CSQ #2: Protectionism and Recession

(a)

Summarize the changes in the external value of the Yuan from 2005-2009. [1] Yuan appreciated/strengthened [1m] over the period as it costs more USD to purchase 1 unit of CNY.

(b) (i) Suggest possible reasons for the relationship between Chinas current account balance and her fiscal balance from 2003 to 2009 as seen in Table 5. [4]

There is a direct relationship between the current account balance and fiscal balance over the period. The increase in current account surplus is mirrored by an improvement in fiscal balance and vice versa, with the exception of 2008 where the fiscal balance worsened but the current account balance continued to improve.

Improvement in fiscal balance could arise from a rise in T or a fall in G while improvement in current account balance could arise from an improvement in visible or invisible balance.

Explain the direct relationship: 1. Fiscal balance affecting the current account Improvement in fiscal balance through an increase in taxation fall in disposable income of people fall in demand for imports since demand for imports is a function of income this fall in the import expenditure will, ceteris paribus, lead to an improvement in CA balance

Improvement in fiscal balance through a fall in G spending fall in AD fall in national income fall in import expenditure since imports is a function of income this fall in the import expenditure will, ceteris paribus, lead to an improvement in CA balance

2. Current account affecting the fiscal balance Improvement in current account balance would lead to an improvement in (X-M) AD rises NY rises income is pushed to a higher tax bracket and so tax revenue collected increase improvement in fiscal balance. Any two reasonable explanations [2 + 2 or 1 (identification of relationship) + 3]

(ii)

Account for the change in Chinas projected current account balance between 2010 and 2011. [3] Identify the change [1m]: The current account surplus is expected to improve as a result of the recovery from its post crisis level in 2009.

Explanation [2m]: This could be due to a rise in OECD-wide growth [Table 5] higher income higher purchasing power higher demand for Chinas exports rise in X revenue for China a projected increase in the CA surplus. Or This could also be a result of the ASEAN-China FTA [Extract 6] that was signed lowered barriers to trade and hence a larger export market for China higher X revenue increase in the CA surplus, assuming that exports grow faster than imports.

[Listing of reasons - max 1m will be awarded] (c) Compare Chinas economic performance with that of the OECD countries in 2009. [4]

Economic Growth
Percentage change in real GDP reflects the growth rate i.e. the rate at which real output increases. China outperformed the OECD average - she registered a high, positive growth rate of 8.7% while the OECD countries suffered a fall in national output of 3.5%. A higher growth rate suggests better material well-being as a larger increase in the income of the people would suggest larger increase in their consumption of goods and services. Current Account Balance The BOP consists of the current account and the capital and financial account. Although data on capital and financial account is absent, the current account balance does provide some insight on the health of the BOP Comparing the CA balance of China with the three OECD countries (USA, Japan and Germany) given, China has the biggest surplus suggest that the goods and services produced by the Chinese are relatively more competitive internationally in terms of price or/and quality.

 If this translates into a healthy BOP for China relative to other OECD countries, then we can conclude that China is living within its means more comfortably Better performance in external balance. However, Chinas CA balance has worsened by 33.3% from the previous year which is only better than Germanys (which has worsened by 45.3%). USA saw an improvement in the CA balance while Japans CA balance only worsened by 19.7%. Inflation Rate Inflation rate measures the % change in the average prices of goods and services within a country in a year. A low and stable inflation (coupled with economic growth) indicates a healthy internal balance as it stimulates investments and growth and generates more employment opportunities. China experienced deflation, a fall in the GPL whereas the OECD recorded a positive and mild inflation rate. However, OECD low inflation rate is accompanied by negative growth rates. In relation to the high and positive growth rate that China recorded in 2009, the falling GPL could be a result of AS increasing faster than AD to allow non-inflationary growth. Overall Data on unemployment rates are lacking, but based on economic growth rates, CA balance and inflation rates, we can infer that China is likely to outperform the OECD countries in 2009. Considering the fact that 2009 was a year where many economies suffered from the backlash of the global financial crisis, the Chinese economy proved to be resilient and continued to be robust.

L2 An answer that provides accurate interpretation of economic indicators and is able to arrive at a reasoned judgment on economic performance. L1 An answer that is able to only describe and compare economic indicators without clear ability to link such macroeconomic indicators to economic performance. Or An answer that demonstrates incomplete usage of data.

34 12

(d) Using Keynesian analysis, evaluate the likely impact of the ASEAN-China FTA on the national income of the various ASEAN nations in Table 6. [8]
Introduction Free Trade Agreements are binding agreements between two or more countries to remove trade barriers and business restrictions. They typically include reducing tariffs on imports and relaxing restrictions on the level of participation in sectors like business and finance which will have significant impact on an economy.

1. Impact on (X-M)

Impact of FTA on AE

With FTA, removal of tariffs & non-tariff barriers on ASEANs goods and services into China will result in our exports becoming more price competitive ASEAN export revenue is likely to increase. (Assuming X rises faster than M from China, X-M improves) 2. Impact on Investment FTA removes business restrictions investment opportunities will increase the inflow and outflow in the capital account. Signing of Evaluation FTAs will also attract FDI from non-member countries who may want to invest in ASEAN to re-export to a larger China market brought about by signing FTAs. FDI from Chinese firms is also likely to rise if they want to capitalize on ASEAN countries FTA with other countries. Hence it is likely for net FDI inflow into ASEAN to be positive increase I The rise in I and (X-M) will lead increase in AE multiplied increase in NY, if ASEAN is operating below full employment. Explain the multiplied increase in NY via multiplier process: Define k & state formula Suppose that (i) ASEAN nations operating with excess capacity (ii) MPC = 0.8 and MPW = 0.2 for every change in income by $1; (ii) the resulting injection from FTA is $10m

Evaluation 1. Depends on the size of multiplier (k) The size of the multiplier will determine the eventual increase in the national income. Size of k is determined by the reciprocal of the MPW (sum of MPS, MPT and MPM).

From Table 6, Singapore have the highest gross domestic savings and the largest proportion of import relative to its GDP, hence its k value is likely to be the smallest. An increase in I and (XM) will lead to a smaller multiplied increase in national income. Philippines, on the other hand, with the lowest gross domestic savings and second lowest proportion of import relative to its GDP, is likely to have a large k.

Based on these figures, we may deduce that increase in NY experienced by Singapores may be the smallest while that of Philippines may be highest compared to the other ASEAN nations for a given increase in injections across the nations.

2. Depends on how attractive the country is for FDI and therefore the extent of increase in I The degree to which the NY would increase from the FTA would also depend on how attractive the country is for FDI. Countries which are more competitive are the ones which investors deem to yield higher returns (higher revenue or lower

Multiplier Process: The rise in AE will encourage firms to increase production. They will hire workers in order to produce to meet the rising AE leading to increase in income of households by $10m. National income will increase by $10m because a rise in the expenditure by one party implies a rise in the income of another. This rise in household income by $10m will stimulate a rise in consumption by the workers (by $8m) as well as on their savings, taxes and imports expenditure (by $2m). The process, however, does not stop here. Suppliers selling goods and services to workers will experience a rise in their income (by $8m). This causes national income to rise further by $8m. In addition, it will also result in spending by this group of suppliers by ($6.4m) and they will also save more, pay more taxes and also spend more on imported goods (by $1.6m). This process will continue, with each round of reduced spending being less that of the previous round. The process will stop when sum of total withdrawals = initial rise in injections ($10m) and a new equilibrium is achieved with a higher national income. Since MPC = 0.8, then k = 5 and NY of ASEAN would increase by $50m. Illustrate with Y=AE diagram

Singapore with the highest net FDI inflows (as % of GDP) amongst the countries given could be reflected of its attractiveness to FDI. If all else remains the same, then an FTA which increases the flow of FDI to ASEAN might suggest that Singapore stand to benefit the most [Table 6]. 3. Depends on the source of comparative advantage of each country and therefore the extent of increase in net X FTA might not boost economic growth in ASEAN evenly. Some countries have also expressed concern because the reciprocal to a lower trade barrier against ASEAN exports also means that the China imports to ASEAN will now be exempted from previous tariffs. This would mean a cheap influx of manufactured products into ASEAN. There were fears among ASEAN countries that entry of cheaper Chinese products would undermine domestic manufacturing sector. [Extract 6]

Furthermore, no doubt FTA presents ASEAN with a huge ready Chinese market, the gains could only be materialized provided if ASEAN is prepared to make structural adjustments to specialize and export goods and services in which she has comparative advantage in.

If any country is unable to make the necessary adjustments to compete with the influx of Chinese imports and capitalize on its comparative advantage, there is a risk that in the long run, ASEAN might not see an increase in net exports

Synthesis: In comparing the potential gains, the ASEAN economy that has the greatest difference in terms of structure and factor endowment (from China) is likely to have more to gain from the ASEAN-China FTA than the others. Considering the fact that Singapore seems more ready to receive the FDI than the other ASEAN economies and potentially possess CA in knowledge-based or capital-intensive products (which is not in direct competition with Chinas labour intensive type manufactured products), she is likely to have highest gain compared to the other ASEAN countries.

L3

For a rigorous answer that demonstrates strong understanding of how national income is impacted through Keynesian framework, with sound evaluation that is based upon case material. For a response that (i) shows clear understanding of Keynesian framework but is limited in terms of scope for evaluation, or (ii) (iii) has a breadth of points in evaluation but lacks rigour in Keynesian analysis, or shows clear understanding of Keynesian framework with weak evaluation or very weak links to case materials cap at 4.

7-8

L2

46

L1

For an answer that demonstrates some superficial ideas of Keynesian framework only.

13

(e)

The world should move from "beggar-thy-neighbor policies to support-thy-neighbor policies," As an economic advisor to the Malaysian government, would you recommend this shift in policy amidst global recession? [10]

Introduction: Addressing the signpost Beggar thy neighbor refers to the use of economic policies to protect the domestic economy at expense of others. In this case it is the use of protectionist policy to defend ones own economic performance by reducing imports. Such a fall in imports means the neighbor will suffer a fall in exports which translates into falling net exports and thus AD, NY and employment. The call by Gordon Brown to support-thy-neighbor is an appeal to countries around the world to remove such protectionistic measures and to continue to buy imports from their neighbors in order to generate income and employment opportunities for the foreign counterparts. This will prevent the worsening of the global recession and prevent the onset of a trade war.

Thesis: Recommend support-thy-neighbour 1. Expected gains from support-thy-neighbour Supporting the neighbours exports and boosting their AD enables them to enjoy an increased national income. Their people can have a higher purchasing power as a result and this in turn would increase their demand for Malaysias exports in the long term. The support-thy neighbor policy thus not only boosts the neighbours export earnings but Malaysias own as well, ensuring a win-win situation for both sides. Moreover, import without imposing trade barriers will allow Malaysia to capitalize on the gains from trade. Countries will continue to export goods in which she has comparative advantage and import goods in which they do not have. By not raising trade barriers, Malaysian consumers get to continue to import goods at a lower price. In addition, the continued imports also lead to a variety of products that is available to consumers thus enhancing consumer welfare. 2. Pains from beggar-thy-neighbour Beggar thy neighbor policy offers temporary relief but damage could be long term. A deliberate protectionist policy will hurt international relations possible retaliation from trade partners hurting the countrys exports revenue and hence impeding growth and employment. In Malaysias case, total trade is very sizeable relative to GDP, especially with exports over 90% of GDP [Table 6]. Should other countries retaliate, it will have significant impact on her Chips, cars domestic employment and growth.

Anti-Thesis: Do not recommend support-thyneighbour maintain beggar thy neighbor 1. Limited gains from supporting thy neighbor Against the backdrop of the global recession, Malaysia claims that foreign countries are going to buy less of their exports where the demand for the regions computer chips, cars and commodities are being slashed [Extract 7]. This fall in demand for Malaysias X will lead to a fall in X revenue and hence potentially reducing AD, hurting its growth further amidst the global recession. Fall in demand for Malaysias goods and services would also cause a fall in demand for factors of production such as labour, leading to rising unemployment. Malaysia may turn to beggar thy neighbor approach out of an urgent need to protect its people with trade barriers in order to support their own industries [Extract 7]. A protectionist policy will offer quick relief to the entire situation by switching expenditure to the output of goods and services of the domestic economy, allowing domestic producers to continue production and to protect home employment. Support thy neighbor requires a longer time to see effects of improvement on own country as it depends on how nimble the economy is (in terms of adjustment costs) to restructuring in the face of recession. Countries that are less nimble may not be able to react to the recession hence turning to the temporary relief that protectionism offers to ensure economic performance.

2. Pains from beggar-thy-neighbour [contd] Use of protectionistic measures will result in loss of consumer welfare and foster inefficiency.
Price Sdomestic

2. Inability to make the shift to support-thyneigbour a. Lack of resources Policy choices often depend on the resources and tools available to the government e.g. budget position.

P1 P2

Sw +tariff b d D Q1 Q2 Q3 Q4 Sw Tariff =P1P2 Quantity

E.g. the imposition of tariff would increase the price of imports to domestic consumers from P 2 to P1, reducing consumer surplus. While production by domestic producers would increase from Q1 to Q2, it is at the expense of welfare loss of society. Area B+D is the loss in societys welfare or deadweight loss due to the imposition of the tariff. There is a misallocation of resources because domestic producers which are less cost efficient than foreign firms will supply more to the domestic market, and consumers will have to pay a higher price of P 1 instead of P2 under free trade.

Shift is more plausible countries with a healthy budget surplus (which meant accumulation of reserves) which will allow the country to implement expansionary fiscal policy in times of recession, without having to resort to protectionist measures.

However, in Malaysias case, it is in fiscal deficit (Table 6), suggesting limited ability to turn to fiscal stimulus amidst the recession, and therefore, may have to use protectionist policy to ensure employment.

b. Limited effectiveness of dd management policies to manage domestic demand Countries with sizeable domestic demand relative to the external demand would make the demand management (i.e. fiscal stimulus) more effective than the protectionist policy. Also, there would be less fear of retaliation from the countries which was made beggar due to higher self-sufficiency.

Conclusion

However, in Malaysias case, the size of her leakages (imports savings) is quite large, In the background of the global recession, beggar thy neighbor approach does seem like and a more convenient option suggesting small k value. In this case, and a normal reaction in an attempt to protect growth and employment from further worsening. However, once a demand management policies may world leader embark on it, the temptation to do likewise for many political leaders (during a time of recession have and hardship) is tremendous. This may possibly start a downward spiral of world trade and thus throw the world economy into a severe recession. For an export dependent country, support- thy-neighbour policy may in fact help the domestic economy more than it helps the neighbor. In view of the potential gains, the Malaysian government should therefore stand firm with the policy of supporting thy neighbor but in the short run, implement other measures such as price and incomes policy may be undertaken to offer the much needed temporary relief for the economy.

L3

L2 L1

For a balanced and competent response that carefully considers the feasibility of the two approaches, supported by case material and wellevaluated comments (Weak judgment cap at 7) For an under-developed response that demonstrates some attempt to make reference to case material but is lopsided or lacking in economic rigor or evaluative judgment. For a descriptive answer with some basic correct facts but lacks explanation and/or substantiation from case extracts.

7-10

5-6 1-4

CSQ #3 The Global Commodities Market

(a) (i) Describe the trend in the price of oil from 2005 to 2010. Oil prices rose with a slight dip in mid 2006 until mid 2008. Prices fell sharply till early 2009 before rising again. (ii) Using a demand and supply diagram, account for the sharp change in the price of oil in the first half of 2008. Increase in Demand: 1. Speculation led to jump in demand due to intense speculative buying driven/ precipitated/ encouraged/fuelled by the weak US$ (fallen to record low against the euro). From investors/speculators point of view the same barrel of oil priced in USD now cost less in terms of euros. It is cheap to use euros to buy oil and more profitable. 2. Huge jump in global oil consumption, particularly by booming economies China and India, due to rapid industrialisation and rising affluence. 3. Anticipation of supply disruptions/ shortages related to the rising political tensions over Irans nuclear programme which may cause oil prices to rise in the future leads to panic buying Decrease or no significant change in Supply: Possible threats of disruptions by/to major oil producers, e.g., tensions in Middle East and OPEC reluctant to increase output. Supply of oil is price inelastic: Due to the fact that there may not be much spare capacity amongst oil producers in the short run (fairly low surplus capacity). Oil is a primary commodity extracted from the ground and quantity supplied is unable to respond fast to the high oil price. Diagram: - Draw a very steep, almost vertical SR SS curve - Draw a huge increase in demand (due to speculative buying and the jump in global oil consumption) will result in a SHARP rise in the price of oil. Note: Ep is not necessary as when there is no shift in supply, the steepness of the demand curve will not affect the price. But it is still good to draw a steep demand curve as oil has little substitutes and thus demand is priceinelastic. Diagram [2m] Explain 2 demand factors [2m] but must include speculation Explain why supply no change or minimal increase [1m] Explain why Es is low [1m] (b) (i) From Extract 9, explain the source of market failure that exists in the palm oil market in Malaysia and Indonesia. Explain how clearing of land for palm oil production leads to negative externalities (external cost). External costs include emission of greenhouse gases such as carbon dioxide which leads to global warming affecting third parties; reduction in [4] [6] [2]

plant and animal diversity Since burning to clear land for palm oil is cheap for producers, producers do not take into account of these negative externalities present, there will be a divergence between the MSC and MPC causing the MSC to be higher than the MPC. The market will produce where MPB=MPC and market equilibrium output, is greater than the social equilibrium output. Overproduction occurs. There is deadweight loss which leads to market failure.

(Diagram is not required to score full marks) (ii) Evaluate two possible measures which the Malaysian and Indonesian governments can adopt to correct this market failure. Possible measure #1: GREEN TAXES THESIS: Explain how measure works to solve the problem Tax per area of land cleared via burning (unit tax = MEC at Qs). By doing so, it would shift the MPC curve upwards and output will correspond to where it is socially efficient (MSC=MSB). Diagram Benefits Provides incentives for palm oil producers to minimise clearing of the land by burning and hence emissions; or to seek other better ways of clearing the land without burning and emitting CO2. Tax rates can be adjusted depending on the magnitude of the problem. ANTI-THESIS: Explain limitations of measure Difficulty in identifying the socially efficient tax rate as it is difficult to assess the external costs, since the effects on the environment is different. Greener / forested areas might be able to absorb the pollution better than non-green areas. The fall in output might be slight due to the fact that biofuel is profitable. Hence as long as revenue received from sales of biofuels can cover the tax imposed, producers will still go ahead to clear the land, hence the problem of pollution is likely to persist and deteriorate. Possible measure #2: TRADABLE PERMITS THESIS: Explain how measure works to solve the problem Each polluting producer must buy a permit which gives it permission to emit a certain amount of pollution when they burn to clear the land. If not, it will have to clean up the pollution. These permits are marketable, so producers are able to buy and sell such permits. The government will estimate the socially efficient level of emissions before it decides on the number of permits to issue. The price of each permit will then be determined in the market. The higher the price of permit, the greater the incentive for the producer to reduce emissions. Benefits Marketable permits give producers the incentive to find ways to cut down emissions so that they can avoid having to buy the permit or best still, sell the permit to other producers who encounter difficulties cutting down their emission level. It is cost efficient as emissions will be reduced by the producers with [8]

the least cost in cleaning up. ANTI-THESIS: Explain limitations of measure Such a scheme allows those producers with high clean up costs to buy the permits from those with low clean up costs. This way, these producers with high clean up costs can afford to continue with their pollution and avoid having to clean up. Furthermore, it is difficult for the government to determine accurately the optimal amount of permits to issue as it is difficult to estimate the estimate the socially efficient level of emission. It could also be administratively expensive to track the source of the emission as burning to clear land is undertaken at forests. OR Possible measure #3: REGULATIONS THESIS: Explain how measure works to solve the problem The use of laws and regulations backed by inspections and penalties (such as fines) for non-compliance. E.g. regulate amount of land permitted to be converted to palm oil plantations Benefits Straightforward to devise, easier to understand by firms and easier to implement. ANTI-THESIS: Explain limitations of measure Not a sophiscated means of reaching a socially efficient output. Monitoring is costly. Conclusion Ultimately, the burning of the land and the use of the land to produce palm oil is not an environmentally-viable option in the first place. And the various measures has their own merits and limitations. The appropriateness of the measures will depend on the conditions faced by both economies. Given the vast areas and costly monitoring, Green Tax appears to be the most straight forward measure and may provide highest net benefit. L1 L2 An answer which identifies and briefly describes the measures. An answer which thoroughly evaluated one measure Or An answer which evaluates two measures with some gaps. Well-explained answer which evaluates two measures. 1-2 3-5

L3

6-8

(c)

From Extract 10, discuss the effects of the European Unions Everything But Arms (EBA) initiative on Mozambiques macroeconomic goals. Intro The initiative will have both positive and negative effects on

[10 ]

Mozambiques economy Discussion of effects will be on the macroeconomic goals of economic growth, unemployment, inflation and BOP

Thesis: Positive impact on the economy Preferential and unlimited duty-free access to the lucrative EU market Mozambique is able to have greater access into EU market and hence will be able to sell its sugar to the EU without import tariffs increase X (higher production of sugar in the economy) increase in AD national income rises. There is economic growth and unemployment decreases. Increase in X leads to improvement in current account, improving the BOP. Countries e.g. Mauritius and S Africa have the intention to take advantage of Mozambique access to the EU market attract more FDI into Mozambique increase in AD national income rises. There is economic growth and unemployment decreases. Anti-thesis: Negative impact on the economy From above, higher production leading to increasing X AD rises SS side bottleneck in the short run as productive capacity cannot be increased fast enough when factors of production are normally less mobile occupationally & geographically in the short run over-heated economy demand-pull inflation. Less supply of sugar in Mozambique in the SR as producers sell to foreign markets to take advantage of higher sugar prices. Price of sugar in Mozambique will increase cost push inflation.

Conclusion The initiative is more likely to have positive impact on Mozambiques economy; however, it is uncertain if the benefits will be sustained in the long run. Changes in agricultural prices are often volatile. Any gains are temporary and short run which usually merely benefit commodity speculators rather than small scale farmers (which could explain the weakening currency against Euro in recent months). The better long term development strategy is to work towards diversification of the economy by developing new areas of comparative advantage and move up the innovation and technology ladder. L1 An answer which describes the effects of the initiative with no economic analysis Or Identifies the impact on the macroeconomic goals without explanation. Well-explained but one-sided argument Or Two-sided argument with gaps in explanation. 1-2

L2

3-5

L3 E

Answer which insufficiently refers to the data. Well-explained two-sided argument with sufficient reference to the 6-8 data. Justified conclusion. 1-2

CSQ #4: Good Brew (a) (i) Describe the trend of Japans wine imports between 1997 and 2006. [2] Japans wine imports have been experiencing an overall increasing trend between 1997 and 2006. (1m) .. with the largest source of imports being from Italy OR with the largest increase (1.2 million) coming from USA. (1m) (ii) To what extent does the trend account for the fall in beer sales? [6] Thesis: Beer and wine are close substitutes. Therefore, if the demand for wine has increased, it is likely that the demand for beer has fallen (ceteris paribus) since they are both alcoholic drinks and serve the same needs of the consumers. (2m) Anti-thesis: o Limitation of the chart the chart only shows the top 5 sources of wine imports and therefore we are not sure the extent of their contribution to total wine imports into Japan (although it is likely to increase). Therefore the chart only hints but we cannot be sure o Limitation of the chart the chart is only from 1997 to 2006 but the fall in beer sales was over 15 years until 2009. Again, although it is likely that the trend from 1995 to 2009 should look similar to the one provided, we cannot be absolutely sure. o There could be other factors affecting demand for beer: Changing tastes and preferences - Japans youth today have changing attitudes about work - having a drink after work with colleagues seems to be out-dated, thus impacting on their reduced consumption of beer. Fall in income - Economic downturn results in a fall in disposable income and thus a fall in ability to purchase beer. Population ages - The ageing population results in a change in demographics and Japans older generation, who are the main consumers of beer ages, thus resulting the fall in demand for beer. Synthesis: Since there are many factors affecting the demand for beer, the trend observed in the wine imports can only in part account for the fall in beer sales. The chart could also be limited as explained Max 3 marks for an answer that is one sided. Max 4 marks for an answer that does not link to effect on Total Revenue Max 5 marks for an answer that does not provide an awareness of the insufficiency of the trend to account for the fall in beer sales Max 5 marks if only one other factor is provided in anti-thesis) (b) (i) Explain the type of market structure in the Japanese beer industry in 2009. [3] Identify the market: Oligopoly. (1m) - Use the chart as evidence: The chart shows a 4-firm concentration ratio of about 99%. (1m) - Identification of price rigidity due to mutual interdependence : Mutual interdependence between the various firms as implied by the line Competition among chain retailers made the price stability possible, thus if anyone of the four firms raises it price, the others will not follow, but if they decrease the price, competitors will follow. So price has remained stable for 18 years. (1m)

(ii) Using demand elasticity concepts, explain Kirins strategies. [5] Kirin may use: Cross-elasticity of demand concept: Define XED and explain that XED between Kirin beer and other brands is high (likely greater than 1) as different brands are close substitutes Application: Reduce the degree of substitutability between Kirin beer and other beers through advertising e.g. a beer with daddy commercials (extract 1) which will build brand loyalty. This will prevent Kirins revenue from decreasing drastically due to a fall in demand should other beer companies lower their prices. Income elasticity of demand concept: Define YED and explain that YED for Kirin beer is high (likely greater than 1) as beer is not a necessity for consumers. When income falls, demand for beer falls (by more than proportionate) and TR falls. Application: Introduce a less luxurious product which has a smaller income elasticity value, i.e. Happoshu which is cheaper and the taste of which is slightly inferior. Any further economic downturn will not see fall in sales of happoshu to any large extent because of the low income elasticity. Also, when income falls, consumers may switch to happoshu from beer and therefore, TR may not fall to a large extent. (Explanation of each of the above demand elasticity concepts and the appropriate strategy used 2 marks each. A maximum of 4 marks for answers that do not link to effect on TR. A maximum of 3 marks if the one/both strategies discussed in the answer do not come from the case material.) (c) (i) With reference to Extract 12, explain the type of merger proposed between Kirin and Suntory. [2] Horizontal Merger: This occurs when firm takes over a similar firm at the same stage of production in the same industry. Two of Japans biggest beer and beverage companies with overlapping operations. OR Conglomerate Merger: Conglomerates have been defined as those mergers, which are neither substantially vertical nor horizontal. They are generally understood to be combination of firms which are not directly related to one another. Among Kirins roughly 400 subsidiaries are a bio-chemical firm, a property company, hotels, a tennis club, and even a flower company and Suntory has an IT-services firm, a chain of fitness clubs, silverware and jewellery shops, an advertising agency and a flower company of its own. (Either answer with explanation is acceptable for 2 full marks.) (ii) Suppose you are the chairman of the Japanese Competition Commission, indicate whether you would approve of the proposed merger. Justify your answer. [12]

State objectives of the Japanese Competition Commission: - Promote greater competition - address anti-competitive practices by firms in the Japanese market From extract 2 paragraph 1, firms such as Kirin and Suntory, which are two of the largest beer and beverage companies are having plans to merge their operations.

Thesis: Merger should be approved for the following reasons: 1) Cost savings can be passed on to consumers through lower prices. By merging to achieve greater scale of production, companies such as Kirin and Suntory are able to enjoy greater internal economies of scale through marketing economies such as bulk purchase of key inputs like aluminum, lower unit costs of advertising as well as distribution costs. (Extract 2 para 3). Such cost savings can be passed on to consumers in terms of lower prices, enhancing consumer welfare. 2) Increased global cost competitiveness With the lower unit cost of production, the enlarged merged firm is able to price their product more competitively in the global market. This is especially crucial as in the global beer market, Japanese firms like Suntory and Kirin need to achieve greater heft by merging to compete better in terms of pricing against the likes of major producers like Anheuser-Busch InBev and SABMiller which are likely to already enjoy substantial internal EOS given their large market share. (Extract 2 para 5). With stronger cost competitiveness, there could be stronger sales of Japanese beer overseas. 3) Ability to earn and retain sufficient supernormal profits for product innovation. With the merger of Kirin and Suntory, the merged firm is able to enjoy greater market power in the form of greater pricing power through its enlarged market share.. With this ability to earn and retain sufficiently high levels of supernormal profits, Kirin and Suntory have greater ability and incentive to product innovate their beer products to compete more effectively against major beer companies in the global market. Product innovation can also benefit consumers through improved product quality and variety. 4) Ability to enjoy greater economies of scope. As both Kirin and Suntory do have existing products and services other than beer production, (Extract 2 para 7-8) through a conglomerate merger, it can perhaps achieve spin-offs among selected product lines by tapping on the synergies between products and services. For instance the merged firm can attempt to bundle its hotel services, silverware and jewellery and fitness club services together to offer a more complete range of products to customers, thus benefiting the consumer. Anti-Thesis: 1) Allocative Inefficiency. The beer industry in Japan is an oligopoly (Figure 2). With the merger, the degree of competition in the beer industry is further reduced. The newly merged firm enjoys greater market power and with its increased pricing power, it has the ability to set higher prices and reduces output. The difference between price and marginal cost is now greater and hence allocative inefficiency is worsened. 2) Gains iEOS that acts as barrier to entry that limits competition in the beer industry. With increased market dominance, newly merged firms have the advantage of its substantial internal EOS in the domestic market which acts as a barrier to entry to deter competition. 3) Inequity. With greater degree of mkt dominance, the merged firm can raise prices and restrict output therefore being able to raise their level of supernormal profits. Such profits are now concentrated in the hands of the merged entities at the expense of consumers who have to bear with the higher prices charged by the dominant merged firms. This results in greater inequity. 4) Higher incidence of unemployment in the beer industy. Merger of the two firms involves shedding staff, culling less profitable brands and closing redundant factories. Due to the need to streamline operations in the merged firm to avoid duplication of operations and functions and reduce costs, workers which are deemed to be surplus to requirements may be retrenched.

Provide a reasoned conclusion: Given the potential benefits and drawbacks of the merger, decision on whether to approve of the merger need to be made by weighing the benefits against the costs of the merger. A case can be made to approve of the merger in view of the high degree of need to allow the Japanese beer companies to be able to compete better globally (Extract 2 para 4 :Beer consumption has fallen by three-quarters over the past 15 years. So the Japanese firms need to go abroad for growth.) In addition, the Competition Commission may recommend alternative measures to address the effects of higher market power in Japan such as redistributing their profits to the consumers or subsidising skills training such that unemployed workers can move onto another sector more easily.

L1

One-sided answer. Explained only the view that merger should be approved/disapproved. No reference to case material. L2 Ability to explain the arguments for and against the merger. Sufficient depth of analysis. Weak application to context. L3 Well balanced answer. Ability to demonstrate good depth of analysis with confident grasp of key microeconomic objectives like efficiency and equity as well as consideration of unemployment effects. Good use of case material. E1 Evaluative judgment that is not explained. E2 Evaluative judgment supported by sound analysis

1-3 4-6 7-8

1-2 3-4

CSQ #6:

(a) (i) Compare the change in US import prices from China in US dollar and Chinese Yuan for 2008. [2] US import prices from China in US dollar has risen but and has fallen in Chinese Yuan. [1] The extent of change for both was greater than the year before. [1] (ii) Using figure 5, explain two factors that may have caused the rise in prices of goods in Wal-Mart. [4] With the US import prices from China increasing in US dollar but decreasing in Chinese Yuan, it suggests that t h e U S $ h a s depreciated against the yuan, making the imports from China more expensive in US dollar. Therefore, if Wal-Mart sells a lot of Chinese-made products, the prices of goods in Wal-Mart will rise. [2] As can be seen in Figure 5 , US import prices from industrialised countries have a l s o risen at an increasing rate, thus the import prices of these other goods have also increased, causing the rise in prices of goods in Wal-Mart. [2] (b) With an appropriate diagram, assess whether the claim that China is no longer exporting deflation to the rich world, but inflation is justified. [6] For a number of years, cheap Chinese goods helped to reduce prices in rich economies. This suggests that China exported deflation to the rich world by helping to decrease the cost of production with an increase in the aggregate supply (AS). However, more recently wages and prices have surged in China. On top of this, it is believed that Chinas huge demand for food and energy is pushing up global commodity prices. This suggests that rather than increasing AS, China is causing a fall in AS with the surge in wages, commodity prices etc. In order to power Chinas high growth rates in the past few years (as high as 12% in 2007 and 9.6% in 2008), the demand for commodities would have increased and this had led to rise in commodities prices. However, this effect may be overstated though as the rise in commodity prices, for example, may not be entirely due to China. The pace of growth in Chinas oil demand has slowed to 4% in 2007 and its food production has in fact grown faster than consumption over the past years. This is further evidenced by As a small, but growing, net exporter of wheat, maize and rice, China has, if anything, helped to ease world grain prices. This suggests that although China has contributed to the increase in AD, that impact might be nullified by the increase in AS China is contributing. Furthermore, the integration of China and other emerging economies into the world trading system has, in effect, more than doubled the global labour force, and by curbing workers bargaining power it has restrained pay increase demands in most developed economies in recent years. Therefore, even though wages may have risen in China and may fuel inflation in the developed world, Chinese wages are still much lower than those in other countries. With globalisation and the increased mobility of factors of production, the relatively lower wages of Chinese workers have prevented workers in other economies from demanding huge wage increases or may even have led to their wages falling. As such, China

has kept the AS from falling or may even have increased it in the rich world. Therefore, the claim seems to be difficult to justify based on the data provided and it appears that the effect of Chinas rising demand has been overstated as it might not have considered how it has contributed to an even larger increase in supply. More information about the relative differences in the levels and changes in wages, level of contribution or change in the relative contribution of China to worlds food production would be helpful in making the assessment.
Level 3 (5-6m) Level 2 (3-4m) Level 1 (1-2m) For an answer that clearly uses economic framework (AD/AS diagram) to elaborate and make an assessment based on analysis and case material on whether the claim is justified. For an answer that is two-sided and has a clear explanation with diagram but can be better elaborated with more reference to the case material. For a weak or one-sided answer that lacks economic framework or is poorly explained. No diagram given.

(c) Identify the macroeconomic problem that China is facing and discuss the measures the Chinese government can take to deal with it. [8] China is facing slowing economic growth. After years of boom, China's GDP growth has now slowed for the last five consecutive quarters. The IMF forecasted that the Chinese GDP will decline from 12% last year to about 9.6% this year. The slowing growth seems to be due to a significant slump in demand for Chinas goods as the recession hits its markets in Europe and America. To deal with the problem, various measures, such as expansionary fiscal policy (possibly with supply-side effects), exchange rate policy and even protectionist trade policies can be implemented. Expansionary fiscal policy Stimulates AD by increasing government expenditure (G) or reducing taxation (T) or both. Government can increase development expenditure (infrastructure roads, railways, hospitals, etc.) and operating expenditure (education, retraining, etc.) This is already seen where the Beijing leadership has vowed to spend more on welfare and construction, such as rebuilding the areas devastated by the earthquake in Sichuan. Government can also decrease income tax (causing an increase in C due to increase in disposable income) or decrease corporate tax (causing an increase in I due to increase in after-tax profits). Should also note that these policies can have supply-side effects where building of infrastructure and investments or subsidies in education or retraining help to increase productive capacity of the economy, causing a rightward shift of the AS curve in the LR. Together, the increase in AD and increase in AS help to negate the effects of a fall in AD, increasing NY by more than proportionately due to the multiplier effect. This helps to stimulate economic growth.

Evaluation of Expansionary Fiscal Policy

1. Problems of Timing Discretionary fiscal policy requires time for implementation. 2. Crowding-out of domestic investment Assuming the government finances an increase in its budget deficit via borrowing. The government thus competes for scarce funds with the private sector and raises the interest rate, causing less investment spending by private firms. This crowding out of private investment partially offsets the impact of the fiscal expansion on aggregate demand. Thus AD does not increase by the full amount of government expenditure, depending on the extent of crowding-out. 3. Size of Multiplier (briefly for H1) The size of k affects the extent of increase in national income for a given increase in autonomous expenditure. A smaller k implies that the government needs to pump in a greater amount of G into the economy to achieve the desired increase in national income. This limits the effectiveness of fiscal policy as the funds required to stimulate the economy may be very high. MPS may be high in China due to Asian value of thrift. 4. Burden on the government budget Large government spending may deplete reserves significantly or cause future generations to be in debt. Devaluation of exchange rate China can devalue its exchange rate which will cause net exports to increase assuming Marshall-Lerner condition is satisfied (i.e. PEDx + PEDm >1). An increase in net exports increases AD, thus increasing NY by more than proportionately due to the multiplier effect. Evaluation of Exchange Rate Policy 1. Possible retaliation China is already forced to yield to international pressure to revalue its currency and make its goods more expensive overseas as countries like the US is unhappy and accusing Beijing of deliberately keeping the yuan undervalued to make its exports artificially cheap. Thus, a devaluation of the currency could instead invite retaliation from trade partners such as the restriction of import of Chinese car and light truck tyres or the recent Buy American policy and end up hurting Chinese exports even further, exacerbating the slowing growth. Protectionist trade policy The policy above of devaluing the currency is an example of a protectionist policy (expenditure switching where the good becomes cheaper for overseas buyers but more expensive for domestic buyers thus causing them to buy less of imports and more of domestic products, thereby increasing net exports). Other measures include giving export subsidies or export tax relief as mentioned in the case which will be introduced in the next few months to ease the pain. Such measures again help to reduce the price paid for and increases the quantity demanded of them by more than proportionately, assuming that demand for them is price elastic. This would lead to an increase in net exports, assuming import value remains constant and thus an increase in AD. Again, this helps to negate the effect of the fall in AD and stimulates NY.

Evaluation of Protectionist trade policy 1. Possible retaliation and goes against theory of comparative advantage Conclusion The measures should help to dampen the fall in national income brought about by the fall in exports and prevent a sharper downturn but the root cause of the problem which is due to external factors is not solved. As such, China would have to wait for the world to recover from its recession and with the policies that it has implemented be ready for the next upturn. Level 3 (7-8m) Level 2 (3-6m) Level 1 (1-2m) For a clear and comprehensive explanation and strong evaluation of at least 2 policies with reference to the case material. For a balanced but underdeveloped explanation with some evaluation and reference to the case material. A general answer with limited reference to case material.

(d) Discuss whether President Obama should restrict the import of Chinese cars and light truck tyres. [10] Reasons for To reduce current account deficit The US trade deficit with China totaled $103bn in the first half of 2009. Importing too much is undesirable as it may lead to a depletion of foreign currency reserves. Thus the government may be prompted to impose restrictions on imports to correct the deficit. To protect against unfair trade practices US has accused China of deliberately keeping the Yuan undervalued to make its exports artificially cheap and on top of that, China also has a policy of allowing US film and music products to be imported only by state-run firms. China's current limitations on US entertainment imports have created a large domestic counterfeit industry, much to US annoyance. This has caused unfair competition to the US firms which are not able to fully access the Chinese marketplace. As such, there is reason for US to impose tit-for-tat measures and restrict import of Chinese products into the US market as well. To increase domestic production and national income in times of recession Considering that US is also facing a recession and high unemployment, protectionism in the form of restricting imports may be implemented as an emergency measure. Money spent on imports will only create employment in foreign countries and not at home. By restricting imports, demand is diverted towards domestic production and serves as a useful counter-cyclical measure. Reasons against By practising protectionism, US may experience welfare loss in the form of reduced

consumer choice, higher prices and reduced export earnings. World trade and total world output will be reduced as a result of retaliatory actions by China.

Protectionism also causes misallocation of resources. American car and light truck tyre companies may be retained unnecessarily by protection in an activity in which its productivity is lower than it could have been in another activity. Sheltered by protective barriers, firms have less incentive to respond swiftly to changes in market conditions or to reduce prices, produce better quality products and/or improve productivity. Once a protectionist measure is imposed, it is not easy to remove it and all sorts of industries may also clamour for protection. Conclusion In a climate of a global recession, the world may sink even deeper into the recession if beggar- thy-neighbour policies are implemented. It would thus be wise for President Obama to resist the temptation of succumbing to political pressures and not restrict the import of Chinese cars and light truck tyres. He should instead encourage more free trade to get the world out of the recession and get countries to stimulate export competitiveness by making efforts to improve productivity and lower unit costs of production instead of practising protectionism. Level 3 (8-10m) Level 2 (4-7m) Level 1 (1-3m) For a clear and comprehensive discussion, with reference to case material, on the justification for as well as drawbacks from restricting imports. Substantiated judgment should also be made at the end. For a balanced (two-sided) but underdeveloped discussion with some reference to the case material. For a weak, one-sided or general answer with limited reference to case material.