2012 A Level Q2

University education in Singapore and throughout the rest of the world

is subsidised by national government rather than left to the market
forces. During 2010, several governments announced that these
subsidies would be cut, stating the need to reduce large fiscal budget
deficit as the reason.
Explain why countries subsidise universities and discuss whether
reductions in subsidies are justified. [25]
Explain why countries subsidise uni education
Explain market failure
• There is GI through subsidies bc the free market has failed to achieve AE which
maximises societal welfare
• Uni edu is a merit good deemed socially desirable yet perceived to be under-
consumed by the gov  attributed to individuals failing to include all benefits due to
underestimation of PB (imperfect info) and disregard ext benefits (positive
externalities)
• Define positive externalities
• PB for consumers=higher potential salaries + high SOL in future
• PC for producers=cost to run universities
• EB for society=co-workers who are third parties do not make payment yet enjoy
external benefits in terms of sharing of knowledge, leading to higher quality work
force, which in turn enhance productive capacity and ability to attract foreign investors
Explain why countries subsidise uni education
Explain market failure
• EB for society: Uni edu also helps to ensure a steady SS of skilled workers for the
nation, which is impt in attracting I and hence bring about higher EG that benefits
society as a whole. Uni edu thus brings about several social benefits eg social
cohesion, better workforce etc
• Presence of positive ext causes MSB to deviate from MPB as individual
consumers do not consider ext benefits while consuming uni edu
Explain why countries subsidise uni education
Diagrammatic analysis
• Assuming no negative ext, MSB=MSC. Mkt o/p of uni edu is Qm, where MPB=MPC. MEB not
considered when consrs decide how much uni edu to consume
• Socially optimal level of edu is Qs, where MSB=MSC since that is where societal welfare is
maximised. Since Qm<Qs, underconsumption of uni edu. Allocative inefficiency and DWL of area
ABC to society
Explain why countries subsidise uni education
Other reasons for MF
• Imperfect information*: consrs underestimate PB when of uni edu due to ignorance of
possibilities of diff job opportunities and full extent of benefits on their future
income/earning potential  underestimation of PB lead to underconsumption
• Income inequity: occurs when market conditions vary across industries, occupations,
geographical locations, abilities etc resulting in differing individual incomes. Because
some individuals may not be able to earn sufficient income to afford basic necessities
such as edu, MF occurs. There might be meritorious yet poor students who are unable
to afford costly uni edu so DD falls below socially optimal level
• Market dominance: few dominant pvt unis charge high fees and restrict enrolment 
allocative inefficiency and DWL. Moreover, due to lack of competition, these unis may
become complacent and lax in cost control, leading to productive inefficiencies  qly
of edu drop  underproduction and hence underconsumption of uni edu
Discuss whether reductions in subsidies are justified
• Gov may adopt measures to increase SS/increase DD to bring mkt o/p level Qm closer
to socially optimal level Qs
Thesis: Justified
• Gov failure to measure MEB: when gov attempt to improve allocation of resources,
they require info to estimate MEB. If subsidies are higher than MEB, lead to over
overconsumption. Hence gov decisions do not always lead to most optimal outcome
since imperfect info may also lead to gov failure
• Degree of MF is relatively small in uni edu: divergence between MPB and MSB not
high compared to eg pri/sec edu. There is less imperfect info regarding PB of uni edu
since individuals are well aware of the wage premium commanded by a uni graduate.
In fact, wage premium increases overtime as graduate stays longer in workforce, rate
of increase in remuneration far outpace those w/o tertiary edu MPB very high and
individuals have strong incentive to pursue uni edu despite high fees  justifiable to
reduce subsidies since rate of underconsumption is low  funds should be channelled
towards lower levels of edu instead
Discuss whether reductions in subsidies are justified
Thesis: Justified
• Fiscal budget deficit: if gov expenditure>rev, subsidies for uni edu will incur high
opportunity costs and worsen gov fiscal position further. Gov might need to raise
taxes to finance policy  create disincentive to work and invest, adversely
impacting EG
• [EV]: given the longer term demographic trend of ageing popn and future
reduction in tax rev due to shrinking pool of working adults, this implies that gov
may have to reallocate resources to HC and cut back on uni edu subsidies. Hence
a blanket subsidy may be unsustainable in the LR
Discuss whether reductions in subsidies are justified
Anti-thesis: Not justified
• Subsidies lead to AE: when gov provide subsidy=MEB, reduces COP and increases SS of
uni edu. MPC shift right until Qm=Qs, correcting under-allocation of resources helps
achieve AE. Given that subsidies do increase consumption of uni edu by making it more
affordable, reduction in subsidies will lead to less uni consumed, making it unjustifiable
• Relatively efficient method of increasing SS: Subsidies involve gov using mkt-based price
signalling through lower course fees, increase Qdd (and reduce underconsumption).
Compared to other methods, generally easy to administer and involve relatively low
cost of monitoring for compliance etc
• [EV]: LT effect on productive capacity: I in uni edu is crucial in improving qly of labour
force to take on higher value-added work. Any cut in subsidies (which discourages C)
may solve a ST problem of reducing budget deficit but this may be gained at the
expense of fall in productive capacity of economy in future. This deterioration of talent
pool might deter high value-added FDI. Hence any ST benefit may not outweigh LT
costs, making it irrational to reduce subsidies
Discuss whether reductions in subsidies are justified
Evaluation: Counterproposal
• Case might be stronger to cut subsidies esp since budget deficit is a major concern and
priority should be on reducing gov funding since private individuals have great incentive
to pursue uni edu on their own
• Alternative would be grant or student loans to lower income group. Grant increases DD
=MEB. MPB will shift right to coincide with MSB, internalising EB and increasing C to
socially optimal level Qs
• Compared to subsidies (blunt instrument), grants more cost effective since they are
targeted and generally means-tested (eg by per capita HH income), lead to less wastage
and can potentially achieve intended results of making uni edu accessible to low income
group at lower cost compared to subsidies as the latter involve a blanket reduction in
price for all income groups, even those who can afford uni edu
• Since all options entail trade-off, gov will have to conduct cost-benefit analysis before
deciding which mixture of policies to best meet challenges posed by current ec condition
 2017 RVHS Prelim Q5
Economists often distinguish small and open economies, such as
Singapore, from large and less open ones.
(a) Explain how size and openness could account for why economies
pursue policy mix to different extents. [10]
(b) Discuss how far the size and openness of Singapore have influenced
her choice of policies to achieve price stability. [15]
Introduction
• Small economy: small dom mkt  necessitates countries to be X-oriented to tap
on global mkt, resource-poor  M-reliant, open to trade, capital and labour
flows
• Large economy: large dom mkt  rely on dom sector and less on trade
• Difference in size and openness of economy affects size of multiplier k
• Consequently, this determines how effective DD-mgmt will policies will be and
thus, the extent to which a policy mix is needed in order to achieve
macroeconomic aims
Main
• Small and open economies tend to adopt a policy mix to a larger extent than large
and less open economies  complement expansionary DD-mgmt policies with SSP to
achieve desired increase in NY
• To illustrate this, the multiplier process will be explained
• Assume a 4-sector economy where idle resources are available to increase prodn.
MPC=0.6, MPS=0.2, MPT=0.1, MPM=0.1 and MPW=0.4. Since k=1/MPW=1/(1-MPC),
k=2.5
• In the event of a recession, suppose the gov adopts EFP via increasing G on public
infrastructure by $100m. In period 1, the increase the increase in G causes AD to
exceed the current o/p available. As such, firms need to increase prodn (employ more
workers) and pay out an equivalent amount of income of $100m
• In period 2, HH which receive this increase in income will spend 0.6 x $100m = $60m
on C, while the rest ($40m) goes to savings, taxes and imports. This increase in C
encourages firms to increase prodn, further generating factor income of $60m
Main
• In period 3, out of this increase in income, HH spend 0.6 x $60m = $36m on C,
while the rest ($24m) goes to savings, taxes and imports. This process of
spending, increase in o/p and income continues until there is no more additional
spending in period n. Since MPC<1, the increase in AD becomes less as this
process continues.
• Ultimately, NY increase by k x change in AD 2.5 x $100m = $250m (2.5 times
the initial increase in G of $100m)
• This multiplier process takes place over many periods
Main
• For small and open economies, their small dom market coupled with high import-
reliance imply smaller MPC and larger MPM compared to larger and less open
economies
• As a result small and open economies have smaller k. When expansionary DD-
mgmt. policies are used, they will have smaller increase in NY (eg compare with
less open economy with k=5  NY will increase by $500m)
• The above analysis implies that when attaining macroeconomic aims, small an
open economies cannot rely on DD-mgmt. policies alone  policy mix is
necessary
• In reality, when faced with recession, countries such as SG are observed to
undertake not just EFP but also SSP. In contrast, large and less open economies
can afford to depend on DD-mgmt policies solely. Policy mix is less of a necessity
and they are less likely to use that
Conclusion
• The strengths and weaknesses of various macroeconomic policies lead govs to
adopt a policy mix when they tackle macroeconomic problems.
• The extent to which this policy mix differs among countries depends critically on
the size and openness of the economy
• Compared to large and less open economies, small and open economies, with
their smaller k, will likely need a policy mix to a much larger extent since DD-
mgmt policies alone are insufficient to achieve the desired change in NY
Introduction
• Achieve price stability  low and stable rate of inflation
• Nature of SG economy makes her prone to inflationary pressures from various
sources
• Having to import a large amt of final g/s, Sg vulnerable to imported and cost-push
inflation when M become more exp
• Strong DD for SG X – due perhaps to increased Y in trading partners, can
potentially fuel DD-pull inflation since SG economy operating near Yf
• To a large extent, the size and openness of the economy do influence the gov’s
choice of policies to achieve price stability. However, other factors such as the
source of inflation also matter
Main
Thesis: Explain how size and openness influence SG’s policy choice to achieve price
stability
• Small and open economy  trade-to-GDP ratio (X+M)/GDP relatively large compared
to large and less open economies
o With (X+M) more than 3 times of GDP, it is more strategic for MAS to choose e/r
policy to achieve price stability as this policy affects a broader spectrum of g/s
and more groups of people
• Default stance: modest and gradual appreciation of SGD  keeps out imported and
cost-push inflation while indirectly moderating DD-pull inflation
o Stronger SGD increases Px in FC and lowers Pm in SGD
o Cheaper M of final g/s keep out imported infln while cheaper imported inputs
reduce the likelihood of cost-push inflation
o High M content in X suggests that even though a stronger SGD reduces X
competitiveness, it is partially mitigated by cheaper inputs to make X
Main
Thesis: Explain how size and openness influence SG’s policy choice to achieve price
stability
• Furthermore, a large portion of SG’s X comprise of electronic products with many
substitutes  PEDx>1 + Given M-reliance, PEDm<1  MLC satisfied  Stronger
SGD leads to fall in NX, moderating any increase in AD and keeping out DD-pull
infln
o A stronger SGD moderate ext DD for X, thereby easing DD for dom resources
eg industrial space, labour etc, since firms do not need to compete/bid up
prices of these resources to produce X
o [EV]: MAS studies show that this channel of keeping out infln is much stronger
than the earlier one, despite being more complex and requiring longer time
to work
Main
Thesis: Explain how size and openness influence SG’s policy choice to achieve price
stability
• While SG’s openness to trade makes it strategic to rely mainly on e/r policy to
achieve price stability, her openness to capital flows restrict her from choosing
conventional policies like MP to keep out infln
o As a global financial centre, huge amounts of hot money enter and leave SG
quickly daily
o As a price taker who cannot set i/r, any attempt to change i/r will be negated
by hot money flows, rendering initial change in i/r ineffective
o Thus i/r policy is not a good choice to achieve price stability
Main
Thesis: Explain how size and openness influence SG’s policy choice to achieve price
stability
• SG small dom mkt: dom I and C comprise a small % out of GDP  greater
reliance on FDI instead
o Even if SG tweak i/r successfully, resultant change in C an D and subsequently
AD and GPL will be minimal
Main
Anti-thesis: Explain how other factors influence SG’s policy choice to achieve price stability
• Source of inflation is a key consideration in influencing gov policy choice, regardless of
size and openness of the economy
o If stems from dom sources, then e/r policy may not be appropriate. Eg strong wage
pressures due to tight labour mkt fuel cost-push infln.
o SG ageing popn and low BR led to shrinking labour force
o Compounded by FWL hikes
o Raised COP across industries as firms invest in more machines or offer higher wages
to attract local workers
o In this case, gov adopted policies to help firms lower prodn costs in other areas by
giving wage subsidies, corporate tax rebates, road tax/rental rebates
o SSP also used to help bring LT reduction in COP by raising productive capacity eg
worker training, PIC  increase qty and/or qly of fop, shift LRAS out  dampen rise
in GPL
Evaluation
• Besides size and openness, other factors eg cause of infln and potential side
effects that arise following the implementation of a policy do influence policy
choice to achieve price stability
• Nonetheless, given importance of country’s nature, size and openness is first
consideration that guides gov’s policy choice. This applies to all countries
• Projecting into the future, while infln may be fuelled by various sources at diff
junctures, prompting the gov to adopt specific measures to tackle them, it is likely
that e/r policy will remain the mainstay policy for SG
• Historically, e/r policy has helped maintain price stability on occasions when
source of inflation is not even externally driven
• e/r policy plays a vital role in restraining price increases in the broader basket of
g/s consumed by ppl and thus helps in attaining price stability
• Without its presence, infln may exist to a larger degree
2013 A Level CSQ1
(a) What do the rising sales of own-label products from Aldi and
Lidl, despite fall in real disposable incomes, tell us about the nature
of products sold by these two stores [2]
• When real disposable incomes fall and DD for Aldi and Lidl’s own-label product
rises, this inverse r/s implies that own-label products are inferior goods with
negative income elasticity of demand ie. YED<0
(b) What would have been the effectiveness of a maximum price of
129 pence for petrol in the UK between December 2010 and August
2011? [2]
• For the max price (price ceiling) to be binding, it has to be set below the market
equilibrium price
• Hence the max price is ineffective before March 2011, since it is higher than the
market equilibrium price and
• Effective after March 2011 since the max price is lower than the market
equilibrium price
(c) Explain one possible reason why average price of petrol in the
UK in supermarkets is less than the avg price in all outlets [2]

• In the UK, supermarkets could have adopted marketing strategies of using “bargain
petrol” as a “loss leader” to attract customers to fill up their tanks and at the same
time shop for other groceries
• The increase in revenue from selling groceries is likely to offset the decrease in
revenue from selling petrol at a cheaper price
• That could have accounted for why the avg price of petrol sold in supermarkets are
less than the avg price in all outlets (which includes outlets which solely sell petrol)
• Alternative answer: supermarkets in UK operate on a larger scale than other
outlets and are better able to reap EOS eg marketing economies by buying in bulk.
This lowers AC which is passed on to customers, translates to lower prices of petrol
sold by supermarkets
(d) Use the concept of opportunity cost to explain 1 effect on each of
consumers, firms and government arising from the fall in real
disposable incomes described in Extract 1. [6]
Consumers:
• Fall in real disposable incomes will reduce PP of HHs. Consrs will then have to make choices of
how they want to spend their remaining income
• If they decide to spend more on groceries, then the opportunity cost would be what they are
willing to forgo eg benefits that could have been derived from a holiday trip
Firms:
• Since firms SS g/s to HHs, fall in real HH disposable Y will likely lead to fall in DD and therefore
sales of those selling normal g/s
• This in turn may cause TR of firms to fall. With fall in TR, firms will be forced to choose how they
would make use of their revenue
• If firms decide to spend on purchase of new machinery, the opportunity cost would be the
benefits that could have been derived from purchase of other factor inputs eg hiring more
workers
(d) Use the concept of opportunity cost to explain 1 effect on each of
consumers, firms and government arising from the fall in real
disposable incomes described in Extract 1. [6]
Government:
• The fall in real HH disposable incomes will also lead to a fall in tax rev collected
and force the gov to choose how to spend these rev among competing needs
• If the gov decided to spend on infrastructure of the country, the op cost would be
other potential areas of gov spending that would have to be sacrificed eg national
defence

General note:
• Is the op cost worth it? MB>MC? Benefit forgone in spending in other areas
(e) Discuss whether the disadvantages to consumers from exorbitant
prices’ (Extract 3) outweigh any benefits they may gain from the
existence of cartels. [8]
Introduction:
• Cartels are formed by a group of firms that work tgt and act like a monopoly in order to
capture the profits that would exist for a monopolist
• The existence of cartels can bring abt both costs and benefits to consumers
Main: Costs of cartel
• Consumers are disadvantaged as the price charged by a cartel is likely to be much
higher than if these firms did not form a cartel. This is because firms in a cartel act like a
monopoly to restrict output and charge higher so as to earn higher profits
• This can be seen from Extract 3, where it is observed that cartels collude to charge
exorbitant prices to exploit consumers. Since o/p under a cartel is likely less than in
more competitive markets, allocative inefficiency results and DWL exists. In addition,
consumer surplus is likely to decrease
(e) Discuss whether the disadvantages to consumers from exorbitant
prices’ (Extract 3) outweigh any benefits they may gain from the
existence of cartels. [8]
Main: Costs of cartel
• The higher price charged by the cartel will also result in greater inequity as it
increases COL. Since the low-income group spends a larger proportion of their Y
on necessities like food, fuel and utilities, an increase in prices of these
necessities is likely to hurt them more. They might not have the means to afford
the essential commodities. As a result, there would be a fall in material well-
being of the low-Y group
(e) Discuss whether the disadvantages to consumers from exorbitant
prices’ (Extract 3) outweigh any benefits they may gain from the
existence of cartels. [8]
Main: Benefits of cartel
• Through their collaborative action, cartels are able to operate on a larger scale of
production, which enables them to reap EOS. Eg in production of basic essential
food items like wheat, flour etc, cartels can better take advantage of bulk purchase
of factor inputs such as specialized farm machinery, fertiliser, seedlings etc and
obtain a larger discount from their suppliers. This lowers AC of production, which
if passed on to consumers, can benefit them in terms of lower prices
• Since cartels are likely to earn supernormal profits, this would provide a
substantial pool of funds for them to undertake innovation/R&D in a coordinated
manner to avoid duplication. If successful, such efforts may lead to a decrease in
AC, which could translate to lower prices for consumers. It could also increase the
quality/variety of goods, which would benefit consumers
(e) Discuss whether the disadvantages to consumers from exorbitant
prices’ (Extract 3) outweigh any benefits they may gain from the
existence of cartels. [8]
Main: Benefits of cartel
• Firms in a cartel effectively act as a monopoly and coordinate their production. As
such, they are likely to SS these essential commodities with greater certainty. On
the other hand, the SS of gods might fluctuate more in a competitive market as
firms might cut back on their production or overproduce based on inaccurate
information after observing their rivals’ behaviour
(e) Discuss whether the disadvantages to consumers from exorbitant
prices’ (Extract 3) outweigh any benefits they may gain from the
existence of cartels. [8]
Evaluation
• While there are benefits arising from existence of cartels, whether these can be
fully realised largely depends on whether firms have incentive to deliver these
benefits to consumers
• Given that cartels are not exposed to competition in a free market nor gov
regulations (in Kenya’s context), it is highly unlikely that firms in cartel will
voluntarily undertake actions to benefit consumers in terms of lower prices and
better qly pdts from R&D
• Hence the disadvantages to consumers from ‘exorbitant prices’ making basic
essentials unaffordable to the majority is likely to outweigh any benefits they may
gain from the existence of unregulated cartels
(f) Discuss whether maximum price legislation such as the proposed
in Kenya would be the most appropriate way of responding to
falling real disposable incomes in the UK. [10]
Introduction:
• To address the falling real disposable incomes in the UK, the gov could consider a
variety of policy options including the use of max price legislation
• A cost-benefit analysis needs to be carried out before a decision can be made
about which policies would be most appropriate to address the problem in the
UK
(f) Discuss whether maximum price legislation such as the proposed in Kenya
would be the most appropriate way of responding to falling real disposable
incomes in the UK. [10]
Main: Maximum price ceiling
How it works, strengths (intended consequences) Limitations (unintended consequences)
- Refers to price ceiling: highest permissible price - The artificially lowered price distorts market
that a seller can legally charge forces and sends wrong signals to both prodrs
- Producers cannot charge a price higher than max and consrs  Prodrs will decrease Qss from Q0
price allowed Pc to Qs and consrs increase Qdd from Q0 to Qd 
- Prices of essential commodities will decrease Shortage of QsQd in essential commodities
from P0 to Pc which allows consumers to market since Qdd>Qss at Pc
maintain their current PP despite fall in real - Consrs unable to obtain the essential
disposable Y commodities might turn to black market to
purchase the goods at an even higher price than
before implementation of max price legislation
- Consrs will be worse off when they are paying a
higher price for essential commodities in
addition to fall in real disposable income  runs
counter to the initial intention of helping consrs
cope with negative effects of falling Y
(f) Discuss whether maximum price legislation such as the proposed in Kenya
would be the most appropriate way of responding to falling real disposable
incomes in the UK. [10]
Main: Alternative policies which are more appropriate
(i) Subsidies for production of basic commodities (ii) EFP/EMP to stimulate the economy and reverse
the falling incomes
- Subsidise production of basic commodities - UK gov can increase G and reduce T in an
directly attempt to encourage consr and firms to
- With subsidies, producers’ COP will lower  SS increase spending
increase  price fall and qty increase  benefit - Gov can also lower i/r to encourage C and I
consumers and preserve their PP - Taken tgt, the increase in C, I, G may increase AD
- However, similar to the implementation of max  multiplied increase in real NY, reversing falling
price legislation, it is difficult to determine which incomes
goods are considered essential commodities - However, in the LR, increase in AD might lead to
- Furthermore, the provision of subsidies will put an increase in GPL
a strain on the gov budget which will not be
sustainable in the LR
(f) Discuss whether maximum price legislation such as the proposed in Kenya
would be the most appropriate way of responding to falling real disposable
incomes in the UK. [10]

Evaluation:
• Max price legislation is not the most appropriate way as it does not address the root
cause of falling real disposable Y. At best, it can only be a ST relief to rising prices as
it distorts the market and lead to even more severe unintended consequences
• Extract 1: “squeeze on real disposable incomes” in the UK might be due to “public
spending cuts” and rising inflation as a result of “rising commodity prices and
increase in sales taxes”. The gov will need to look at alt measures that address the
root cause of the prob in the LR
• Given the public spending cuts which might imply austerity measures undertaken by
the gov to better manage its gov budget position, this might mean that EFP is less
viable compared to EMP to stimulate AD and NY
• More info regarding cause of UK’s falling real disposable Y would be helpful for the
gov to make a more informed decision on which policies to implement for a more
effective outcome