VJC P2 Answers QN 5 For Jenson

VICTORIA JUNIOR COLLEGE
JC 2 PRELIMINARY EXAMINATIONS 2020
H2 ECONOMICS
PAPER 2 – ESSAY QUESTIONS
SUGGESTED ANSWERS & MARK SCHEMES
Victoria Junior College H2 Economics Paper 2 – Essay Questions 2020 JC2 Prelim Exam
Suggested Answers & Mark Schemes
QUESTION 1
2018 marked another strong year for Singapore’s tourism sector, with visitor arrivals achieving a new
high. Tourists’ spending on entertainment grew, while expenditure on accommodation fell.
Source: Singapore Tourism Board, 13 February 2019
(a) Explain the determinants of a rational tourist’s decision on whether to go for a holiday and a firm’s
decision on whether to open a new hotel. [10]
(b) Evaluate the likely reasons for the increase in spending on entertainment and decrease in
expenditure on accommodation by tourists in Singapore. [15]
Part (a)
Approach
Answers should demonstrate the key concept of rational decision making, based on the marginalist
principle. Answers should also recognise that decisions involve both willingness & ability of the agent to
undertake the action, and thus explain the gains and constraints for the agent. Explanations should be
set in the given context.
Introduction
Rational decision-making involves the use of the marginalist principle to maximise net benefits, which
involves weighing of marginal benefits (MB) and marginal costs (MC). Net benefits are maximised when
MC = MB. If MB > MC, it is rational to do the activity or do more of it since the addition to total benefit
exceeds the addition to total cost which means net benefit is rising. On the other hand, it is rational not
to do it or to do less of it if MB < MC since reducing the activity will lower total benefits by less than total
cost, thus increasing net benefit. The optimal level of an activity is attained when MB equals MC.
Rational decision-making for a tourist
A rational tourist will make use of the marginalist principle in order to maximise his net utility when
deciding whether to go for a holiday. The tourist would consider his marginal benefits and costs. For
the tourist, the marginal benefits can come in the form of the satisfaction from visiting places such as
Universal Studios. It can also come in the form of utility derived from having experiences in countries
such as visiting nature parks. Marginal costs would come in the form of the money that would be spent
on airfare and accommodation.
The tourist will also have to consider his income constraint before deciding whether or not to go on a
holiday – if he earns insufficient income to afford to go on a holiday, he would then not be able to do so.
The tourist will also consider the opportunity cost incurred from going on a holiday. The next best
1
alternative forgone in this case could be what could have been bought with the money spent on the
holiday, such as a television set. (any other valid alternative is acceptable)
Rational decision-making for a firm
A rational firm will make use of the marginalist principle in order to maximise profits when deciding
whether to open a new hotel. MB could come in the form of revenue from the spending of hotel guests
while MC would come in the form of utility bills, cost of ingredients and also wages for hiring workers.
The firm needs to expect to be able to earn at least normal profits, where total revenue equals total
cost. It is the minimum return the owner must make on his money invested in the business to induce
him to continue in his existing business instead of closing and moving into some alternative business.
The firm will also have to consider barriers to entry (BTEs) for the hotel industry. BTEs could be high
due to the high cost required in building a hotel and also the marketing cost required. The higher the
BTEs, the more difficult it would be for the firm to start up a new hotel, so the firm would have to consider
its ability to overcome the BTEs which would depend on factors like how much start-up capital it has
available and whether the firm can successfully persuade consumers to choose its hotel. The firm would
also consider the barriers to exit, which might be high due to the difficulty involved in selling the assets
such as pillows and mattresses. The higher the exit costs, the less likely the firm would open the hotel,
as it would incur higher sunk costs that cannot be recovered should the hotel end up being unprofitable
and have to close.
Mark Scheme
Level Descriptors Marks

3 Well-developed explanation and accurate application of the marginalist 8-10
principle and opportunity cost to both tourists and firms + BTE/normal
profit for firms (i.e. willingness & ability in decision-making)
2 Underdeveloped explanation of the marginalist principle to both tourists 5-7

and firms (with no examples or poor use of examples)
OR
Well-developed explanation for either tourists OR firms (good use of
examples + accurate application to context)
1 An answer that shows some knowledge about the marginalist principle 1-4
2
Part (b)
Introduction
In order to explain the observed change in expenditure in the two different markets, we will make use of
the demand and supply model to analyse the factors leading to these outcomes.
Market for entertainment
A rise in expenditure by tourists on entertainment can be attributed to a rise in demand.
There is a rise in demand for entertainment by tourists due to the rise in tourist arrivals and rise in income
of tourists. An increase in income increases the ability of the tourists to consume entertainment, thus
the demand for entertainment increases.
It could also be due to a change in taste and preference as there have been successful campaigning
projects by Singapore Tourism Board. As such, tourists would have greater willingness to visit
Singapore’s entertainment sites, leading to a rise in demand.
Due to a rise in demand from D0 to D1, there will be a shortage of Q0Q2 at the initial equilibrium price of
P0. Due to the shortage, frustrated consumers will be willing to bid higher prices. Due to this upward
pressure on price, firms will be willing to increase their quantity supplied due to the higher prices
covering the higher marginal cost of production. A rise in price will also reduce the quantity demanded
due to a fall in the consumers’ ability to purchase goods and services. This will continue until quantity
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demanded equals quantity supplied at output Q1 and price P1. This will cause expenditure to increase
from 0P0E0Q0 to 0P1E1Q1.
The income factor is likely to be the stronger factor driving a rise in demand as entertainment is deemed
more as a luxury good (YED>1). Thus, a rise in income would lead to a more than proportionate rise in
demand. On the other hand, tastes & preferences take time to adjust, and other countries also have
their respective attractions that appeal to tourists. Hence, the income factor is likely to be a more
significant reason for the rise in demand than changing tastes & preferences.
Market for accommodation
A fall in expenditure by tourists on accommodation can be attributed to a rise in supply and a

rise in demand.
There has been a rise for demand due to the increase in tourists’ arrivals. Accommodation is a
complement to consuming holidays as tourists would need a place to stay during their time in Singapore.
The rising incomes of tourists mentioned earlier would thus lead to higher ability to consume
accommodation as well.
There has also been a rise in supply due to the rise in the number of hotels opening, such as the
springing up of boutique hotels. There has also been a fall in the marginal cost of production for hotels
as they have been harnessing the use of technology to make their processes more efficient.
Given that the expenditure on accommodation have fallen, we can infer that the rise in supply has been
greater than the rise in demand. Since accommodation is a necessity for tourists, the increase in
demand might not have been significant as 0<YED<1. Moreover, the rise in supply could have been
relatively larger as there have been a substantial number of boutique hotels that have been opening.
P D0 D1
S0
S1
surplus
E0
P0
P1 E1
Qty of
0 Q0 Q1 accommodation/t
4
A rise in supply is represented by a rightward shift of the supply curve from S0 to S1 and a rise in
demand is represented by a rightward shift of the demand curve from D0 to D1. At the initial price P0,
a surplus results, leading to a downward pressure on price as producers lower prices to clear excess
supply. As price falls, Qd rises and Qs falls, until a new equilibrium is achieved at E1. Overall,
equilibrium price has decreased from P0 to P1, and equilibrium quantity increased from Q0 to Q1.
Keeping supply constant, when demand increases from D0 to D1, there will be a rise in both price and
quantity, causing expenditure to increase.
Keeping demand constant, when supply increases from S0 to S1, price falls while quantity rises. Given
that the demand for accommodation is price inelastic due to a lack of substitutes available since tourists
need to stay in hotels / hostels when they come to a foreign land, the rise in quantity demanded will be
less than proportionate to the fall in price. Hence, the rise in expenditure from the rise in quantity
demanded is less than the fall in expenditure from the fall in price, leading to consumer expenditure
falling.
Overall, since SS increased more than demand, we can expect that the fall in consumer expenditure
from the rise in SS would be greater than the rise in expenditure from the rise in DD, so tourists’
expenditure on accommodation in Singapore would see an overall decrease.
However, the rise in demand for accommodation may be different for different types of accommodation.
We could see a bigger rise in demand for the 5-star hotels as compared to the smaller boutique hotels,
given the more luxurious nature of high-end hotels. Hence, this may lead to a smaller fall in expenditure
(or even an increase) for high-end hotels.
Conclusion
The rise in total expenditure for entertainment is likely due to rising demand, whereas the fall in total
expenditure for accommodation is likely due to supply rising by a greater extent than demand.
The rise in tourists’ expenditure on entertainment is more likely driven by rising tourists’ incomes, due
to the fact that many emerging economies in nearby Asian countries are seeing a rise in income of their
citizens, leading to a rise in purchasing power.
The fall in tourists’ expenditure is probably driven by rising supply, driven by the Singapore
government’s push for technology adoption to raise productivity, and the increasing number of hotel
operators in response to rising popularity of niche boutique hotels as consumers’ preferences change.
However, the above analysis assumes that the tourists still stay for the same duration. It could be a
case of how the tourists arrivals may have increased but they are staying for a shorter period of time.
Hence, the demand for accommodation might have actually fallen instead of increasing.
5
Mark Scheme

3 Well-developed explanation of the changes in expenditure in the market 8-10
for accommodation and entertainment
2 Underdeveloped explanation of the changes in expenditure in the market 5-7

for both accommodation and entertainment
OR
Explanation is well-developed for only one market (either entertainment or
accommodation)
1 An answer that shows some knowledge about the free market mechanism 1-4
E3 Well-substantiated judgement on the relevant importance of the demand 4-5

and supply factors on total expenditure, with strong use of context
E2 Judgement with some substantiation on the relevant importance of the 2-3

demand and supply factors on total expenditure
E1 Unsubstantiated judgement on the relevant importance of the demand and 1

supply factors on total expenditure
6
QUESTION 2
The price of mobile data varies greatly across countries. For instance, in 2018, the average price of one
gigabyte of mobile data costs US$0.26 in India and US$6.66 in the UK. In Canada, where the market is
dominated by the three biggest players, the price of mobile data is among the highest in the world at
US$12.02 per gigabyte.
Source: cable.co.uk
(a) Explain the possible reasons for why mobile data prices are higher in some countries than in others.
[10]
(b) Discuss the view that government intervention in the mobile services market would result in better
outcomes for consumers and society. [15]
Part (a)
Approach
Students are to illustrate the knowledge and understanding that prices are different across countries
due to the relative levels of demand and marginal costs. Reaons may include level of income in each
country differ, costs of factor inputs or extent of EOS reaped, and degree market affecting the firm’s
ability to set a high price.
Introduction
Firms’ pricing decisions are based on the their demand and cost conditions. Mobile data prices in
different countries are determined by the the relative levels of demand, the degree of market power the
firms have, and the economies of scale that the firms get to reap.
Body
The price of mobile data is higher in countries where there are relatively higher levels of demand.
Nations with higher income levels tend to have a higher demand for mobile data due to their greater
purchasing power, and hence mobile operators are able to charge more for their services, as in the case
of Canada. This is in contrast to a developing country like India, where the demand for mobile data is
not as high, given that most of the population still lives in poverty and connecting to the rest of the world
is not deemed as a priority. Therefore, the ability to pay for mobile data plans is higher in Canada than
in India, leading to higher prices, ceteris paribus.
In addition, India is largely still dependent on agriculture to drive its economy, and mobile data is not as
important as in Canada. The latter has a heavy reliance on the financial sector, which requires a strong
connectivity to the rest of the world, and hence, the willingness to pay for mobile data plans is higher in
Canada than in India due to differences in needs for work and leisure.
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Degree of market power also affects the price of mobile data plans.
Market power allows firms to set the price for the goods and services sold and monopolise the market.
It would seem plausible that the market share is very much concentrated amongst the 3 biggest firms in
Canada, compared to India where the market power is more evenly spread out. Dominance by a few
large firms in the mobile data market is due to high barriers to entry that prevents new firms from entering
the market. Therefore, if there is less competition in the market, the demand for each individual firm is
relatively higher than in a market that has more competitors. The demand for firms with greater market
dominance would also be more price inelastic due to having fewer competitors offering substitute
services. Hence, a profit-maximising firm with more market power is able set a higher price for its mobile
services. As shown below in figure 1, with a higher and more price inelastic demand of DD’, the firm is
able to command a higher price at P’ based on MC=MR’; as compared to a firm with lower market share
and power would set a price of P based on MC=MR.
Price /
Revenue / MC
Costs
P’
MR MR’ DD’
DD
Quantity
0 Q Q’
Q
Fig 1: Differences in market dominance
Cost differences – (EOS etc) will also affect the price of the data plans
The size of the market and market share of the incumbent firms have will have an impact on the EOS
these firms get to reap. Large firms have a cost advantage over small firms due to economies of scale.
Large firms have a lower average cost than small firms because of their larger scales of production.
When a firm expands the scale of production, average cost will usually fall and this phenomenon is
called economies of scale.
Economies of scale (EOS) occur due to several reasons. For example, division of labour is the process
whereby each job is broken up into its component tasks and each worker is assigned one or a few
component tasks of the job. An expansion of the scale of production may enable the firm to engage in
greater division of labour and hence greater specialisation which will lead to higher labour productivity
resulting in a fall in average cost. Larger firms may be able to afford to create more specialised
8
departments where specialists perform specific administrative functions. These specific administrative
functions include human resource, purchasing, finance and marketing. Greater specialisation in these
areas of expertise will lead to greater efficiency resulting in a fall in average cost. As shown in Figure 2
below, telecommunication firms which can reap more EOS are able to pass on their lower average costs
of production to consumers in the form of a lower price. Firms with more internal EOS reaped would
have lower short-run MC and AC curves leading to a lower price charged at P1 based on MC1 = MR;
whereas firms with less EOS would have higher short-run MC and AC curves, and charge a higher price
P0 based on MC0 = MR.
Alternative – answers may consider differences in variable input costs (e.g. labour) or differences in
productivity arising from different level of technology in production
Fig 2: Differences in internal EOS reaped
Remark: Government policies would not the best argument to bring in for part (a) as there will be a
tendency for points to be repeated in part (b). Furthermore, it may be difficult to justify why certain
countries see government intervention while others do not – e.g. Canada has among the highest degree
of market power and yet it is unlikely to have government intervention as seen by the high prices.
9
Mark Scheme
Level Descriptor Marks

L3 For a well-developed essay that 8 – 10
Considers cost and revenue perspectives to arrive at a logical conclusion of
the price of mobile plans being higher in some countries than those in others;
and
Has sufficient scope by considering the price-setting ability of the sellers in
different countries.
L2 For an underdeveloped essay that 5–7

Compares the levels of demand and costs to arrive at a logical conclusion of
the price of mobile plans being higher in some countries than those in others
but with gaps in rigour; and/or
Lacks scope when considering the price-setting ability of the sellers in different
countries.
L1 For a demonstration of relevant knowledge that 1–4

fails to analyse the differences in prices effectively using economic logic and
framework; and/or
states the differences in demand and cost conditions, but do not go on to
justify or explain the reason for the differences; and/or
is severely lacking in scope, with limited factors that account for the difference
in price.
10
Part (b)
Approach
Answers should explain the gains and losses to consumers and society from various forms of
government intervention, then evaluate the likely extent of these gains and losses.
Introduction
The high degree of market power of firms in the mobile services market and the resultant
underproduction of their output result in rather large welfare loss in these markets. The high degree of
market power could also result in higher prices for consumers. The high entry barriers also make it
possible for firms to sustain their supernormal profits into the long run contributing to inequitable
distribution of income. As such, governments could intervene with command or market-oriented
measures. However, this may not always result in better outcomes for consumers and society.
Body
The government can regulate pricing of the mobile services.
When market concentration is high, the few large firms with market dominance in the
telecommunications market tend to restrict output and produce far less than the allocative efficient
output. Firms that are profit maximising will produce at output Q m where MR = MC, and price is Pm.
However, the allocatively efficient output (where P=MC) and price are Qmc and Pmc. As such, the
equilibrium output Qm is much lower than Qmc while Pm is much higher than Pmc. This underproduction
of output results in an allocatively inefficient outcome. The shortfall in production of Qmc- Qm units result
in a large welfare loss represented by area abe. To achieve the socially optimum level of production,
the government can regulate the market by using MC Pricing. Firms in the telecommunications market
are thus compelled to charge at P* and produce q*.
Fig. 3: Regulatory pricing
Fig 3: Regulatory pricing qty / t

qM
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However, such a pricing regulation will cause the firms to make a loss, as the price charged P* is lower
than the cost C’, at q*. Hence, in order for the firms to be able to continue production, the government
would have to provide subsidies, such that the firms earn at least normal profits, but this is in turn
dependent on the government’s fiscal position. For a government that has been in deficit for years, this
subsidy will not be sustainable.
Alternatively, MC pricing may be feasible if the telecommunication firms are allowed to levy a fixed initial
charge for access to their mobile services, such that these fixed charge amounts to the loss incurred so
as to offset the loss due to pricing their services below the AC. Very often such charges are known as
registration fees that cannot be refunded, even if the mobile contracts are terminated.
The government can also deregulate the telecommunications market.
Governments can allow more firms to enter the market by reducing barriers to entry. By issuing more
licenses to new entrants, more firms may enter the industry, and this increased competition and
innovation by firms will lower prices for consumers. As shown below, the increased number of firms will
result in each firm facing a lower demand due to a smaller market share, with the demand for their
services being more price elastic as well with more substitutes available. Demand for individual telco
firms thus shifts from DD to DD’. This allows for greater consumer choice and lower prices, as prices
fall from P to P’, benefitting the consumers with increased consumer surplus and society with reduced
allocative inefficiency caused by market power.
For example, the deregulation of the mobile service market in Singapore over the years ensured that
the original incumbent Singtel faced competition, leading to a fall in prices of mobile services over the
years and allowing consumers to be better able to choose a plan that best suits their needs from the
other competing firms.
Price /
Revenue /
Costs
MC
P AC
P’
AC’
AC
DD
MR’ MR
DD’
Quantity / t
0 Q’ Q
Q
12
However, with more competition, the firms are less able to earn large supernormal profits in the long
run, which can be channeled to fund process and product innovation. From the above diagram, the
firm’s supernormal profits fall from [(P-AC) x q] to [(P’-AC’) x q’] which is sufficient to keep them in
business but the fall in supernormal profits may disincentivise the telecommunication firms to undergo
R&D. Such R&D undertaken by the firms may result in lower operating cost and hence lower prices of
their mobile, or higher quality services like better network coverage that better suit consumers’ tastes.
Government intervention may therefore lead to worse outcomes for consumers and society, due to the
potential innovation that these firms can realise given the supernormal profits available to be channeled
into research.
Whether deregulation leads to better outcomes for consumers and society would depend on the initial
level of market dominance, and extent of supernormal profits earned. If the market was initially very
concentrated with a few dominant firms (e.g. Canada), deregulation would likely lead to better outcomes
as the initial allocative inefficiency would have been high. Furthermore, the firms would likely have been
earning very large supernormal profits, such that even if some profits are eroded with increased
competition, the firms still retain substantial supernormal profits to retain the ability to invest in R&D.
The government can also take over production to become the producer of the mobile services
(i.e. nationalise it).
When a government nationalises a firm, it would then decide on the price and output, and cover any
potential losses using tax revenue. Since it pursues the maximisation of society’s interest rather than
maximisation of profits, the nationalised firm will produce the allocative efficient output and charge the
price that equals MC. Since the firm is owned by the government, the latter would be able to know the
cost structure of the firm and so engage in more accurate MC pricing. When P=MC, the society’s welfare
is thus maximised when the price of mobile services charged is equals MC.
However, since the government does not aim to maximise profits, it has very little incentive to minimise
unit costs and significant X-inefficiency may result instead. Therefore, to obtain a more efficient outcome
is for the government to build and manage the telecommunications network and allow private profit-
maximising firms to ride on the network to supply their services directly to consumers. For example, the
different mobile operators can pay the government for the use of the network while competing against
each other in supplying mobile services to consumers. This ensures that costs are kept low while the
society’s welfare is being maximised.
Conclusion
In conclusion, government intervention may not always lead to better outcomes for the consumers and
society but this is largely dependent on the initial extent of welfare loss incurred due to market power,
whether telecommunications is deemed as a necessity for the country, as well as the method of
government intervention.
The primary consideration would be the intial level of market dominance – the more concentrated the
market is, the more likely it is that government intervention would lead to better outcomes as market
power is reduced.
In addition, whether the country deems mobile services as a necessity would determine whether
government intervention would lead ot better outcomes. For a country that is moving towards
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digitalisation of transactions and services like Singapore and Canada, there is a greater need for the
government to make mobile services more affordable as residents need access to mobile data services
to participate in the digitalisation movement.
The method of intervention also matters. In this context of a dynamic technology based service, allowing
the free market to operate and respond to changing market conditions is crucial. For instance, new
developments like 5G networks or changing consumer preferences to demand contract-free
subscriptions means that telco providers need to adapt quickly. Hence, deregulation while allowing for
private firms to operate would likely lead to better outcomes for consumers and society, as compared
to more restrictive command measures like price regulation or nationalisation.
Mark Scheme
Level Descriptor Marks

L3 A well-developed and two-sided discussion on the impact of the government 8 – 10
intervention policies to consumers and society
L2 An underdeveloped two-sided discussion on the impact of the government 5–7

intervention policies to consumers and society
OR
A well-developed but one-sided discussion on the policies
L1 Descriptive answer which shows some knowledge of the impact of government 1–4
intervention
E3 Strong, relevant substantiation of a stand on the factors that determine the 4–5
desirability of the government intervention policies. Good and appropriate use
of examples for context
E2 Some attempts at substantiation of a stand on whether government intervention 2–3

is desirable to society
E1 Unsubstantiated judgement on whether government intervention is desirable to 1

society
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QUESTION 3
In situations of public goods or where there is consumer ignorance, reliance on price signals alone will
not lead to an optimal allocation of resources.
(a) With the use of appropriate examples, explain why this may be the case. [10]
(b) Discuss the considerations a government may have when deciding how to intervene in such
situations. [15]
Part (a)
Introduction
The allocation of resources is said to be optimal when it results in society’s welfare being maximised,
i.e. allocative efficiency is attained. When there is public goods, this will not happen because reliance
on price signals will result in a missing market; when there is consumer ignorance, reliance on price
signals will result in too few resources are being allocation to the production of the good (in the case of
goods being underconsumed) or overconsumption of the good.
Body: Explain case of public goods
A public good is a good that is non-excludable and non-rivalrous, such as national defence.
Non-excludability means that it is impossible or very costly to prevent someone who has not paid from
consuming it. Hence, consumers can be free riders that benefit from a good without paying for it,
therefore no consumer would be willing to pay for it. Using national defence as an e.g. – once it exists,
it is impossible for the benefit of national defence, which is a foreign army not invading, to only be
enjoyed by those who pay for it as everyone is protected once a defence force exists.
Hence, there is no effective demand in the market since consumers are not willing to pay for public
goods and hence producers will be unable to sell their good at any positive price level and thus will not
be able to earn revenue to cover the cost of production. Left to the free market, there will be no
production of public goods and total market failure occurs. The potential net benefit to society from
having some level of public goods produced and consumed is lost, resulting in allocative inefficiency.
Non-rivalry means that consumption of the good by one person does not diminish the availability of the
good for another person. This implies that consumption of the good by more people does not incur any
additional costs, i.e. marginal cost of providing for an additional user is zero. Using the example of
national defence once it exists, an additional person consuming national defence does not reduce the
the level of defence available for the next person in the country, and as such there is no additional cost
of providing national defence for that next person.
According to the Marginalist Principle, a good should be consumed up till the point where MB=MC to
society so as to maximise society’s welfare and achieve allocative efficiency. Since the MC of providing
for an additional user is zero, the good should be consumed to the point where MB is also zero in order
to maximise society’s welfare, which can only be achieed if P=0 since the maximum price a consumer
is willing to pay for a good is the MB he derives from it.
However, at zero price, no profit-motivated private producers would be willing and able to supply the
good, and therefore there is no possibility that the free market can achieve allocative efficiency.
15
While not non-rivalry does allow for a good to be produced if they firm could charge a non-zero price,
giving rise to underconsumption of the good, the fact that public goods are non-excludable means
reliance on the price signals to allocate resources towards proudction of the good would result in the
good not being produced at all, resulting in a missing market and loss of benefit to society from the
consumption of the good being forgone.
Body: Explain case of consumer ignorance
Consumer ignorance leads to consumers over-valuing or under-valuing the benefits of consuming a

good. Hence reliance on the price signal will result in more or less resources being allocated towards
the production of the good respectively than that , leading to allocation of resources to be sub-optimal.
Using the example of cigarettes as a case of over-consumption, which is a demerit good, the smoking
of cigarettes causes long-term harm to one’s own health and well-being. For example, smoking
increases the likelihood of further health complications in the future such as lung cancer. However, due
to imperfect information, consumers may be ignorant about these harms from smoking and over-
estimate the true value that smoking cigarettes provides.
With reference to Figure 1 below, the over-estimation of the value of smoking by the consumer causes
the perceived marginal private benefit (MPB) to be higher than the true MPB of smoking cigarettes.
Consumers would base their consumption decision on their perceived MPB, hence the perceived MPB
curve is also the market demand curve.
Costs, Benefits ($/q)
Figure 1: How consumer ignorance results in overconsumption of cigarettes
SS= MPC = MSC
P* A
‘Perceived’ MPB (DD)
B
’True’ MPB = MSB (assuming no
externalities)
Q/t
0 Q* Q
Assuming no externalities, the MSB curve will be the same as the True MPB curve, while the MSC curve
is the same as the MPC curve, which is also the supply curve. Left to market forces, market equilibrium
output will be at Q, where the demand curve intersects the supply curve. The socially optimal output is
at Q*, where MSC = MSB, and society’s welfare is maximised. Since the market equilibrium is at Q,
there is an overconsumption of cigarettes of Q – Q* units. For Q* to Q, the MSB is lower than the MSC,
which means that there is a net loss to society’s welfare from these additional units of cigarettes
consumed. At the output of Q, a deadweight loss of area A is incurred by society, as the total social
costs of consuming Q* to Q units (areas A+B) is greater than the total social benefits (area B).
16
On the other hand, using healthcare as a case of under-consumption, consumption of healthcare

confers long-term benefits to one’s own health and well-being. For example, preventive healthcare or
early treatment of illnesses can help reduce the likelihood of further health complications in the future.
However, consumer ignorance about these long-term gains lead them to under-estimate the true
benefits that consuming healthcare provides. As a result, the market equilibrium output which is
determined by where perceived MPB (DD) = MPC (Ss), will be lower than that of the socially optimal
level, and hence there is under-allocation of resources towards production of the good.
Mark Scheme

L3 For an analytical answer that considered how public goods and consumer
ignorance leads to market failure. 8 – 10
L2 Answer explains how public goods and consumer ignorance leads to market
failure but is lacking in details for either/both and/or contains some
5–7
theoretical inaccuracies and/or does not give any examples.
L1 Knowledge of how public goods or consumer ignorance lead to market

failure is largely unexplained or answer contains basic theoretical error. 1–4
17
Part (b)
Approach
Answers need to be organised based on factors for the government to consider. For each consideration,
there should be clear links to how it influences the method of intervention, by contrasting policy options.
Evaluation would entail weighing which of the considerations are relative more/less important.
Introduction
When the goverment decides to interve in a market to bring about a more efficient allocation of resources
in the cases of public goods and consumer ignorance, there are several policies a government may use.
In deciding which policy to use, there are various considerations a government has.
Consideration 1: Root cause of problem
The government may consider the root cause of the problem in deciding how to intervene.
In the case of public goods, as explained previously, there is complete market failure, i.e left to the
market there will be a missing market. Recognising that market provision is not possible, the
government needs to intervene by direct provision at zero cost to user at point of consumption and fund
the provision from taxation.
In the case of consumer ignorance leading to overconsumption of a demerit goods such as cigarettes,
as explain earlier, the government could reduce over consumption through a tax as doing do would raise
marginal cost of production, reduce supply, and increase the price of cigarettes which will result in
consumers cutting down on consumption. However, it would be more appropriate to use public
education to directly tackle consumer ignorace being a source of market failure in the case of demerit
goods as this is one of the root causes of overconsumption (the other being externality which is
addressed by the tax). Public education would make consumers more aware of the full impact of
smoking cigarettes on their health such as those which appear on later in life like lung cancer which
would help to correct consumption decisions by shifting ‘perceived’ MPB towards the ‘true’ MPB.
Consideration 2: Availability of government finances
The government may consider the state of its finances when deciding how to intervene.
In the case of imperfect info, as explained above government may ideally want to intervene by public
edcuation as this addresses the root cause of the problem. However this may incur considerable
resources, and opportunity cost is incurred by every spending decision made. For a government already
experiencing severe budgetary this opportunity cost could be very high and entails diverting resources
from other important sectors, for e.g. retraining workers to prevent structural unemployment. Hence
instead of relying heavily on educational campaigns such as anti-smoking drives, the government may
have to rely on less resource intensive measures to reduce overconsumtion such as compulsory
labelling of cigarettes to inform consumers of the harmful effects of smoking, advertising bans which
also reduces consumer ignorance, or implementing a minimum age for smoking. A production tax can
also be considered, which would help the government raise tax revenue to supplement its budget.
In the case of public goods, the government may still need to provide the public good. A government
which lacks the finances to do so then has to reduce the scale of provision – for e.g. fewer street lights,
or a less technologically advanced defence force
18
Consideration 3: Extent of market failure
The government may consider the extent of market failure in deciding how to intervene.
In the case of public goods, there is complete market failure as the good will not be produced. If the
government deems the good to be essential such that net benefit of the good being prodcued is high,
an improvement in welfare will only come about via direct provision.
In the case of consumer ignorance, the extent of ignorance will determine the extent to which there is
underconsumption or overconsumption of the good. This will then determine how the government
should intervene. Using the case of cigarettes, a measure such as public education to influence the
level of market demand may suffice, but such a measure would require time to take effect. However, if
there is significant consumer ignorance which would result in significant overconsumption and where
the government could want a quicker outcome, as in the case of e-cigarettes in Singapore, the
government may instead implement a ban and force the quantity consumed to drop to zero.
However, imperfect information may result in the government misjudging the extent of market failure –
for example it could be the case that e-cigarettes is less harmful than current evidence suggests, which
means the government may incorrectly implement a ban leading to worse outcomes for society’s welfare.
Consideration 4: Effect of intervention on efficiency
The government may consider the effect of its intervention on efficiency
In the case of public goods, direct provision is likley to result in X-inefficiency / productive efficiency not
being attained as the lack of profit motive suggests there is lack of incentive faced by the government
to minimise unit costs when supplying the good. As a result, there may be wastage of resources when
the government takes on production directly, resulting in welfare loss to society. Additionally the
government may lack expertise needed in supplying goods such as street lighting – for e.g. detailed
knowledge of electrical systems and technology which is likely to lead to poor quality of good supplied
and hence society’s welfare is not maximised (e.g. faulty street lighting networks). Hence the
government may want to outsource the supply of the good to a private firm with the relevant expertise
in return for a sum paid by the government.
Consideration 5: Nature of good
The government may also consider the nature of the good in deciding how to intervene
In the case of public goods the government may outsource the supply of a good such as fireworks to a
private firm, to avoid potential X-inefficiency from government direct provision due to a lack of profit
incentive to minimise unit costs. However, the same cannot be done when it comes to a sensitive good
such as national defence, where the only option is for the government to undertake direct provision to
preserve security and sovereignty.
Overall Evaluation / Synthesis
The most important factor is likely to be the root cause of the problem as this plays an important role in
determining the effectiveness of intervention measures. This is seen clearly in the case of public goods
whereby the absence of price signals means direct provision at zero cost is only way of intervening, and
also in the case of consumer ignorance. Without public eduation and a ban on advertising of demerit
19
goods such as cigarettes, such demerit goods are likely to be overconsumed despite other measures
such as taxes due to misconceptions and social acceptance of smoking among certain demographics,
e.g. teenagers.
The least important factor is the availability of government finances, as where resources are significantly
misallocated government needs to intervene. In case of public goods, this involves substantial sums
involved which cannot be avoided – the government at best outsources the supply to private firms
through competitive bidding to keep costs as low as possible, while still paying for the supply of the good.
Likewise, in case of consumer ignorance, some amount of spending may be needed for public education.
Hence, despite limited resouces governments would still have to spend on intervening if it will be
effective.
Mark Scheme

A well-developed analysis of the factors a government would consider in
deciding how to intervene in cases where both public goods and consumer
L3 8 – 10
ignorance is present.
Answer attempts to explain the factors a government would consider in

deciding how to intervene in cases where public goods and/or consumer
L2 ignorance is present, but factors are not explicitly identified and/or not 5–7
sufficiently well developed.
For an answer which shows some knowledge of policies pursued by

government to address market failures mentioned.
L1 1–4
Answer that has basic theoretical errors.
Response ranks factors a government would consider and is well explained.

E3 4–5
Makes a stand on importance of factors with some substantiation and/or
E2 2–3
Some attempts to evaluate the factors a government would consider
Makes a stand on importance of factors with no further substantiation of why

this is the case OR
E1 1
Some attempt to evaluate the factors a government would consider
20
QUESTION 4
Some economists argue that a minimum wage law would not only benefit low-income working families,
but it would also provide a boost to consumer spending and the broader economy through its
redistributive effects. On the flip side, others argue that it would not solve the problem of low wage
workers as firms will opt to automate.
Discuss whether the implementation of a minimum wage law in Singapore is the most appropriate policy
for achieving inclusive growth. [25]
Introduction
Inclusive growth indicates a rate of growth that is sustained over a period of time, is broad-based across
economic sectors and creates productive employment opportunities for the majority of the country’s
population. Thus this essay will consider the appropriateness of a minimum wage law and other relevant
policies in helping Singapore attain actual and potential economic growth, as well as equity in income
distribution.
Thesis: A minimum wage law is appropriate for achieving inclusive growth in Singapore
1. A minimum wage law raises the wages of lowest income earners in the economy. Even for
occupations just above minimum wage, there may be spillover effects as firms may be forced to
raise wages in order to attract and retain workers given more competition from jobs affected by
the minimum wage law. This narrows the gap between the rich and poor in the economy,
improving equity in income distribution.
Using a simple demand and supply analysis as shown in Fig. 4.1 and 4.2, the initial wage gap
between low and high wage earners can be depicted as Wo-Wh. With the implementation of the
minimum wage law, which stipulates a wage higher than the market wage rate of Wo for low
wage earners, their wage rises to Wm. This reduces the wage gap to Wm-Wh, which serves to
improve equity in income distribution in the economy.
21
2. With the rise in minimum wage, firms with high substitutability between capital and labour will
perceive an increase in marginal benefit to automate or substitute towards a more capital
intensive production process in view of higher labour cost. Such a move will lead to higher capital
accumulation in the economy. In addition, the more attractive wages may increase labour force
participation and increase the willingness of stay-home moms or perhaps seniors to re-enter the
workforce. The rise in quantity and quality of these factors of production will thus increase the
AS as illustrated by a rightward shift of the vertical portion of the AS curve from AS to AS’ in Fig
4.3. This will lead to a higher full employment level of income from Yf to Yf’ and lead to potential
economic growth.
Fig. 4.3
3. As the wages of the lower income workers rise, overall consumption will likely rise as a
considerable proportion of this increase will go towards consumption. This is because the poor
possess a larger marginal propensity to consume than the rich since much of their income goes
towards expenditure on basic necessities. This rise in induced domestic consumption will mean
a larger increase in AD when there is an injection in the economy, thereby leading to higher real
GDP and actual growth.
Anti-thesis: A minimum wage law may not be the most appropriate policy to achieve inclusive
growth in Singapore
1. Assuming labour markets are competitive, introducing a minimum wage law will lead to
unemployment. With reference to Fig 4.1, the higher wage, Wm, which is set above the market
equilibrium wage rate of Wo for low wage earners will lead to a surplus of labour at Wo, leading
to unemployment of Qd-Qs as the quantity supplied of workers will exceed the quantity
demanded. The is because while the higher wage will raise the MB for relevant workers and
incentivise them to work thus raising Qd, it will also raise the MC for profit-motivated firms thus
leading them to cut back on employment, thus reducing Qs. Furthermore, if firms do substitute
towards capital goods by changing their production processes, this will lead to structural
unemployment given that the low skilled workers retrenched will likely lack the necessary skills
and thus mobility to take up jobs in the sunrise industries. Since the lower income segment of
the economy are typically made up of these low skilled workers, greater inequity in income
distribution may even result with the introduction of the minimum wage system. With a higher
22
level of unemployment, it may also offset whatever increases in consumption from the higher
wages to the lower income workers. Thus the impact on actual growth may be overstated.
In light of these limitations, an alternative policy would be to tap on transfer payments to achieve
inclusive growth. Transfer payments would allow targeted aid to the lower income in Singapore
thus improving equity in income distribution. Furthermore, the redistribution of income from the
rich via the progressive income tax system to the poor via transfer payments would similarly
boost consumption as analysed above with the minimum wage law as the poor possess a higher
MPCd. Transfer payments would lead to a higher disposable income and since the poor will
spend a large proportion of the allocated funds, this will raise Cd and AD in the economy from
AD to AD’ in Fig 4.4, thus contributing to a rise in real GDP from Y to Y’, thus achieving actual
economic growth.
Fig 4.4
2. The minimum wage law will raise factor costs in Singapore. Thus the unit cost of production will
rise given that labour is a common factor input across most sectors. The rise in UCOP will lower
AS as illustrated by an upward shift in the horizontal segment of the AS curve. This will raise
GPL, leading to cost-push inflation and negative actual growth as evidenced by the lower
equilibrium real national income, ceteris paribus. Furthermore, the higher labour costs will also
lower the expected rate of return of firms, thus lowering investment since it would indicate a
lower marginal benefit relative to the marginal cost of investing. The fall in investment will not
only lower AD but also capital accumulation. This will affect Singapore’s actual and potential
growth adversely given her dependence on foreign direct investment.
In light of these trade-offs, subsidising training to raise productivity for low wage earners and
retrain those who are structurally unemployed to take up new jobs in sunrise industries could be
a more appropriate alternative. With better skills, this will possibly raise the demand for such
workers leading to higher incomes. In addition, industries that tap on such workers tend to be
more labour intensive (e.g. cleaning, construction) and thus a productivity boost will help lower
the economy’s unit cost of production given that most industries tap on these services to some
extent. In addition, the quality of the labour force will be raised as well. This will raise AS as
illustrated by an outward shift of the entire curve, leading to actual growth via a rise in real GDP
and potential growth via a rise in the full employment level of income.
23
Conclusion
The minimum wage law is arguably the most appropriate to improving inclusive growth, assuming that
the desired emphasis is to first and foremost improve equity in income distribution.
The law will likely not make significant contributions to sustained economic growth unlike skills training
but given the nature of Singapore’s economy, it will not likely make a severe dent to her international
competitiveness which is the main driver of growth since the export industries apart from tourism are
largely capital intensive or knowledge based. Foreign firms that invest are in search of skilled labour
while the low skilled labour employed in most industries are largely in the form of cleaning and other
menial services, which forms a smaller proportion of services rendered.
Transfer payments work better as a once-off policy and will not be sustainable in the long term given
the much heavier burden it exacts on the government budget. While skills upgrading seems to be the
most holistic in achieving inclusive growth, Singapore’s current emphasis on it seems to be inadequate
in addressing the needs of the poor. This could be due to the difficulty in in ensuring the relevant workers
are being trained and that the training directly translates to a rise in productivity since so much depends
on the learning attitude of the workers.
All in all, the use of a minimum wage law can be seen as most appropriate to achieve inclusive growth
when viewed as a means of better sharing the spoils of economic growth with the lower income segment
of society. If the emphasis is still sustained growth as opposed to improvements to equity, the use of
supply-side policies such as SkillsFuture will likely be more appropriate to target the various
macroeconomic objectives with minimum trade-offs.
24
Mark Scheme

L3 A well-developed and two-sided analysis of whether minimum wage is the most 18 - 20
appropriate policy to achieve inclusive growth. The objectives associated with
inclusive growth are adequately addressed. Alternative policies are raised in light
of the limitations associated with minimum wage.
A well-developed and two-sided analysis of whether minimum wage is the most 15 - 17

appropriate policy to achieve inclusive growth. The objectives associated with
inclusive growth are adequately addressed.
L2 A one-sided explanation of whether minimum wage is the most appropriate policy 12 - 14

to achieve inclusive growth, which adequately addresses the objectives
associated with inclusive growth
OR
An underdeveloped two-sided explanation of whether minimum wage is the most
appropriate policy to achieve inclusive growth. This answer may not fully address
the objectives associated with inclusive growth.
A one-sided explanation of whether minimum wage is the most appropriate policy 9 – 11

to achieve inclusive growth. Answer does not fully address the objectives
associated with inclusive growth.
L1 For an answer which shows some knowledge of macroeconomic policies and the 5–8
macroeconomic objective(s) associated with inclusive growth.
However answer consists of significant logical gaps and theoretical errors. This
may be seen in an inability to link the policy clearly to the macroeconomic
objective.
For an answer which is mostly listing various policies governments can adopt to 1-4
achieve their macroeconomic objectives with little to no reference to inclusive
growth.
E3 A clear stand that explicitly addresses the question as to whether minimum 4–5
wage is the most appropriate policy for achieving inclusive growth. The
substantiation will demonstrate good consideration of the Singapore context.
E2 Some substantiation of whether minimum wage is the most appropriate policy 2–3
for achieving inclusive growth.
E1 Makes a stand with no further substantiation on whether minimum wage is the 1

most appropriate policy for achieving inclusive growth.
25
QUESTION 5
In 2018, the US trade deficit widened to a 10-year high of US$621 billion.
(a) Explain why governments may be concerned about a persistent trade deficit. [10]
(b) Discuss the potential causes of a worsening trade balance for different countries. [15]
Part (a)
Introduction
An economy will face a trade deficit when the total export revenue from the sales of exports to foreigners
is less than the total import expenditure spent by locals on foreign imports. This will result in a net outflow
of currency in the balance of payment account. Governments would be concerned with a persistent
trade deficit because of the negative macroeconomic consequences that it brings. The impact on an
economy can be seen in terms of effect on level of real national income, level of employment of
resources, overall balance of payment, exchange rate and economic growth in the long term.
Body
A persistent trade deficit would be a concern for the government as it could mean that the real
GDP of the country is falling while unemployment is rising.
A government would be concerned with a country’s persistent trade deficit if it is a result of its goods
and services being less competitive than their trading partners. This will mean that the country’s people
will end up buying more foreign imports due to the better quality while foreigners will be buying less of
the country’s lower quality exports. The higher import expenditure and lower export revenue will cause
the net exports (X-M) to fall. This will lead to a fall in the economy’s aggregate demand (AD). The
components of aggregate demand are consumption expenditure (C), investment expenditure (I),
government expenditure (G) and net exports (X- M).
In the diagram below, assume that the country AD was initially at AD0 and equilibrium national income
occurs at full-employment output level (Yf). Thus, the trade deficit will cause the AD curve to shift to the
left from AD’ to AD. With the fall in AD, inventories build up and firms will cut back on production and
hire fewer factors of production (FOP), such as labour. As a result, household's income will decrease
inducing lower consumption of other domestic goods and services, leading to further decreases in these
other domestic firms’ output . This will result in a further fall in the hiring of labour, income and spending
of other households creating a downward multiplier effect leading to fall in real national income from Yf
to Ye as seen in the diagram. So if there is a persistent trade deficit, it will result in negative economic
growth and demand-deficient unemployment.
26
A persistent trade balance deficit would be a cause for concern it might result in speculation and
instability of the foreign exchange rate.
If the country is under a managed float system, a persistent trade deficit may invite forex speculation of
the exchange rate. When trade deficit occurs, the country’s forex rate will depreciate as there will be
lesser demand by foreigners for its currency and/or an increase in supply of the local currency. If the
forex rate falls below the band set, the central bank will have to intervene by using its foreign reserves
to buy back its own currency. Since these foreign reserves are finite, this situation might invite
speculation that the central bank is unable to sustain this intervention and the central bank may be
forced to allow its currency to depreciate causing significant economic problems. E.g. In 1997, the Thai
Baht came under massive international speculation and its eventual devaluation sparked the Asian
Financial Crisis. Many financial institutions had to call in loans and foreclose on collateral associated
with bad debts. Unemployment resulted as businesses close and recession follows. Even if the Central
Bank does not immediately depreciate the currency, the uncertainty due to the speculation would also
lead a drop in investment in the economy as firms are unsure of future prospects.
final systems,
For countries with freely floating goods and services imported
a persistent inflation
trade deficit will lead to a depreciation of thecost push
foreign exchange rate. Households will then face rising price of its imports which may further contribute
to lower material SOL. Firms will also face rising unit costs due to higher prices of imported inputs and
would pass on the higher costs to consumers through higher prices of goods and service. This will lead
to a fall in AS as illustrated by an upward shift of the horizontal AS curve leading to cost push inflation.
A persistent trade deficit could also dampen investors’ confidence, as they may fear that the deficit will
lead to further depreciation in the currency value. This would reduce their expected rate of return on
investments and lead to an outflow of foreign investments affecting the country’s actual and potential
economic growth.
27
A persistent trade balance deficit would be a cause for concern as it could result in lower material
standard of living for future generations.
When the spending on imported goods and services is higher than what is earned from the country’s
total exports, it means that households are currently enjoying a higher material living standard than that
which is provided by their income. This excess spending might need to be paid for by borrowing from
foreign lenders. This would mean that in future, not only will the debt have to be repaid, it will also incur
interest charges. Thus the future generation will face a lower standard of living as they would end up
having to sacrifice their future consumption to repay the debt and all interest. Moreover, if the deficit is
big and the country is not able to fulfil its external loan obligations, it can result in a debt crisis where
lenders stop lending or agree to continue to lend but at very high interest rates due to the high risk of
default by the borrower. This increases the country’s external debt burden and further lower further living
standards.
In addition, the trade deficit might be caused by excessive government spending on imports and this
spending might be greater than what it earns. This would result in a higher level of debt as a proportion
of GDP in the longer term and taxes would likely have to be raised to fund the debt repayment. Ceteris
paribus, Consumers will end up with lower disposable income and standard of living in the future.
Mark Scheme

L3 For a well-developed analytical answer that clearly explains 3 reasons why
a persistent trade deficit might be a concern for governments.
8 – 10
(Max 8 marks for 2 very well explained reasons)
L2 Answers that provide an incomplete or descriptive explanation of the

different macroeconomic impacts of a persistent trade deficit. 5–7
L1 For an answer that demonstrates some knowledge of a trade deficit and

implications for the economy. 1–4
28
Part (b)
Introduction
The trade balance is part of the current account in the balance of payments of a country. The trade
balance measures the net value of the exports and imports of goods. A worsening trade balance could
be a result of either a fall in the export revenue of domestically produced goods or an increase in import
expenditure on foreign goods. This could occur because of internal and/or external reasons
Body
One possible reason for a worsening trade deficit is a possible deterioration of the country’s
export competitiveness due to changes in comparative advantage.
A country’s goods might no longer be competitive due to quality or cost reasons. If the country’s
domestically produced goods are seen to be of a relatively lower quality or relatively higher priced
compared to foreign goods, local consumers will switch to buying the relatively better quality of cheaper
imported goods. This will result in a rise in demand for imports and import expenditure. On the other
hand, foreigners will also buy less of the domestically produced goods resulting in a fall in demand for
the country’s exports and export revenue. The fall in export revenue and rise in import expenditure will
lead to a worsening of a country’s trade balance. For example, the expansion of labour intensive
manufacturing industries in lower-cost countries which export their relatively cheaper products to
developed countries like the US, has resulted in the US firms not being able to compete with them. This
has led to a fall in demand for US products both from locals and foreigners contributing to a worsening
trade balance.
Loss of comparative advantage tends to be more relevant for developed countries as they will likely
losing their export competitiveness in labour intensive industries to developing countries with an
abundance of labour. The extent that trade balance worsens will also depend on the country’s
dependence on external trade. For smaller countries like Singapore that have a small domestic market,
a fall in its export competitiveness will lead to a substantial worsening of the trade balance.
A stronger foreign exchange rate might be another reason for a worsening trade balance
An appreciation of the domestic currency of a country against other foreign currencies means that
foreigners would be required to exchange more units of their currencies for the domestic currency to
buy the same quantity of goods. This will cause the price of her exports in terms of foreign currency to
rise and price of imports in terms of domestic currency to fall. Therefore, foreigners will buy less of the
country’s exports, causing the demand for exports to fall. This means that with a lower quantity of exports
and the price of exports in domestic currency unchanged, export revenue will fall.
Since residents now find imported goods relatively cheaper in terms of domestic currency, quantity
demanded for imports will rise. Assuming |PED for M| >1 as there are many close substitutes, import
expenditure will rise as the fall in expenditure from the lower price of imports will be more than offset by
the rise in expenditure from the more than proportionate rise in quantity demanded of imports. Given
that import expenditure exceeds export revenue, it will result in a trade deficit.
29
This cause would be more applicable for a country on a freely floating ER system like the United States.
For countries such as China that are on a managed or fixed ER system, the central bank would usually
step in if the appreciation of the currency falls outside the band that has been set. Small countries that
lack factor endowments might also suffer less as the need for foreign imports will mean that that the
demand for imports will likely be price inelastic so that stronger currency might lead to a fall in M
expenditure.
Strong economic growth in the economy may also cause a worsening of the balance of trade
Strengthening of the domestic economic environment can cause a country’s trade balance to worsen.
When there is domestic economic growth, there will be a rise in national income, ceteris paribus and
this will lead to higher purchasing power, increasing the ability of consumers to purchase more goods
and services including imported ones. With a rise in demand for imports, import expenditure will rise. If
the import expenditure exceeds the export revenue, this will result in a trade deficit and if the trade
balance is a major component of the current account balance, there will be a CA deficit, ceteris paribus.
This reason is more likely to apply to countries with a larger population as the increase in income will
mean a significantly large increase in the total import expenditure compared to smaller countries where
the smaller population limits the increase in M spending. In addition, for countries that impose
protectionist measures on imports, even with an increase in national income, the consumers might face
difficulties in importing foreign goods and this will result in a negligible increase in import expenditure.
Conclusion
There are many reasons why the balance of trade of a country will worsen but the most significant
reason for different countries will depend on various factors including the nature and state of the
economy and the E/R system among others. For example, how reliant a country is on the external sector
can determine whether internal or external causes are more likely to cause the worsening trade balance.
For small countries lacking factor endowments, the impact of a global recession would significantly
cause a sharp decrease in export revenue while only resulting in a minimal drop in import expenditure
compared to bigger countries that have a larger domestic market and production base.
Mark Scheme

L3 A well-developed economic analysis of at least 3 possible causes of a 8 – 10
worsening trade balance.
L2 Incomplete explanation of the different causes of a worsening trade balance. 5–7
L1 For an answer which shows some knowledge of the causes of a worsening 1–4
trade balance
E3 Provides clear economic analysis of the importance of different causes of a 4–5
worsening balance of trade for different countries.
E2 Some attempt to substantiate why causes of a worsening trade balance are 2–3
different for different countries.
E1 Makes a stand on the possible causes of a worsening trade balance for 1
different countries.
30
QUESTION 6
Even as Singapore faces challenges that are both external and internal, Trade and Industry Minister
Chan Chun Sing said there are also significant opportunities and strategies that have been mapped out
to ensure the country’s future success.
Source: Channel NewsAsia, 25 October 2018
(a) Explain how challenges in the global environment can lead to macroeconomic problems for
Singapore, given the nature of her economy. [10]
(b) Assess appropriate policies that Singapore can adopt to overcome these macroeconomic problems.
[15]
Part (a)
Introduction
Given Singapore’s small and open nature, its economy is highly dependent on trade as a source of
economic growth and employment. Furthermore, given the lack of factor endowment, Singapore imports
a substantial amount of factor input as well, leading to a higher susceptibility for imported inflation. Some
challenges the global environment is facing now are the reversal of the globalisation trend and
increasing oil prices.
Body
The reversal of globalisation can slow Singapore economic growth and increase its level of
unemployment.
A reversal of the globalisation signifies the slowing of global trade as economies around the world,
including Singapore's trade partners focusing more on developing their domestic industries and trade.
Hence, this reduces the flow of trade in the global economy. This causes a fall in export revenue (X)
which is one of the AD components. The autonomous decrease in AD will cause a leftward shift in the
AD curve. There will be an unplanned rise in inventories. Firms decrease production and hire fewer
factors of production (FOP), such as labour. As a result, household's income will decrease inducing
lower consumption of other domestic goods and services, leading to further decreases in firms’ output,
resulting in a fall in national income (from Y1 to Y2). Thus, there will be negative economic growth and
rise in demand-deficient unemployment within the Singapore economy. Given the high dependence of
Singapore's economy on external trade, this fall in AD and resultant fall in NY will be significant.
Alternative points: Slowing global growth, Reduction of FDI as countries encourage firms to stay local
31
Another global challenge is rising oil prices and the consequent rise in energy cost, leading to
higher inflation rates in Singapore.
When the global prices of oil are rising, there is an increase in the cost of importing oil, which is a key
factor input for generating energy, fueling transportation, and production of goods. Hence, increase in
the global price of oil will cause an increase in the unit cost of production leading to a fall in AS as shown
by an upward shift of the horizontal AS curve from AS1 to AS2. The rise in unit COP is passed on as
higher prices to consumers, leading to cost-push inflation with the GPL rising from P1 to P2. The limited
factor endowment of Singapore’s economy causes Singapore to be highly dependent on imported
energy. Hence, we can expect this rise in UCOP and its resultant GPL to be significant.
Mark Scheme

L3 For an analytical answer that considered the small and open nature of
Singapore’s economy and how at least 2 global challenges will lead to
8 – 10
macroeconomic problems.
L2 A descriptive explanation of how global challenges will lead to macroeconomic

problems.
5–7
Answer may have considered the nature of Singapore’s economy to a limited
extent.
L1 Knowledge of the current global challenges and Singapore’s economy.

Statements are mostly unexplained. 1–4
32
Part (b)
Introduction
In view of the increasingly challenging global environment, Singapore is facing economic challenges
and problems that are unseen since the Global Financial Crisis and the Asian Financial Crisis. To
address these challenges, Singapore will need to resort to policies that are unique to the Singapore
situation given the small and open nature of its economy as established above. These policies range
from pursuing a gradual appreciation of the Sing Dollar, improving Singapore trade competitiveness
through skills improvement and product offerings.
Body
Exchange rate policy is appropriate to address the rising cost-push inflation in Singapore.
Singapore is dependent on imported raw materials due to a lack of natural resources available
domestically, making it likely to suffer from imported inflation such as due to the rising cost of imported
oil. To curb imported inflation, the Monetary Authority of Singapore maintains a long-term gradual and
modest appreciation of SGD. An appreciation will cause a fall in the price of imported factor inputs in
SGD terms and since most firms in Singapore rely on imported inputs, this will reduce the unit cost of
production of goods and services, thereby leading to a rise in AS. This is seen as a downwards shift in
AS curve from AS0 to AS1, leading to a fall in GPL from P0 to P1, thus reducing cost-push inflationary
pressure.
However, this might make Singapore's export relative more expensive in foreign currencies. This will, in
turn, reduce the demand for Singapore's export and a corresponding fall in export revenue. Hence, this
will further worsen the slowdown in economic growth from the slowing trade.
33
Singapore can use supply-side policies to improve its competitiveness in the global economy to
boost economic growth
Through the promotion of Research and Development (R&D), Singapore will be able to improve on its
product offerings and methods of production. This can be seen from the S$20 billion allocated by the
government to support areas such as health and biomedical sciences, climate changes and artificial
intelligence in the recent 2020 Budget. Through these innovations, Singapore's exports might be
deemed to be of higher quality relative to trade partners. Furthermore, with improvements to methods
of production and assuming that these innovations trickle down to various industries, Singapore's export
will be relatively cheaper to produce, making it more price-competitive in the global economy. Both these
effects will lead to a rise in export revenue for Singapore.
Supply-side policies such as the reduction in business regulations can help attract foreign firms to
establish their regional headquarters or node of production in Singapore. This can then lead to a rise in
Foreign Direct Investment (FDI) and a rise in Investment expenditure (I).
This rise in X and I will result in a rise in AD and cause AD to shift from AD1 to AD2. The rise in AD leads
to an unplanned fall in inventories, as planned expenditure exceeds actual output. This will lead to firms
increasing production and hiring more factors of production, such as labour, which leads to the multiplier
process. Coupled with potential growth driven by investments, the economy can enjoy sustained
economic growth as shown by the increase in real GDP from Y1 to Y2.
The rise in I would also lead to an increase in the quantity of capital stock, assuming the rate of
accumulation of capital exceeds the rate of depreciation. This increase in the quantity of capital available
increases the productive capacity of the economy, leading to a rise in AS as shown by a rightward shift
of the AS curve from AS1 to AS2
AD2
AD1
However, supply-side policies will take a long time to come into effect; especially for processes like R&D
where innovations will take time to bear fruits. Furthermore, the success of these policies might not be
certain.
34
The Singapore government can also consider using fiscal policies to address the challenge of
slowing economic growth
A more direct method for the government to arrest the slowing economic growth is to increase fiscal
spending while lowering taxes. By lowing income tax, households will experience an increase in their
disposable income, allowing them to increase their consumption expenditure (C). At the same time,
lowering corporate taxes will increase the expected rate of returns for firms' investments. Assuming that
the marginal cost of investment remains constant, firms will increase their investment expenditure (I).
Also, the Singapore government can increase its expenditure (G) such as the construction of the new
Thomson-Downtown Line.
Together, Singapore’s AD is expected to rise, leading to economic growth through the multiplier process
as explained above.
However, given that Singapore is highly dependent on external demand and trade as a source of
economic growth, an expansionary fiscal policy will have limited impact as the domestic sector only
takes up a small proportion of the Singapore economy. Rather, the fiscal policies used can take on a
supply-side slant where it seeks to boost Singapore’s infrastructure and connectivity while maintaining
its competitiveness to attract FDI.
Conclusion
The unique nature of Singapore's economy necessitates more outward-looking policies.
This is especially so given the fast-changing global economy and the increase in competition from
neighbouring countries. Hence, Singapore needs to maintain its competitive edge in the global economy.
While its effects will be limited to drive economic growth, domestic-focused policies such as fiscal
policies will still have a place in the set of policies that the government can employ. Fiscal policies can
be seen as more of a stopgap measure to temporarily boost Singapore growth, especially in the current
global pandemic induced recession.
However, a key thrust of the government to meet the challenges will be to ensure the relevance of the
Singapore labour force to the needs of the global economy. This will be increasingly important giving
the shifting nature of the global economy towards a more insular and exclusive nature.
The following are possible alternative policies that use Common Last Topic knowledge:
In addressing the reversal of globalisation, Singapore can continue to pursue free trade
agreements and attract foreign investments as drivers of growth.
The government can actively sign free trade agreements (FTAs) with other countries. By signing FTAs,
barriers to trade are eliminated or reduced, which facilitates the cross-border movement of goods and
services. For example, Singapore has FTAs signed with the European Union, ASEAN, China, and the
35
US. This will allow small economies to gain access to larger external markets, hence increasing export
revenue (X).
Singapore makes use of trade agreements to diversify import sources, to mitigate the risk of
imported inflation
Given Singapore's reliance on imports for many key inputs and goods, having only limited sources of
imports would run a higher risk of supply disruptions leading to inflation. Hence, the Singapore
government pursues and an extensive network of import sources to diversify, through the signing of
trade agreements. This is particularly so for food imports, where for example, chicken is imported not
only from Malaysia, but also from Brazil, the US, and Argentina. In doing so, should supply from any
one country face disruption, the impact on Singapore's food price inflation would not be as severe.
Mark Scheme

A well-developed analysis of at least 2 policies that the Singapore
L3 government can implement to tackle the identified challenges. 8 – 10
An underdeveloped explanation and/or descriptive explanation of the

policies Singapore can use to address the challenges.
L2 5–7
Cap at L2 - For an answer that does not consider the macroeconomic
problems as explained in part (a)
For an answer which shows some knowledge of the policies.

L1 1–4
Answer that has basic theoretical errors.
Makes a stand as to which policy is appropriate at tackling the problems

associated with the challenges. Substantiation includes consideration of the
various strengths and limitations of the different policies in tackling the
problems.
E3 4–5
Considers the relative appropriateness of the policies applicable to the
Singapore context.
Some attempts to substantiate the appropriateness of the policies

E2 2–3
Makes a stand with no further substantiation on the appropriateness of the
E1 policies to address the challenges. 1
36

VJC P2 Answers QN 5 For Jenson

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VICTORIA JUNIOR COLLEGE

JC 2 PRELIMINARY EXAMINATIONS 2020

Source: Singapore Tourism Board, 13 February 2019

Rational decision-making for a tourist

Rational decision-making for a firm

Level Descriptors Marks

2 Underdeveloped explanation of the marginalist principle to both tourists 5-7

Market for entertainment

A rise in expenditure by tourists on entertainment can be attributed to a rise in demand.

Market for accommodation

A fall in expenditure by tourists on accommodation can be attributed to a rise in supply and a

Level Descriptors Marks

2 Underdeveloped explanation of the changes in expenditure in the market 5-7

E3 Well-substantiated judgement on the relevant importance of the demand 4-5

E2 Judgement with some substantiation on the relevant importance of the 2-3

E1 Unsubstantiated judgement on the relevant importance of the demand and 1

Fig 2: Differences in internal EOS reaped

Level Descriptor Marks

L2 For an underdeveloped essay that 5–7

L1 For a demonstration of relevant knowledge that 1–4

The government can regulate pricing of the mobile services.

Fig. 3: Regulatory pricing

Fig 3: Regulatory pricing qty / t

The government can also deregulate the telecommunications market.

Level Descriptor Marks

L2 An underdeveloped two-sided discussion on the impact of the government 5–7

E2 Some attempts at substantiation of a stand on whether government intervention 2–3

E1 Unsubstantiated judgement on whether government intervention is desirable to 1

Body: Explain case of public goods

Body: Explain case of consumer ignorance

Consumer ignorance leads to consumers over-valuing or under-valuing the benefits of consuming a

SS= MPC = MSC

On the other hand, using healthcare as a case of under-consumption, consumption of healthcare

Level Descriptors Marks

L1 Knowledge of how public goods or consumer ignorance lead to market

Consideration 1: Root cause of problem

Consideration 2: Availability of government finances

Consideration 3: Extent of market failure

Consideration 4: Effect of intervention on efficiency

The government may consider the effect of its intervention on efficiency

Consideration 5: Nature of good

Overall Evaluation / Synthesis

Level Descriptors Marks

Answer attempts to explain the factors a government would consider in

For an answer which shows some knowledge of policies pursued by

Response ranks factors a government would consider and is well explained.

Makes a stand on importance of factors with no further substantiation of why

Level Descriptors Marks

A well-developed and two-sided analysis of whether minimum wage is the most 15 - 17

L2 A one-sided explanation of whether minimum wage is the most appropriate policy 12 - 14

A one-sided explanation of whether minimum wage is the most appropriate policy 9 – 11

E1 Makes a stand with no further substantiation on whether minimum wage is the 1

In 2018, the US trade deficit widened to a 10-year high of US$621 billion.

Level Descriptors Marks

L2 Answers that provide an incomplete or descriptive explanation of the

L1 For an answer that demonstrates some knowledge of a trade deficit and

Level Descriptors Marks

Source: Channel NewsAsia, 25 October 2018

Level Descriptors Marks

L2 A descriptive explanation of how global challenges will lead to macroeconomic

L1 Knowledge of the current global challenges and Singapore’s economy.

The unique nature of Singapore's economy necessitates more outward-looking policies.

Level Descriptors Marks