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Question 1
(a)(i) Define the term budget deficit indicated in bold in the text (paragraph 2). [2]
(a)(ii) Define the term gross domestic product (GDP) indicated in bold in the text
(paragraph 3). [2]
(b) Using an exchange rate diagram, explain how raising interest rates would “stop
the fall in the peso’s value” (paragraph 4). [4]
(c) Using an AD/AS diagram, explain how the peso’s weakness is “raising inflation”
(paragraph 6). [4]
(d) Using information from the text/data and your knowledge of economics, discuss
the view that Argentina should keep its floating exchange rate system. [8]
Question 2
(a)(i) Define the term tariff indicated in bold in the text (paragraph 2). [2]
(a)(ii) Define the term trade war indicated in bold in the text (paragraph 3). [2]
(c) Using an AD/AS diagram, explain the desired impact of China’s eased monetary
policy” on its economic growth (paragraph 5). [4]
(d) Using information from the text/data and your knowledge of economics, discuss
the arguments for and against the trade protection measures imposed by the US on
China. [8]
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Model Essays – November 2020
Question 3
(a)(i) State two functions of the International Monetary Fund (IMF) (paragraph 2). [2]
(a)(ii) Define the term human capital indicated in bold in the text (paragraph 5) [2]
(b) Using a poverty cycle diagram, explain how the government of Pakistan could
intervene to “break out of the poverty cycle” (paragraph 3). [4]
(c) Using an externalities diagram, explain how “greater access to education” for
girls in Pakistan could reduce market failure (paragraph 5). [4]
(d) Using information from the text/data and your knowledge of economics,
evaluate the potential impact of the IMF and World Bank on economic development
in Pakistan. [8]
Question 4
(a)(i) State two functions of the World Trade Organization (WTO) (paragraph 1). [2]
(a)(ii) Define the term inflation indicated in bold in the text (paragraph 2). [2]
(b) Using a Lorenz curve diagram, explain the possible impact on the distribution of
income in the Philippines when “the income tax for the highest income earners has
been raised from 30% to 35%” (paragraph 4). [4]
(c) Using an AD/AS diagram, explain the impact on the potential output of the
Philippines of the government increasing its “spending on new airports, roads and
bridges”. [4]
(d) Using information from the text/data and your knowledge of economies,
evaluate the use of export promotion as a means of achieving economic
development in the Philippines. [8]
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Model Essays – November 2020
Question 1
(a)(i) Define the term budget deficit indicated in bold in the text (paragraph 2). [2]
(a)(ii) Define the term gross domestic product (GDP) indicated in bold in the text
(paragraph 3). [2]
GDP is the total monetary value of the final goods and services produced in a given
economy in a given time period.
(b) Using an exchange rate diagram, explain how raising interest rates would
“stop the fall in the peso’s value” (paragraph 4). [4]
Rising interest rates will attract short term capital inflows from foreign investors who
wish to save in Argentinian banks to earn a higher rate of interest returns on their
savings. This would increase the demand for the Argentinian peso as foreign
investors would require Pesos to save in Argentinian banks, leading to an
appreciation of the currency and “stop the fall in the peso’s value”. This is shown in
the diagram below.
A rise in demand for the Argentinian Peso from DPeso to DPeso’ will lead to an
appreciation of the currency due to the shortage of the currency at the old exchange
rate P0. Buyers of the Peso would have to bid up the price of the currency in order to
obtain scarce Pesos, causing the appreciation from P0 to P1.
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(c) Using an AD/AS diagram, explain how the peso’s weakness is “raising inflation”
(paragraph 6). [4]
From Paragraph 6, it is said that the peso’s weakness “causes imported oil prices to
go up”. This is because a weak currency leads to higher cost imported raw materials
in terms of the domestic currency, since it would cost more Pesos to buy imported oil.
This raises the aggregate cost of production in the economy, leading to a fall in the
short run aggregate supply (SRAS) as firms are less willing to produce goods and
services on aggregate due to lower profitability. This would lead to cost push inflation
as shown in the diagram below.
Due to the rise in imported cost of oil, firms will demand higher prices to produce
goods and services in order to maintain profit margins, leading to a leftward shift in
the SRAS from SRAS0 to SRAS1, leading to cost push inflation as general price levels
(GPL) rise from GPL0 to GPL1.
(d) Using information from the text/data and your knowledge of economics,
discuss the view that Argentina should keep its floating exchange rate system. [8]
A floating exchange rate system is one where the value of the country’s currency
relative to another is determined purely by forces of market demand and supply.
Argentina’s decision to keep or change its exchange rate system depends on the
pros and cons of the floating exchange system and the impact on its economy.
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Firstly, a floating exchange rate system allows Argentina to automatically reduce its
current account deficit. From paragraph 3, the current account deficit is said to have
narrowed from about 5% of GDP as the peso was allowed to float freely. A
depreciation of the peso would make domestic exports cheaper in foreign currency
while imports more expensive in domestic currency, leading to an increase in export
demand and export revenues while import expenditure declines, improving the
current account deficit. Countries with a floating exchange rate system could thus
benefit from an automatic correction of its current account deficit without Central
Bank intervention. Allowing the Peso to depreciate under a floating exchange rate
system is also likely to avoid the overvaluation of the currency in 2015 that brought
about the current account deficit in the first place.
Secondly, Argentina could benefit from greater flexibility to pursue monetary policies
under a floating exchange rate system. Countries with fixed or managed-float
exchange rate systems could be forced to use monetary policies to maintain the
value of their currency, making it impossible to use monetary policy to pursue other
macroeconomic objectives. This is important for Argentina due to its high inflation
rates that have reached 50% (paragraph 1), necessitating high interest rates to raise
cost of borrowing and reduce consumption and investment spending in the
economy to alleviate inflationary pressures in the economy.
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push inflation as discussed previously would also help Argentina avoid stagflation,
which further reduces the risk of a recession since real GDP would have declined
from a fall in the short run aggregate supply (SRAS) of the economy.
In evaluation, while it would be ideal for Argentina to move away from a floating
exchange rate system to either a fixed or managed-float system, their concerns over
a lack of foreign currency needed to prop up its currency, as well as already high
interest rates, suggest that it might not be possible for them to maintain a stronger
exchange rate. Attempting to fix their currency will likely lead to even greater
exchange rate volatility if they were forced to give up on the fixed or managed-float
system due to an inability to raise interest rates further or sell enough foreign
currency to prevent a depreciation. Instead, the country should maintain its currency
floating system and attempt to stimulate the economy and combat inflation via
supply-side policies and can only contemplate abandoning a floating system when
the economy stabilizes.
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Question 2
(a)(i) Define the term tariff indicated in bold in the text (paragraph 2). [2]
(a)(ii) Define the term trade war indicated in bold in the text (paragraph 3). [2]
A trade war describes a scenario where the imposition of trade barriers by one
country on another, results in a series of retaliatory trade barriers implemented
between the two countries.
A tariff on imports from China would benefit US producers as it raises the price of
imported goods, such as Chinese cars and car parts (paragraph 2), which increases
the selling price of American goods. This is illustrated in the diagram below.
Initially, US would import Chinese car and car parts at the world price of Pworld, leading
domestic producers producing only Q1 worth of output as producers are less wiling to
produce output at low prices due to low profitability. With a tariff, the world price rises
to Pworld + T, incentivizing US producers to increase their production to Q2 in light of
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higher profitability. US producers thus benefit from increased revenues as they enjoy
a higher selling price of Pw + T and higher output of Q2.
(c) Using an AD/AS diagram, explain the desired impact of China’s eased
monetary policy” on its economic growth (paragraph 5). [4]
An increase in AD from AD0 to AD1 would lead to an increase in real GDP from Y0 to Y1
as firms increase production to meet a higher level of desired spending in the
economy. This would lead to higher rates of economic growth in the Chinese
economy and reduce the risk of a sharp economic slowdown.
(d) Using information from the text/data and your knowledge of economics,
discuss the arguments for and against the trade protection measures imposed by
the US on China. [8]
Trade protection refers to the use of protectionist barriers to prevent the free flow of
goods and services between countries. Trade protection imposed by the US primarily
takes the form of tariffs, and there are both arguments for and against the
imposition of such trade barriers.
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Firstly, the imposition of tariffs can be justified on the grounds of unfair trade
practices by Chinese producers (paragraph 1). If the Chinese were unfairly
subsidizing domestic producers, allowing them to dump their products in the US at
artificially low prices, such tariffs can be justified. Unfair trade practices would lead to
higher imports in the US and a fall in domestic production, leading to lower revenues
and profits for US producers while raising the unemployment rate among American
workers. The imposition of tariffs would be beneficial to US producers and workers as
shown in the diagram below.
The tariffs can raise the imported price of Chinese goods to Pworld + T, eliminating the
unfair trade advantage enjoyed by Chinese producers and encouraging American
consumers to buy domestic products (paragraph 4). This would increase the
revenues and profits of US producers and lower the unemployment rate.
However, the trade protection has led to highly detrimental impacts on the Chinese
economy. The fall in imports would lead to a fall in the (X-M) component of China,
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Moreover, the resultant trade war from US tariffs has lowered business confidence in
America (paragraph 4), and companies like Caterpillar and Apple have already
suffered from falling Chinese demand for their exported goods. A deterioration in
business confidence would hurt US growth in the short and the long run, since firms
would cut back on investments (I) in capital goods if they anticipate lower demand
for their goods and services, which in turn lowers AD in the economy. This would then
lower real GDP in the short run. In the longer term, falling investments would decrease
the rate of potential growth in the US economy due to a lower rate of increase in
capital goods, hurting long term economic growth.
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Question 3
(a)(i) State two functions of the International Monetary Fund (IMF) (paragraph 2).
[2]
The IMF oversees the stability of the international monetary system and promote
international monetary cooperation.
(a)(ii) Define the term human capital indicated in bold in the text (paragraph 5)
[2]
Human capital refers to the quality of labor that is dependent on educational levels
and the level of health of the labor force.
(b) Using a poverty cycle diagram, explain how the government of Pakistan could
intervene to “break out of the poverty cycle” (paragraph 3). [4]
The government may attract foreign direct investments (FDI) by pursuing market
oriented supply-side policies to lower labor costs in the economy and pursue
deregulation to increase the ease of starting businesses in Pakistan. FDI would
increase the quantity of capital available in the Pakistani economy and help the
country to break out of the poverty cycle. This can be illustrated with the poverty
cycle diagram below.
The poverty cycle illustrates how low income perpetuates low levels of investment
and growth, resulting in persistently low levels of real GDP in the economy. By
attracting FDI, the government could promote the increase in physical capital,
increase the productivity of land and labor and raise long term economic growth.
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This would raise incomes and savings in Pakistan, encouraging more investments
and helping the economy to break out of the poverty cycle.
(c) Using an externalities diagram, explain how “greater access to education” for
girls in Pakistan could reduce market failure (paragraph 5). [4]
Under the free market provision, education is underconsumed due to the presence of
positive externalities in consumption. Consumers of education only considers their
private costs and benefits, disregarding positive externalities in the form of increased
labor participation that can promote long term economic growth due to an
expansion of the labor force. This results in market failure and allocative inefficiency
in the market for education. This can be shown in the diagram below.
From the diagram, the free market consumption of education would be at Qm where
MPB = MPC, while the socially optimal level of output is at Qopt where MSB = MSC. The
presence of positive consumption externalities (MEB) as explained above results in
the MSB existing at a higher level than the MPB curve, such that Qopt is higher than
Qmkt. This results in allocative inefficiency and deadweight losses as the free market
fails to allocate sufficient resources to the provision of education.
(d) Using information from the text/data and your knowledge of economics,
evaluate the potential impact of the IMF and World Bank on economic
development in Pakistan. [8]
The IMF is a multinational financial institution that oversees the stability of the global
financial system, while the World Bank serves as a development assistance
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organization that provides long term loans for economic development. Economic
development refers to an increase in the country’s real GDP that is accompanied by
improvements in living standards across the population through a reduction in
income inequality and increasing access to merit goods such as education and
healthcare. Both the IMF and World Bank represent sources of foreign aid for Pakistan
and could be important to economic development in Pakistan, despite the existence
of some crucial limitations.
Firstly, the IMF loan could restore confidence in the Pakistani economy (paragraph 2)
and attract foreign direct investment (FDI). FDI could promote short- and long-term
economic growth in Pakistan by raising capital spending and aggregate demand
(AD) in the short run, leading to an increase in real GDP, while increasing the long run
aggregate supply (LRAS) and the maximum productive capacity of the economy
over time. This could help Pakistan break out of the poverty cycle and overcome the
lack of investments due to high levels of poverty and low levels of savings in the
economy. Widespread poverty and a large budget deficit (paragraph 1) would mean
low levels of productivity in Pakistan due to a lack of investment in human and
physical capital. Consequently, economic growth would be low, perpetuating the
poverty cycle. Being able to attract FDI would help the economy to overcome the
lack of investments and instead promote a virtuous cycle of growth, savings and
investments. This would promote economic development by raising living standards
and increasing access to merit goods such as healthcare and education as real GDP
rises over time.
Secondly, the World Bank has financed education and infrastructure (paragraph 6)
in Pakistan which could also contribute to economic development. Financing
education can increase the rates of female participation in the labor force
(paragraph 6), contributing to long-term economic growth while increasing
educational outcomes for girls who were previously unable to attend school. It could
also contribute to improving human capital by providing skills to its rapidly growing
population and allow workers to earn higher wages, improving living standards.
Infrastructure would contribute to long-term economic growth and raise productivity
in the economy, attracting investments as a result of greater efficiency in the
economy. This could raise living standards and contribute to economic development
as increased capital spending would increase real GDP in both the short and long
run.
However, there are limitations to relying on the IMF and World Bank for economic
development. Firstly, investment projects of the World Bank have been criticized for
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Model Essays – November 2020
Moreover, IMF aid could come with the requirement that Pakistan pursue market-
oriented policies and reduce its fiscal budget, measures that could be detrimental to
its economic development. Increasing indirect taxes and cutting government
spending (paragraph 2) could be contractionary for the economy, lowering real GDP
and worsening developmental outcomes due to lower living standards. Raising
indirect taxes would raise cost of production in the economy, leading to a fall in
Pakistan’s short run aggregate supply (SRAS) and could contribute to stagflation,
with rising cost of living and falling incomes. Moreover, a reduction in government
spending (G) could lead to a fall in AD leading to further declines in real GDP. This
would worsen poverty in Pakistan as unemployment would increase with falling real
GDP. Moreover, market-oriented policies such as deregulation on financial
institutions could lead to marginalization of low-income borrowers and small
businesses who are unable to obtain loans as they are deemed to be un-credit
worthy. This would further worsen inequality as low-income groups are unable to
secure much needed loans to raise their productivity for their businesses in order to
raise their incomes.
In evaluation, while foreign aid from the IMF and World Bank could benefit the
Pakistan economy, they might be insufficient in achieving long term economic
development outcomes, particularly since the loan conditions from IMF and World
Bank investments could often run contrary to development objectives of the
Pakistani economy. Thus, alongside the aid offered by the IMF and the World Bank,
Pakistan could pursue supply-side policies and free trade to promote economic
growth and reduce their reliance on foreign aid.
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Question 4
(a)(i) State two functions of the World Trade Organization (WTO) (paragraph 1).
[2]
The WTO is responsible for setting and enforcing rules for international trade and
provide a forum for promoting trade liberalization.
(a)(ii) Define the term inflation indicated in bold in the text (paragraph 2). [2]
(b) Using a Lorenz curve diagram, explain the possible impact on the distribution
of income in the Philippines when “the income tax for the highest income earners
has been raised from 30% to 35%” (paragraph 4). [4]
An increase in the income tax for the highest income earners would make the
income tax system more progressive, reducing income inequality by taxing a greater
proportion of income from higher income groups. This would shift the Lorenz curve
towards the line of perfect income equality as shown in the diagram below.
The Lorenz curve shifts leftwards from Curve1 to Curve2 as a result of the fall in income
inequality. This can be seen from the reduction in income gap, as the top 10% of
income earners previously earns 25% of total income in the economy as compared
to 50% before.
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(c) Using an AD/AS diagram, explain the impact on the potential output of the
Philippines of the government increasing its “spending on new airports, roads and
bridges”. [4]
The growth in potential output is shown as a rightward shift in the long run
aggregate supply (LRAS) curve of the economy from LRAS0 to LRAS1, increasing the
total level of real GDP attainable from YF to YF1.
(d) Using information from the text/data and your knowledge of economies,
evaluate the use of export promotion as a means of achieving economic
development in the Philippines. [8]
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However, export promotion might not succeed due to the lack of quality
infrastructure in the agricultural sector (paragraph 2). High costs of doing business
and low productivity might discourage private investment needed to make the
export promotion policy a success. Moreover, uncertainty and the lack of
infrastructure to support export-oriented manufacturing (paragraph 4) further
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Model Essays – November 2020
discourages both domestic and foreign direct investment. Consequently, the inability
to attract investments would mean that exports from the Philippines remain
uncompetitive, limiting its ability to depend on (X-M) as a source of economic
growth for the country. The lack of infrastructure would also mean an inability to
access export markets, as it could be difficult and costly to transport manufactured
goods for export. This further limits the viability of an export-oriented growth strategy
to achieving economic development.
In evaluation, while promoting trade could promote developmental outcomes for the
economy, narrowly depending on the food manufacturing sector for exports is
unlikely to be sufficient for the Philippines. Between having to raise taxes and
promote further investments in infrastructure, export promotion is unlikely to improve
economic development in the short term. Instead, the government should focus on
other policies, such as supply-side policies to promote long-term economic growth
across all sectors while spending on redistributive programs such as minimum price
support schemes for farmers to raise living standards in the short term.
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