If firms and households respond to the fall in the interest rate because of

good business outlook. Extent of job creation depends on the size of the

multiplier.

Possible evaluation: what is the possible size of multiplier in USA & UK and

therefore its impact on job creation.

External effect: outflow of hot money depreciation ofcountrys currency

which results in exports being cheaper in terms of foreign currency, ceteris

paribus. This can counter, to some extent, the initial loss of Xcompetitiveness to the emerging economies.

Possible evaluation: is this a long term solution to the unemployment

problem? How dependent are these advanced economies on imported inputs

from the emerging economies?

Anti-thesis: Interest rate policy is the not the best policy to solve unemployment

- Explain limitations of the policy:

o For policy to be effective, firms and households to increase investment and

consumption. However,

MEI inelastic less than proportionate increase in I when interest rate

falls. Therefore, is less effective. Imore dependent on animal spirit. Is there already a liquidity trap? If yes, then fall in interest rate is

ineffective and thus not the best policy.

FDIs not affected by changes in interest rate alternative sources of

funds

More importantly, demand-management tool and does not solve

structural unemployment.


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Effect on I and C is uncertain. Much depends on the economic outlook

e.g if pessimistic lower interest rate may not induce firms to increase

- Identify and explain alternative policies that are better than interest rate policy to solve

unemployment

o To counter the element of uncertainty in impact, government may want to resort to

expansionary fiscal policy.

E.g Fiscal stimulus increasing G on public works projects boost

demand increase in production and income fall in cyclical

unemployment. Better than interest rate policy? Analysis of merits and

demerits.

Merit: G increases amount injected into the circular flow can be

controlled by the government i.e first round of increase = the amount that

by which G is increasedk works its way through to bring about an

increase in income that is a multiple of this increase in G.

Demerit: crowding out. Its another demand-management tool that can

help to solve only cyclical unemployment. Therefore government needs

to implement supply-side policies too to solve structural unemployment. Recognise that reduction in personal and corporate income taxes which

is aimed at increasing C and I, like a fall in interest rate, does not yield a

predictable outcome.

o Supply-side policies (beware; not all are appropriate and thus students must be

discriminating in choice of supply-side policies) to solve structural unemployment

Analysis of merits and demerits of supply-side policy to solve structural

unemployment brought about by competition from China and India.

Education and training new skills, higher productivity lower unit cost

-- enable them to compete with the cheaper labour from China and India

to some extent.

Need to re-structure from industry from which US and UK had lostcomparative advantage to new sunrise industry.

Note: If R&D is used as a point in your answer, it must be linked to the search for a

new niche area, to regain comparative advantage (in context of preamble), to

compete with China and India. At the same time, candidates must recognise that 1)

R&D, when in progress, does not generate many jobs given its very specialized

nature. 2) R&D requires a longer time to yield results than demand-management

policies but it is necessary if USA and UK want to solve structural unemployment.

Conclusion & Overall Evaluation:

- While a fall in interest rate can reduce only demand-deficient unemployment it is still a

necessary but insufficient policy that is needed to solve the current unemployment

problems in the US and UK. If the root cause of structural unemployment is to be dealt

with, then interest rate is not the best policy and it has to be supplemented by other

policies esp supply-side policy .

- Qn to ask: Is there really a best policy?


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Mark Scheme:


L1 - A cursory treatment of the issue.An explanation of the transmission mechanism with little attempt toaddress the issue. Lacks balance in perspective.

1 6

L2 - A balanced (thesis-anti-thesis) analysis of interest rate policy as focalpoint in dealing with the issue. Provides adequate theoreticalframework in the analysis.

- Does not offer alternative policies (max: 8m). If some analysis of @least one alternative analysis (mark up to 9 or 10m)

- If answer offers only demand-side solution and scope is thus limitedto discussion of cyclical unemployment max 10mIf no rigour in application of theoretical framework i.e no MEIapplication (just a diagram or/& mentioning it doesnt count as rigour)and no mention of external effect max: low L2

7 10

L3 - Answers are well-considered and application of policies to the given

situation is clearly relevant including appropriate supply-side policiesto solve structural unemployment.

- Analysis of interest rate and alternative policies is balanced (withmerits and demerits of alternative policies) and theoretical frameworkis used appropriately and accurately.

11 - 13

Evaluation

E1 An unexplained judgement An unexplained evaluative

conclusion/comment

1 2

E2Evaluative assessment supported by economic analysis Substantiation of

an evaluative comment and/or conclusion3 - 4

Examiners Comments:

- In explaining how a fall in interest rate is brought about, it is appropriate to use the Liquidity

Preference Theory / Money Market Model and not the Loanable Funds Theory as the Central

Bank has full control over the supply of money in the former.

- Far too many dealt with the interest rate policy briefly and superficially in their eagerness to

go on to the other policies that they have learned (lest they forget!). While these other policies

may be relevant, their explanation and analysis should not be allowed to overshadow the

analysis of the interest rate policy.

- In analyzing the interest rate policy, the transmission mechanism must be explained and for a

complete explanation of the impact on AD, the following components of AD must be included:

C, I & X. Often, the analysis for the export component was left out and the other two dealt

with superficially.

o There was a fair number of candidates who did not mention the external effect of a

fall in interest rate in the thesis. As a result, they proposed that US or UK adopt an


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exchange rate policy (depreciation) or devaluation of the currency in the anti-thesis.

This was clearly irrelevant.

o Candidates, who managed to explain the effect on the export prices as a result of the

consequent depreciation of the currencies of the advanced economies, got carried

away and ended up losing focus on the issue of unemployment. Instead, they wrote

(visibly, with much effort, pride and satisfaction) irrelevantly about Marshall-Lerner

Condition and thus ended up looking at impact on Balance of Trade and Balance of

Payments.

o If elasticity is used, the depreciation of the currency should be related to the extent of

the change in USs and UKs ability to sell their products abroad, the extent by which

this change drives production, thereby generating employment.

- In some classes, the explanation of the multiplier process took centre stage and was too

detailed. While marks were not taken away, candidates must realize that in doing so, they

were wasting precious time. A number of candidates gave the impression in their answers

that the multiplier works only for Fiscal Policy which they offered as a supplementary policy.This is clearly a misconception. If the size of the multiplier was big for fiscal policy, it too

would be big for the interest rate policy or any other policy. To use this as an argument for or

against the use of one policy is thus not a valid point.

- The transition from one policy to the next was abrupt. For example, after explaining the

limitations of the interest rate policy, another policy to solve cyclical is fiscal policy is seen

in many of the scripts. While this may not be wrong, it makes sense to bring in the rationale

for suggesting why fiscal policy is necessary when interest rate can solve cyclical

unemployment despite its limitations. In doing so, candidates are also comparing and

assessing these two demand-management policies: fiscal policy and interest rate policy.

- A common error that was noticed in a fair number of scripts was the error in reading the

horizontal axis of the AD-AS as employment even though it was correctly labeled as real

national income. While there is a direct relationship between real national income and

employment, the two are not synonymous. Candidates must therefore look at how an

increase in real national income (output of goods and services), in the diagram, could lead to

increase in demand for labour and thus employment.

- Marks for evaluation were often not scored as opportunities for evaluation were often passed.

For example, in explaining how an increase in Government expenditure (G) could possible

lead to the crowding out of private investment, candidates could also question the likelihood

of crowding-out taking place in such an economic climate that was filled with pessimism, a

bleak economic outlook for the households as well as the firms. Therefore, when firms werereluctant to invest, crowding out is not likely to happen. An increase in G is even more

pertinent in stimulating the economy and creating jobs.

- Alternatively, recognizing that crowding can possibly take place if the interest rate policy is

very effective in getting firms to invest, candidates may want to suggest that an alternative for

the government is to borrow externally.


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- Only a few candidates attempted to compare across the

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Y6 H2 CT2 2011 - Examiner's Report

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