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Anderson Junior College JC2 H2 Economics Paper 2 Preliminary Exam 2009 Suggested Answers Question 1 1 Certificate of Entitlement (COE) supply for the fiscal year starting April 2009 will be cut by 24 per cent. A smaller COE quota will mean that overall sales of cars will be affected across the board since the supply of new cars will be restricted by a smaller quotaOn the other hand, SMRT has decided to reduce bus and train fares and to increase number of train trips given the severe economic crisis... Adapted from the Straits Times, Feb 2009 (a) Using a diagram, explain how the recession and fall in the supply of COEs will affect the market for new cars. [10] Discuss the relative significance of price elasticity of demand and cross elasticity of demand in explaining the decisions made by the public transport operator SMRT. [15]

(b)

Suggested answer for part (a) Demand side effect: Recession fall in income => fall in dd for brand new cars Dd for brand new cars is income elastic (seen as luxury good as compared to public transport or second-hand cars) = > fall in dd by significant extent Supply side effect: Fall in supply of COEs => ss of new cars Combined effect of dd and ss => Q dd of new cars but effect of price depends on extent of fall of dd and ss (use elasticity or relative extent of fall in dd/ss) Extent of dd likely to be more than ss due to fall in public transport fares likely P of new cars (accept alternative conclusions if well justified) Knowledge, Application, Understanding and Analysis For an answer that uses demand-supply analysis to explain how recession causes demand to fall, and fall in COE supply causes supply to fall, and explains combined effect on Q & P. For top L3, the combined effect on Q & P must be well justified. For an answer that shows an understanding/application of how recession causes demand to fall, and fall in COE supply causes supply to fall. Attempts to explain the impact on price and quantity. For an answer that shows a descriptive knowledge of demand and supply of cars. And/or an unexplained diagram.

L3

8-10

L2

5-7

L1

1-4

Suggested answer for part (b) Define PED & XED Relevance of PED in explaining decision taken by SMRT: o DD for bus/train rides provided by SMRT may be price elastic due to the presence of other substitutes such as bus/train rides provided by private bus companies or rival company (SBS) or taxi rides.

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o As such, lower fares can result in a more than proportionate increase in Qd (explanation + diagram) PED is relevant in explaining why SMRT has decided to lower fares. Fulfils profit maximization objective higher revenue

o o OR o DD for bus/train rides provided by SMRT may be price inelastic => seen as necessity to most Singaporeans o As such, lower fares can result in a less than proportionate increase in Qd lower revenue (explanation + diagram) o PED does not seem relevant in explaining why SMRT has decided to lower fares. o Decision taken could be motivated by other objectives (welfare for the people in times of recession) Relevance of XED in explaining decision taken by SMRT: o From (a): either increase in decrease in price of new cars o Drop in price of new cars fall in dd for public transport SMRT should decrease output therefore not relevant OR o Increase in price of new cars increase in dd for public transport SMRT increase output (relevant) o In view of the current economic crisis, many consumers may view public transport and private transport as close substitutes. Furthermore, many consumers are likely to switch from private transport/taxi rides to bus/train rides. o With high positive XED value, a reduction of bus/train fares will bring about a significant fall in demand for private transport or taxi rides. This can help SMRT to attract more customers. o Therefore, XED helps to identify close substitutes - P of substitutes (SBS) => need to respond accordingly Limitations of PED and XED (criticise the accuracy of estimates, ceteris paribus condition etc) Evaluation o Judgement on the relative significance of price elasticity of demand and cross elasticity of demand in explaining the decision taken by SMRT o Other factors need to be taken into consideration e.g. pressure by government to reduce prices given current economic crisis welfare perspective o YED could be more relevant in explaining output decision Knowledge, Application, Understanding and Analysis For an answer that uses analysis to underpin the discussion of relative significance of price elasticity of demand and cross elasticity of demand to the public transport operator SMRT. A balanced analysis considering both sides (relevance and limitations) is required for this level. For an answer that attempts to apply price elasticity of demand and cross elasticity of demand to the public transport operator SMRT. And/or considers only relevance but not limitations (max of 6m if analysis is one-sided). For an answer that shows knowledge of price elasticity of demand and cross elasticity of demand. Does not apply to the public transport operator SMRT. Some inaccuracies. Allow up to 4 additional marks for Evaluation For an evaluative judgement on the price and output decision taken by SMRT. For an unexplained judgement or one that is not supported by analysis.

L3

9-11

L2

6-8

L1

1-5

E2 E1

3-4 1-2

## Anderson Junior College 2009

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Question 2 2 Sim Lim Square is a six-storey shopping centre in Singapore where tourists can find over 300 small shops selling electronic items such as computers and cameras. (a) Explain how a shop retailing electronics in Sim Lim Square can determine its price and output to maximise profit, and consider whether a perfectly competitive firm determines its price in a similar way. [10] To what extent does the market structure in which electronics retail shops operate in explain how all firms in Singapore compete? [15]

(b)

Suggested answer for part (a) A shop in Sim Lim Square is a monopolistic competitive firm facing a downward sloping demand curve because it produces a differentiated product. Explain profit maximising condition MR=MC in order to determine price and output (consider output levels where MR>MC and MC>MR to show why MR=MC maximises profit) A perfectly competitive firm may also maximise profit with profit maximising condition MR=MC. However, because perfectly competitive firms are small firms selling an identical product in an industry with freedom of entry and exit, a large number of firms and perfect knowledge, they are price takers and cannot set price. So when perfectly competitive firms maximise profit, they take the price from market demand and supply. Knowledge, Application, Understanding and Analysis For an answer that uses analysis to explain how a monopolistic competitive electronics retailer maximises its profit, i.e. by setting its price and output where MR=MC, and distinguishes this behaviour from that of a perfect competitive firm. For an answer that shows an understanding/application of the marginalist concept to determine price & output under monopolistic competition. For an answer that shows a descriptive knowledge of either monopolistic competition and/or profit maximisation. And/or an unexplained diagram.

L3

8-10

L2 L1

5-7 1-4

Suggested answer for part (b) Electronics retail shops operate in monopolistic competition (over 300 small shops, with product differentiation, low entry barriers) Thesis: Monopolistic competition explains how many (not all) firms in Singapore compete Monopolistic competition is common: e.g. electronics / fashion retail, restaurants / hawker stalls / bakeries, bread / coffee / provision shops, travel agencies, hair salons / barbers These are characterised by low barriers to entry Competition: - Price: not the focus they try to differentiate (in theory: they operate independently, in practice: in close proximity they may compete by price)

## Anderson Junior College 2009

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Non-price: yes product differentiation by location, image, physical appearances, service, including advertising to create perceived differences

Antithesis: Oligopoly or monopoly is more appropriate for other markets Especially in markets where barriers to entry are high Oligopoly, e.g. petrol retail, telecommunication companies, supermarkets, taxis, cinemas, airlines Competition: influenced by mutual dependence - Price: unlikely kinked demand curve - Non-price: possible product differentiation by location, image, physical appearances, service; R&D Monopoly, e.g. water, electricity No competition: product is unique - Except where there is a threat of potential competitors (contestable market) Evaluation It depends on barriers to entry. While monopolistic competition is appropriate for some market structures where barriers to entry are low, in markets characterised by high barriers to entry, oligopoly or monopoly is more appropriate. Oligopolistic competition is more prevalent in Singapores small market, because a few small firms easily dominate the market. Firms may pursue alternative objectives to profit maximisation, and may not compete. For example, public sector firms may maximise social welfare instead. Knowledge, Application, Understanding and Analysis For an answer that uses analysis to underpin the discussion of whether monopolistic competitive behaviour explains real world price and non-price competition in Singapore. A balanced analysis considering both sides (Thesis and Antithesis) is required for this level. For an answer that applies monopolistic competitive behaviour to real world examples in Singapore. And/or considers only price or only non-price competition. And/or considers only Thesis or Antithesis (one-sided). For an answer that shows knowledge of how monopolistic competitive firms compete. Does not apply to Singapore. Allow up to 4 additional marks for Evaluation For an evaluative assessment based on economic analysis. For an unexplained assessment or one that is not supported by analysis.

L3

9-11

L2

6-8

L1

1-5

E2 E1

3-4 1-2

## Anderson Junior College 2009

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Question 3 3 Explain why the level of innovation in markets is likely to be less than desirable and discuss the view that innovation should therefore be solely carried out by the government. [25]

Suggested answer The process of undertaking innovation, or the end result of the innovation process (e.g. a product), often generates wider benefits (positive externalities). Reasons why market will under-provide innovation. (A diagram should be drawn to support explanation) Private firms will undertake too little innovation because of ignoring positive externality. Left to the market, projects that are unprofitable but would generate large social benefits (SMB>PMB), may not be taken forward e.g. research for vaccine Knowledge tends to be under-provided because it tends to have the qualities of a public good hard to exclude. It may be difficult or impossible for an individual or firm that invests in information creation to prevent others who do not pay for the information from using it e.g. the ideas in a product can be copied by a competitor. Non-excludability. Once discovered it can be, if desired, passed on to anyone without diminishing (non-rivalry in consumption). Imperfect and asymmetric information: due to information problems, small medium enterprises (SMEs) engaged in high-tech innovative projects with good prospects may find it difficult to obtain funding as potential lenders of funds are not certain of the value or commercial potential of a new idea/process.

Role of government Arguments for government being sole provider Direct provision government undertake innovation activity and produces Qs level of innovation. It has the financial resources to recruit researchers and set up research institutes or work with public universities. By making findings public and freely shared to private firms, it is absorbing the high fixed costs of finding that knowledge. Firms can freely use the knowledge in various ways to develop new goods and services. This way there will be no copyright issues and hence innovation will increase significantly.

Arguments against government being sole provider The private sector is arguably more informed than the government regarding what the market trends are and what consumers want/need and where the greatest profit potential lies in. Thus the private sector should take the leading role in the determining the kind of research and innovative activity to take.

Other policies The government can extend the patent period covering innovation. The lengthening of this temporary monopoly power will spur more firms to undertake innovation as the duration of potential supernormal profits will lengthen. However, patents can be ineffective in promoting research/innovation if the market for the innovation is too small (revenue too low to recoup the costs of research) The government should encourage/support business innovation by subsidising the research and development or offering tax credits e.g. R and D tax credits. However the size of marginal external benefit may be hard to identify.

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Besides grants/subsidies, the government should also make it easy for entrepreneurs/firms to obtain finance. Financial supports should be available not only to large firms but also small and medium-size businesses who usually are more disadvantaged in finding funds from banks/venture capitalists. However, the extent of help may be limited by available funds or if the procedure to obtain funds is a cumbersome process. There could also be possibility of crowding out effect if government tries to finance through borrowing.

Evaluation There is a role certainly for the government to play but not as sole provider as the private sector may be more efficient at identifying commercial opportunities. Government failure possible if costs of government spending exceed the benefits derived from government intervention Innovation policy is not only about funding the correct quantity of innovation however desirable that may seem to be. It is also about funding the correct type of innovation that promises the most likely potential and which the country is capable of exploiting given its own capabilities.

L3

L2 L1

Knowledge, Application, Understanding and Analysis For an answer that uses an appropriate framework to underpin the analysis of why market failure is likely to occur in the provision of innovation/R and D and a balanced discussion of the role of the government. The framework diagram for SMC=PMC+EMC used should be illustrated for positive externality. For an answer that gives an explanation of the policies adopted by a government and how market failure is overcome with regards to the provision of innovation. For an answer that shows a descriptive knowledge of what is meant by innovation and/or gives a list of the potential policies that government could adopt Allow up to 4 additional marks for Evaluation For a discussion justifying the conclusions drawn - this could be one evaluative comment done well. For an unexplained evaluative statement(s) without explanation.

15-21

9-14 1-8

E2 E1

3-4 1-2

## Anderson Junior College 2009

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Question 4 4 (a) (b) Explain the conditions for equilibrium in the circular flow of national income. [10] Discuss how an increase in import expenditure may affect the standard of living of a country. [15]

Suggested answer for part (a) Define equilibrium: National income is said to be in equilibrium when there is no inherent tendency for it to change. It is when the plans of all economic agents in the economy are fulfilled and consistent with each other. Briefly describe the circular flow define injections and withdrawals Equilibrium achieved when injections = withdrawals and when Y = AE Use of Y=AE diagram to show equilibrium, including: o when Y>Ye unplanned inventory accumulation decrease output o when Y<Ye unplanned inventory depletion increase output Link to circular flow o any injections (I, G or X) or withdrawals (S, T, M) will change AE and hence the equilibrium level of national income o Equilibrium is reached when initial amount of injections is leaked away as withdrawals

L3 L2 L1

Knowledge, Application, Understanding and Analysis For an answer that has a good elaboration of equilibrium with well-labelled diagram. For an answer that shows an understanding/application of the equilibrium in circular flow of income with relevant diagram. For an answer that shows a descriptive knowledge of equilibrium and circular flow.

## 8-10 5-7 1-4

Suggested answer for part (b) Define standard of living: material and non-material SOL Thesis: Increase in M will lower SOL o Material SOL M AD/AE falls lower NY less goods and services available for consumption lower material SOL o Non-material SOL Lower NY less tax revenue less funding for government expenditure may lead to lower non-material SOL Anti-thesis: Increase in M will improve SOL OR Increase in M may not affect SOL o Material SOL M may also indicate wider choice of goods available for consumption M more imported capital goods higher productivity lead to higher NY in the future o Non-material SOL M transfer of green technology from more advanced countries less pollution M consumers may substitute domestically produced goods with imported goods lower domestic production less negative externalities and more leisure time higher non-material SOL

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Need to consider other factors that will affect SOL Quality of life may not have changed by much given M Evaluation o Extent of how SOL is affected depends on other factors in circular flow o Extent of how SOL is affected depends on composition of import expenditure: different types of imported goods will have different effects of SOL o May need to supplement with more comprehensive indicators e.g. HDI, PQLI, MEW

L3 L2 L1

Knowledge, Application, Understanding and Analysis For an answer that uses analysis to discuss how SOL is affected (consider both material and non-material) For an answer that explains how SOL is affected. Inadequate elaboration. For an answer that shows knowledge of the link between import expenditure and SOL. Answer fails to address both material and non-material SOL. Allow up to 4 additional marks for Evaluation For an evaluative judgement For an unexplained judgement or one that is not supported by analysis.

E2 E1

3-4 1-2

## Anderson Junior College 2009

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Question 5 5 In light of the current worldwide recession, some countries have allowed their exchange rates to depreciate. (a) Explain how macroeconomic problems might result from a depreciation of Singapores [8] exchange rate. Using the concepts of income elasticity of demand and the multiplier, assess whether Singapore is among economies that have most to lose in the current worldwide recession. [17]

(b)

Suggested answer for part (a) Introduction: Define depreciation 1) Depreciation of the S\$ conflicts with internal goals Weakening of the S\$ reduce investor confidence and imported capital goods are now more expensive. This results in fall in FDI AD NY. In the short run, Marshall Lerner condition may not hold, the depreciation might lead to a fall in (x-m). Increase in the domestic price of import meaning higher price of imported raw materials. Higher COP leads to a fall in AS causing imported inflation. This also reduces Singapores export competitiveness. Impact is significant given Singapores exports has high import content. 2) Depreciation of the Sing \$ conflicts with external goals Worsening of capital account and current account may worsen given a fall in FDI and net exports worsening of BOP Conclusion: In conclusion, a depreciation of Singapores exchange rate is likely to have an adverse impact on the Singapore economy which depends heavily on external factors such as FDI and net exports for growth. Knowledge, Application, Understanding and Analysis Clear, detailed explanation on how the weakening of the S\$ may conflict with the macroeconomics goals in with good references to Singapores context and able to consider the conflict in terms of internal and external goals Some attempt to explain how the weakening of the S\$ may conflict with the macroeconomics goals with some references to Singapore. Higher L2 requires more references to Singapore or able to consider the conflict in terms of internal and external goals Briefly mention how the weakening of the S\$ may conflict with the macroeconomics goals

L3

7-8

L2

4-6

L1

1-3

Suggested answer for part (b) Introduction: Define income elasticity of demand, multiplier. Explain impact on worldwide recession on the small and open Singapore economy.

## Anderson Junior College 2009

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Thesis: Singapore is among the economies that have more to lose Singapore: YED E.g. Singapore has CA in the production of high-end manufactured goods and invisible exports such as tourism that are normal goods and the demand is income elastic (explain) Demand for Singapores imports is income inelastic. E.g. Basic necessities. A fall in income would lead to a less than proportionate fall in demand for Singapores imports. Therefore, in X greater than the in M leading to a significant fall in (x-m). On the other hand, other economies: For developing countries such as China, Vietnam, Thailand, Brazil etc which produces agricultural products and demand for such goods are income inelastic (elaborate), hence less to lose in terms of (X-M) Multiplier Small multiplier effect might mean demand management policies to reduce the impact of worldwide recession is less effective compared to other economies with large K.

Antithesis: Singapore among economies may not lose the most Singapore: Multiplier Singapore has a small multiplier (reversal of the multiplier effect on NY is low) Briefly explain the reversal multiplier process. Explain why Singapores K is small. However, other main exports such as Biomedical services and petrochemical products are YED income inelastic in demand (explain). Singapore might gain as a fall in AD reduce inflation, lower and more stable prices may Gain enhance Singapores export competitiveness Conclusion: Whether Singapore is among economies that loses the most depends on the countries in comparison developing vs developed countries openness of an economy nature of the exports and imports Knowledge, Application, Understanding and Analysis Able to use the concepts to analyse in detail why Singapore as compared to the other economies may or may not lose more, the balanced answer is well developed. A balanced answer that is able to use the concepts to explain why Singapore as compared to the other economies may or may not lose more, however this balanced answer is undeveloped. Answer shows some knowledge of YED and multiplier to explain why Singapore suffer from the worldwide recession. Answers either presented one sided argument or lack comparison with other economies. Some valid points made. Allow up to 4 additional marks for Evaluation Judgement based on the analysis and substantiated. Mainly unexplained statement.

L3 L2

10-13 6-9

L1

1-5

E2 E1

3-4 1-2

## Anderson Junior College 2009

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Question 6 6 In view of globalisation, discuss the appropriate policies that the Singapore government should use to achieve its internal macroeconomic aims. [25]

Define globalisation Increasing integration of the international economy Characterised by greater global interdependence Implications of globalisation free-er labour mobility higher trade volume due to specialisation & trade higher FDI increased competition from L-abundant economies Reference to Singapores context and how its internal aims are being affected Sustained economic growth - mainly X-led and dependant on FDI Price taker in the world economy increase vulnerability to external shocks esp. susceptible to imported cost push inflation if there is rise in price of imported raw materials More volatile global economy leading to o increased threats and opportunities from emerging economies constant restructuring of the economy will lead to structural unN o recent economic recession Singapore is one of the first Asian economies to undergo recession DD-deficient unN Appropriate policies to achieve its internal macro-economic objectives Sustained economic growth Maintain export competitiveness Exchange rate policy gradual appreciation will lower cost of production for exports with high import content Supply side policies subsidise on R&D to improve on the non-price competitiveness of our exports Trade policies signing of FTAs lower tariffs higher export sales growth of X-oriented industries meet the higher increase in AD by increasing production and create employment attract and maintain FDI Fiscal policy lowering of corporate tax continue to encourage local and foreign investments increase I higher AD in SR and increase AS in LR Flexible wage system to keep labour costs low limitations of policies Price Stability solve imported cost push inflation Exchange rate policy gradual appreciation to prevent cost escalation of imported raw materials as well as final goods and services Prices and income policies - cushion the impact of rising import prices but its only temporary Supply-side policy to improve productivity limitations of policies Low Unemployment solve structural unemployment

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Supply-side policy retraining of workers allow for better match of skills and jobs available while speeding up its restructuring of the economy solve demand- deficient unemployment Expansionary demand management policies to increase AD limitations of policies Conclusion/Evaluation Need to constantly review current policies to ride on waves of globalisation Possibility of Singapore losing its CA in future?

L3

Knowledge, Application, Understanding and Analysis A thorough and well balanced answer with clear, detailed explanation to propose appropriate policies with limitations to solve the negative impacts and enhance the positive impacts brought about by globalisation An answer that gives a descriptive understanding of the impact of globalisation and its appropriate policies Policies are under-developed and/or Impact analysed are of limited scope Limited application to Singapore context For an answer that shows descriptive knowledge of what is meant by globalisation and gives a list of some impact of Globalisation or Brief description of some policies to address the impacts of globalisation

15-21

L2

9-14

L1

1-8

E2 E1

Allow up to 4 additional marks for Evaluation Judgement based on the analysis and substantiated. Mainly unexplained judgement.

3-4 1-2

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