2013 A Level H2 Essays PDF

2013 H2 A Level Essays
1. Economics assumes rational decision – making by consumers, firms and government.

a. Explain what is involved in rational decision – making both by consumers and by firms. [10]
b. Discuss whether rational decision-making by consumers, firms and government always leads to
an efficient allocation of resources. [15]
Introduction
• Consumers and Producers/Firms are assumed to be rational decision makers
• Rational decision making involves weighing up the marginal benefit and marginal cost of
any activity to determine if it is worthwhile to do the activity
• This applies to consumers and firms (and governments too).
• A rational consumer weighs his private benefits and cost of an extra unit of a good
consumed, and chooses to consume the good such that it yields the highest satisfaction
(or utility) to himself for the lowest cost or effort.
• A rational firm weighs its private benefits and cost of an extra unit of a good produced,
and chooses to produce the good such that it yields the highest profits (total revenue –
total cost).
Development 1: Consumers
• They will allocate their scarce resources in such a way as to maximise utility (satisfaction).
• In order to enable utility maximisation they must be able to monetize/ value the private
benefits receive from consuming all goods & services and thus, allocate their income (scarce
resource) to equate price with marginal private benefit.
• The demand curve for a good reflects the additional benefit that consumers obtain for an
additional unit of good consumed.
• As the marginal utility of consuming the good falls when consumers buy more of a product
due to the law of diminishing marginal utility (as a person increases consumption of a
product while keeping consumption of other products constant there is a decline in
the marginal utility that person derives from consuming each additional unit of that
product), the demand curve (also known as the Marginal Private Benefit) slopes downward.
• Hence, the downward sloping demand curve, provides signals to the market about the
willingness and ability of consumers to purchase quantities of goods at each market price.
• With reference to fig. 1, at the equilibrium price (P1),
consumers will continue to buy extra units of the good or
service as long as the marginal private benefit of the good,
exceeds the price
• Consuming less than Q1 where MB>MC: If consuming an
extra unit of a good adds more benefit than the additional
cost (i.e. price) incurred, it would be rational for the person
to consume that extra unit.
• Consuming more than Q1 where MB<MC: if an extra unit
of a good gives the consumer less extra benefit compared
to the price involved, then it would be rational for the
person not to consume that extra unit.
• As MB falls, consumers will continue to consume the good until the price they pay for a unit
is equal to the marginal benefit that they get from it at Q1
• This maximizes their consumer surplus  the difference between what they are willing and
able to pay and what they actually pay for the good.
Development 2: Producers
• They will allocate their scarce resources in such a way as to maximise profits.
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• In order to maximise profit, they must be able to calculate the cost and revenue from the
production of a good and thus, allocate their scarce resources to equate marginal cost with
marginal revenue.
• A firm’s marginal cost (MC) curve reflects the additional cost that it incurs by producing an
additional unit of good. MC falls initially, but rises due to the law of diminishing marginal
returns ( When one or more factors are held fixed,
there will come a point beyond which the extra
output from an additional unit of variable factor will
diminish).
• MC<MR: If producing an additional unit adds more
to revenue than cost  it will be profitable to
produce it  producer should raise output
• MC>MR: if producing an additional unit adds more
to cost than revenue  it will lead to a fall in profits
 producer should reduce output
• Profit-maximising firms will continue to produce a
good until the MC=MR
• The profit maximising output occurs at OQ1 where
price is P1 as shown in fig 2. The supply curve is the marginal cost curve above its AVC curve
and it provides signals to the market about the amounts of rice supplied at each market
price.
• [Evaluative Comment] In reality, firms may not be able to identify the profit maximizing
price and output. This is because the lack of information and the violation of the ceteris
paribus assumption. For instance, it is difficult for firms to calculate the marginal cost and
marginal revenue as the current conditions of determining demand and supply curves are
continuously changing.
Conclusion
• Rational decision making by both producers (firms) and
consumers  working of the price mechanism
• Both will aim to maximize their self-interest (satisfaction
and profits respectively)
• Equilibrium attained a point E where Demand = Supply
(for perfect competition)
Suggested ans for b
Introduction
• Allocative efficiency is attained when the right amount of the right goods are produced.
• Allocative efficiency would require firms to produce at the output level where the
MSB=MSC thereby maximising the society’s welfare.
• The price charged (P) is equal to the marginal cost (MC).
Thesis: Rational decision making can result in an efficient allocation of resources

• Assume: Perfect Competition & No Externalities
• D=MPB=MSB & S=MPC=MSC
• Note: Perfect competition  includes perfect information/knowledge
• Rational decision making results in allocative efficiency
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• Via the price mechanism, consumers and

producers maximize their self-interest at point E
where D=MPB=MSB=S=MPC=MSC with price P1
and output Q1
• Society’s welfare, represented by the sum of
consumer surplus (area P1AE) and producer
surplus (area P1EC), is maximized.
• If society produces OQ2 units of rice where
MSB>MSC, more units of rice should be
produced as society receives more benefit than
cost when producing an additional unit of rice.
• Society’s welfare thus increases until MSB=MSC
where it is maximized.
• As there is no way to change the allocation of resources so as to further increase
society’s welfare, allocative efficiency is achieved at OQ1 units of rice.
Anti-thesis 1: Rational decisions by consumers and firms might lead to an inefficient allocation
of resources due to market failure (2 examples)
• However, when there is either imperfect competition and/or externalities  market failure 
allocative inefficiency
[explain why the market fails in the case of merit goods] Merit goods are goods that the
government believes consumers will buy too few units if provided by the market because of
information failure and positive externalities in consumption.
Private benefits of merit good underestimated:

In the case of education, individuals who make
decisions about how much education to receive do
not fully appreciate the private benefits that will be
received through being educated. For example,
education increases the productivity of individuals
and raises their salaries over their working lives.
However, the increases in income are in the future,
uncertain and difficult to estimate accurately thus
leading to people to underestimate the private
benefits of education. As such, MPB1 (info failure)
<MPB2 (perfect information).
External benefits of merit good not considered:

In addition, having a highly educated workforce would increase the international competitiveness
of the economy and attract direct foreign investment into the country. This would promote
economic growth and boost tax revenue collected by the government. Overall society’s standard of
living will improve. Since consumers do not take into account these external benefits on society,
these goods are often under-demanded and under-consumed. This is seen in Figure 1 where MPB2
(perfect information) < MSB.
The market equilibrium output is at OQ1 where MPB=MPC as producers and consumers maximize
their self-interest. However, society's welfare is maximized at the socially optimal level of output is
at 0Q3 where MSB=MSC. There is, thus an underproduction and underconsumption of Q1Q3 units
of the good leading a welfare loss of area E1E3C. Hence there is allocate inefficiency in the market
where the right amount of the good is not produced and thus the market fails.
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[explain how market dominance leads to market failure]

Firms are assumed to be profit maximizing and they produce at the profit maximizing level of output
where MC=MR. However, for firms with market power, at this quantity, P>MC.
As shown in the figure 2, firms with no market power (which are firms in a perfectly competitive
market) would have produced at the socially efficient output level of 0Q2, where D(=MPB=MSB) =
S(=MPC=MSC). Society’s welfare is maximized.
On the other hand, the monopolist produces the profit - maximizing output of 0Q1 where MR = MC.
This output of 0Q1 is allocatively inefficient as price charged for the last unit is greater than marginal
cost (P > MC). The society values the last unit of output more than the costs to produce it and society
will benefit if more is produced. Hence, there is under-allocation of resources and under-production
by the amount Q1Q2. Society’s welfare is compromised when production is at Q1 instead of Q2, total
benefit lost to society is measured by area Q1BDQ2. The reduction in cost to society is area Q1EDQ2.
The fall in welfare (deadweight loss) to society is area EBD.
Price / Cost /
Revenue /
Benefits
MPC = MSC = S
B
P1 LRAC Figure 2
A C
D
P2 = MC2
MC1 E
MR AR = D = MPB = MSB
Output
0 Q1 Q2
With the presence of barriers to entry in the market, it means that producers may not respond
quickly or fully to changes in consumer demand due to the market power that firms possess. They
may not produce goods and services that are most desired by consumers since consumers cannot
turn to an alternative easily. There is thus a lack of consumer sovereignty and allocative inefficiency
occurs. The right amount of the right good that is most valued by consumers may not be produced.
Anti-thesis 2: Rational decisions by govts might lead to an inefficient allocation of resources

• Rational decisions by govts aim to
achieve an efficient allocation of
resources
• However, sometimes the govt
fails  creates new market failure
or deepens current one
Subsidies are transfers from the

government to the firm for the
provision of goods and services. When
the government grants a subsidy of
E3F equivalent to divergence between
MPB & MSB at output, 0Q3. This
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reduces the unit cost of supplying education. Producers are more incentivized to increase the
quantity supplied at every price thus shifting the supply curve from S to S2 as shown in figure 3. The
output thus increases from 0Q1 to the socially optimum output of education, 0Q3, correcting the
under-allocation of resources.
However, due to information failure, government has difficulties in estimating the right amount of
subsidy per unit to impose. By imposing a subsidy of an amount greater than E3F to the producer
as seen in figure 3, this will cause the supply curve to shift rightwards to S3. This worsens allocative
inefficiency due to the over-production of Q3Q4 units of output, generating a greater deadweight
loss of E3GA. Resources could have been utilized elsewhere generating greater societal welfare.
Government failure ensues.
Conclusion
Hence rational decision-making by consumers and firms does not always lead to an efficient
allocation of resources. For instance, in the case of healthcare services which give rise to a positive
externality in consumption, the market mechanism will be unable to achieve efficiency (and equity)
and thus require government intervention. Governments too do not always leads to an efficient
allocation of resources as it could fail too
[Criteria  Assumptions must be present] Whether rational decision making by firms and
consumers results in an efficient allocation depends on whether there is both perfect competition
and no externalities present in the market. For governments, it depends on the information
available for governments to accurate intervene.
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2. The Urban Redevelopment Authority (URA) announced that prices of private residential
properties in Singapore rose by 1.3% in the third quarter of 2011, but the rise in the prices has
been slowing for eight consecutive quarters. At the same time it reported that the total supply
of new private residential properties nearing completion was at a record high.
Source: http://www.ura.gov.sg/pr/text/2011/pr11-135.html, accessed 28 October 2011
Discuss the different supply and demand factors and their likely importance in determining the
reported changes in the prices of private residential properties in Singapore. [25]
Suggested Answer
Introduction
• Market for private housing: market for owner occupied houses for purchases
• Egs: Private housing condominum apartments, as well as, landed properties
• Housing prices are determined by dd and supply for housing. Demand refers to the quantities
of a product that consumers are willing and able to buy at various prices per period of time,
ceteris paribus. Supply refers to the quantities of a product that suppliers are willing and able
to sell at various prices per period of time, ceteris paribus.
• URA announced that prices of private residential properties in Singapore rose by 1.3%.
however, while prices for private residential properties in Singapore are increasing, it has been
slowing down. This observation that prices are increasing but at a decreasing could be due to
(i) increase in demand occurring together with (ii) increased supply.
Explain 2 factors leading to an increase in demand for housing
a. Increase in income
• Increase in disposable income due to strong economic growth in Singapore after the Global
Financial Crisis  increase in consumers’ purchasing power  consumers more willing and
able to purchase houses increase D for private residential properties assuming normal
goods (positive YED value)
• YED measures the degree of responsiveness of the change in demand for housing given a
change in income, ceteris paribus.
• However, the extent of the increase in demand due to the increase in income would be
dependent on the value of YED.
▪ Larger increase in luxurious private housing prices as YED>1, compared to basic private
housing which is regarded as necessity & with YED <1
▪ Private residential properties can be categorised into either necessities (e.g. basic
condominium) or luxury goods (e.g. luxury condominium, landed properties). For basic
condominium, they are likely to be considered necessities with YED<1. Demand will
increase less than proportionately as a result of an increase in income. This could be due
to Singaporeans being pushed out of the income ceiling for public residential housing
and will thus be only be able to purchase from the private residential housing market.
Demand will shift rightwards by a smaller extent resulting in a smaller increase in price.
▪ On the other hand, for private residential properties such as luxurious condominium
and landed properties, they are likely to be considered luxury goods with YED>1. They
are likely to be considered luxury goods due to the larger land area and better quality
fittings. Given an increase in income, it will lead to a more than proportionate increase
in demand, shifting demand rightwards by a larger extent resulting in a larger increase
in price.
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b. Cost of borrowing (mortgage interest rate)

• Interest rates are very important as mortgage repayments are usually the biggest part
of a house owner’s monthly spending. Buying a house is a long term decision which is
usually financed by borrowing. A decrease in mortgage interest rate  lower financial
burden of servicing house loans  likely to shift the house D curve to the right and lead
to a rise in the price of houses.
• Also dependent on interest elasticity of dd for housing.
o Basic private housing – less interest elastic (necessity)  not likely to increase
demand significantly
o Private housing – more interest elastic (other factors e.g. speculation, outlook
of economy)  likely to increase significantly.
Explain the impact of the increase in demand for housing on the price of housing
[adjustment process] The increase in demand for housing to dd1  creates a shortage at P1 
upward pressure on price  new eqm is achieved where eqm price and quantity has increased to
P2 and Q2 respectively.
[extent of increase in price is dependent on PES] However, the extent of the increase in price would
be dependent on the PES of housing market. PES measures the degree of responsiveness of quantity
supplied of houses given a change in the price of houses, ceteris paribus.
Often the supply of available houses in the market is relatively price inelastic. This is because there
are time lags between a change in price and an increase in the quantity supplied of new properties
becoming available or other homeowners deciding to put their properties onto the market.
Thus, in the short run when PES<1 (SS1), an increase in demand would bring about a larger increase
in price of housing market to P2. However, over time, supply of houses is likely to be relatively more
price elastic (SS2), thus a given increase in demand would bring about a smaller increase in price of
houses to P3 instead.
Explain factors leading to an increase in ss of houses (ss has increased as mentioned in the
signpost whereby the total supply of new private residential properties nearing completion is at
a record high )
Short run supply: In the short run supply of housing is fixed because it takes time to build houses.
It takes time to obtain building permission, acquire land and workers.
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Long run supply: Availability of land

• Land-use control policies may affect the market for houses. Planning regulations exist to control
the way in which land is used; to prevent loss of agricultural land; to protect the environment.
To the extent that limits the amount and location of land available for new housing
development, such policy will affect the supply of houses – and hence influence the price of
houses. .
• The more land that is freed up for residential purposes & the greater the number of new private
housing being constructed, the greater the supply of housing  the lower the prices of housing.
• This is one of the most impt factors affecting supply.
Economic outlook:
• Optimistic business outlook  developers more willing to bid for new land and increase supply
of private housing as expected returns increases.
• Prices of private housing falls
Explain the impact of the increase in supply for housing on the price of housing
The increase in ss of housing to SS2 will

bring about a fall in the price of house to
P3s. However, the extent of the fall in
price would be dependent on the PED
for houses.
PED measures the degree of
responsiveness of quantity demanded
of houses to a change in the price of
houses, ceteris paribus.
Basic condominiums: For basic

condominiums, the PED is likely to be
less than 1. This is due to a lack of close substitutes as this group of consumers could possibly be
unable to afford more luxurious private residential properties but at the same time is ineligible for
new public residential housing. Their option includes only the HDB resale market. When supply
shifts outwards and demand is relatively inelastic (DD 1) the result is a large fall in market price (P1
to P3) and a relatively small expansion of the quantity of houses traded (Q1 to Q3). Hence the
increase in supply has a greater dampening effect on the increase in prices due to the increase in
demand.
Luxury residential properties: Also, the PED for luxury residential properties are likely to be greater
than 1. This is due to the greater availability of substitutes for this group of consumers. When supply
shifts outwards and demand is relatively elastic (DD 2) the result is a smaller fall in market price (P1
to P2) and a relatively large expansion of the quantity of houses traded (Q1 to Q2). Hence the
increase in supply has a smaller dampening effect on the increase in prices due to the increase in
demand.
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State the combined impact of the

increase in dd and ss on the price of
private houses: the increase in ss
would limit the extent of increase in
price brought about by the increase in
dd for houses. This accounts for the
slow rise in the price of houses
mentioned in the signpost.
Synthesis: Responding to key word: ‘likely importance’. Timeframe is used as a criterion for
judgement.
In the short run, the price of houses is more likely to be affected by demand factors than supply.
This is because in the short run, supply of housing is fixed because it takes time to build houses.
Empirical evidence has also shown that demand factors tend to be more influential in affecting
housing prices in Singapore. In particular, the prices in the housing market are largely affected by
changes in income, changes in government policies governing borrowing to finance the purchase
and immigration. However, if the supply of houses is price inelastic then an increase in demand will
lead to a relatively large increase in price. In this sense, supply has some part to play in explaining
the rise in private house prices.
The situation is different in the long run. In the long run, the rise in house prices in Singapore is
closely related to fundamental shortages in supply and conversely. E.g. for private residential
properties, the increase in the release of land supply for private residential properties by URA and
lower indirect taxes such as stamp duties will increase the supply of houses and dampen the
increase in prices significantly.
Level Knowledge, Understanding, Application & Analysis Marks

L3 A competent answer that demonstrates application within the context of 15-21
the question with the ability to assess the relative importance of the various
determinants.
L2 Theoretical explanation of the various determinants of housing prices but 9-14
lacks application to the S’pore housing market.
Or
A developed explanation of the determinants that lacks scope.
L1 Undeveloped explanation of the determinants of housing prices, containing 1-8
some inaccuracies.
Level Up to additional 4 marks for evaluation Marks
L2 Reasoned judgements 3-4
L1 Mainly unexplained judgements 1-2
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3. ‘Recessions put weak firms out of business whilst strong firms use a recession to become more
efficient.’
a) Explain the relevance of different types of cost in the decision of a firm to close when faced by
a fall in the demand for its products. [10]
b) Discuss the extent to which firms faced by high levels of competition are more vulnerable to
closure in a recession than firms in less competitive industries. [15]
Suggested ans for a:
Introduction
• There are various cost concepts that a firm considers including: total fixed costs, total variable
costs, total costs, marginal costs, average costs
• Using an example of a car manufacturing firm, we will determine the relevance of these various
cost concepts in a firm’s decision to close when faced with a fall in demand due to a recession.
Development
1. Explain key cost concepts

• Total Fixed Costs (TFC)
• Total costs of the fixed factors.
• Fixed factors are factors of production that cannot be increased or decreased within a
period of time.
• Example: Cost of the factory space, machinery (or capital)
• In the short run, TFC does not vary with output as the qty of fixed factors does not
change.
• Total Variable Costs (TVC)
• Total costs of the variable factors.
• Variable factors are FOP that can be ↑/↓ within a period of time.
• Example: Cost of wages of factory workers, raw materials such as steel, glass,
rubber, etc…
• In the short run, Total variable cost varies directly with output. With zero production,
the TVC is 0.
• Total Costs (TC): In the short run, TC = TFC + TVC
• Marginal Cost (MC): Change in total cost as a result of producing 1 additional unit
• Average Cost (AC) : Cost per unit of output
2. Analyse the impact of ↓demand

• Assume a profit maximising firm initially faces a
demand of AR1
• Equilibrium occurs at MC=MR with price P1,
and output Q1
• [Explain profit max condition] Producing one
more or less unit will lead to a ↓profit e.g.
producing more than Q1, MC>MR  an
additional unit will add more to TC than TR thus
↓profit  firm should ↓output to MC=MR
• Assume supernormal profit of P1abC1
• Recession  ↓NI  ↓PP  ↓qty dd at every price 
↓Demand for normal goods (YED>0)
• Illustrated as a ↓AR and ↓MR to AR2 and MR2
• New eqm occurs at MC=MR2, Price  ↓P2, Output ↓Q2, AC ↓C2
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• Firm is now earning subnormal profit of C2cdP2
3. Explain shut down condition

• In the short run, firm needs to decide whether to continue to produce OR shut down
production.
• In the short-run, fixed costs still have to be paid even when the firm is not producing at all.
• If AR (P2) > AVC (VC), it will be able to cover total variable costs and some of its total fixed
costs. This will make a firm better off than if it were to shut down production (as the full
TFC would still have to be incurred)
• However, if AR<AVC, choosing to produce will incur both fixed costs as well as some of the
total variable costs that was not covered by the revenue, and hence the firm is better off
shutting down.
4. Explain the LR equilibirum

• In the long run, a firm will exit in the industry if AC>AR
i.e. subnormal profit
• The firms does not need to consider TVC or TFC as in the
long run all FOP are variable.
The ease of this happening depends on the ease of exit and entry
in the market.
Conclusion
• [Rank - SR] Therefore, in determining in the short run whether a firm should close, variable
cost is more relevant than fixed costs which does not matter in the decision process.
• [Rank - LR] In the long run, only total cost is relevant
• [Respond to sign post] Hence, weak firms such as those which cannot cover variable cost in
the short run as well as those that cannot cover total cost in the long run will be put out of
business by recessions. However, strong firms which are able to become more efficient e.g
by adopting various cost cutting measures and by raising productivity will be able to survive.
Suggested ans for b:
Introduction
The degree of competition in a market generally influences the behaviour and performance of a
firm.
Highly competitive markets tend to have significantly low barriers to entry. For eg, in the MC
industry (hawker food industry) there are many firms sharing the market and therefore each firm
is usually small and face a relatively price elastic demand for their goods due to the large availability
of substitutes.
On the other hand, less competitive markets such as oligopolistic markets (telecommunication
industry) may have very high barriers to entry which prevents potential firms from entering the
market easily, allowing existing firms to continue dominating a large share of the market and face
a relatively price inelastic demand curve.
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During a recession when there are at least two consecutive quarters of negative economic growth
 consumers are likely to be experiencing falling incomes  falling purchasing power  demand
for normal goods (with tve YED values) will fall.
Thesis: Firms faced by high levels of competition are more vulnerable to closure in a recession
than firms in less competitive industries because:
Recession  fall in Yd  fall in consumer’s purchasing

power  fall in demand for goods and services
assuming normal goods  reflected by a leftward shift
of firm’s AR and MR curves to AR3 and MR3 respectively
 assuming firms seek to profit max where MC=MR, the
new eqm price and output will be at P3 and Q3
respectively. Firms will experience a fall in profits in the
SR.
Assuming firms (oligopolistic & MC) are currently

making normal profits, the fall in AR & MR would result
in firms making subnormal profits (C3efP3).
Firms will shut down in the short run if AR < AVC to

minimise losses. But should AR > AVC, firms will continue production to minimise losses.
[proportion of AFC relative to AVC] PC/MC firms are more vulnerable to closure given the greater
proportion of AVC relative to AFC. An MC firm is more likely to face a greater proportion of AVC
relative to its AFC. AFC is relatively higher for oligopolistic/monopolist firms due to the huge capital
requirements needed to start production. This thus accounts for the relatively higher set-up costs.
Thus, a slight fall in AR would imply that it is more difficult for these firms to be able to cover their
AVC. As such, they are more vulnerable to closure in times of recession.
Meanwhile, in the long run, as there are no fixed costs, firms earning subnormal profits due to the
fall in demand for their goods and services will have to shut down as AR< AC. PC/MC firms are more
vulnerable to closure in the LR given that they can only earn normal profits due to the absence of
BTE.
[explain LR eqm for MC firms] If existing MC

firms are earning supernormal profits in the SR
 attract new firms into the industry  they
will take away customers from existing firms.
Therefore, each existing firm will now have a
smaller market share and hence a smaller dd for
its product  The demand (AR) curve of the
firm will shift leftward and becomes relatively
more price elastic due to the existence of more
substitutes. Supernormal profit is thus reduced
 AR continues to fall and becomes relatively
more price elastic until it is tangent to the LRAC
curve and normal profit is made. When the
firms in monopolistic competition make only normal profit, there is no incentive for new firms to
enter the market. Long run equilibrium is attained. The firm produces output OQ1 & charges a price
of OP1 which allows the firm to make only normal profits.
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As highly competitive firms makes only normal profits in the LR, a fall in the firm’s AR & MR would
imply that these firms are now earning subnormal profits and would have to shut down.
However, on the other hand, an oligopolist/ monopolist is able to retain supernormal profits in the
LR due to the presence of high BTE. As such, a fall in AR & MR would imply that these firms are now
earning lesser profits. Even if these firms earn subnormal profits, they are able to tap on past profits
to help them cover costs for the duration when they are unable to do so.
EV: However, anti-competitive laws and high taxes may deter firms in less competitive markets
from making large supernormal profits even if they are able to do so. Hence, in such instances, these
firms may not necessarily have an advantage over other firms in highly competitive markets.
[inability to invest in R&D] In addition, an MC firm is more vulnerable to closure due to its inability
to influence unit COP/ demand through investing in R&D/ advertising as it lacks the ability to do so.
As explained earlier, unlike an MC/PC firm, an oligopolistic firm is able to retain supernormal profits
in the LR due to the presence of BTE. Due to lack of LR supernormal profits, an MC firm does not
have the resources to conduct R&D and advertising to ↑demand to mitigate the ↓demand due to
the recession  more vulnerable to closure
Anti-Thesis: Firms faced by high levels of competition may not be more vulnerable to closure in a
recession than firms in less competitive industries because there are other factors affecting the
vulnerability to closure.
The nature of the good determines the vulnerability

• Firms selling normal goods where YED +ve  recession  ↓income  ↓demand 
subnormal profit  more vulnerable to closure
• The magnitude of YED determines the vulnerability to closure  the greater the
magnitude  the greater the ↓demand  more likely to earn subnormal profit  more
vulnerable to closure
• However, for firms selling inferior goods where YED -ve  recession  ↓income 
↑demand  ↑supernormal profit  not impacted negatively by recession
Conclusion
• [Address Question] The degree of competition, among other factors, plays an important role in
influencing profit levels and therefore a firm's vulnerability to closure.
• [Evaluation - other strategies] Therefore in times of a recession, firms that are likely to be less
vulnerable to closure would be those that have made conscious effort to diversify the products
that they sell, as they are able to use the profits made from the sale of certain goods to offset
losses incurred from some of the other goods that have falling demands.
• [Evaluation – theory of contestable markets] In reality, firms may not face actual competition
but may still face potential competition. Thus, even if there were only a few firms facing little
actual competition  they may only be able to earn normal profits for fear of potential entrants
 more important to look at degree of potential competition than actual competition.
13
4. Governments have aims in relation to unemployment, economic growth and the balance of
payments.
(a) Explain the consequences of failing to achieve these aims [10]

(b) Discuss whether failure to achieve these macroeconomic aims is more likely to be caused
by domestic or international factors [15]

Introduction:
- Highlight the 4 macro aims: High and sustained economic growth, low and stable
unemployment, low and stable inflation and healthy balance of payments. [Focus on the 3 from
sign post]
- High and sustained economic growth  >3% increase in real GDP
- Low and stable unemployment  <3% Unemployment
- Healthy balance of payments  small surplus or balanced
Development:
(link between negative growth, high unemployment and balance of payments deficit) Failure to
achieve the above three macroeconomic aims could have similar consequences as the three aims
could be linked. An economy may not be able to achieve high and sustained economic growth. In
some cases, they may end up with negative growth whereby real GDP decreases from y1 to y2 as
seen in figure 1 where AD decreases. This negative growth could be due to a fall in export revenue
which results in a worsening of the current account and thus unhealthy balance of payments ceteris
paribus and also a fall aggregate demand in the economy. The fall in real GDP would mean the
output produced has decreased and therefore demand for factors of production will decrease. This
could result in a fall in demand for labour resulting in demand deficient unemployment, assuming
presence of sticky wages.
Figure 1
(ST: fall in material well-being) One of the negative consequences is a decrease in standard of
living, both in terms of material and non-material well-being. Material well-being is measured by
the quantity of goods and services that individuals can get access to which is now fewer due to a
fall in purchasing power as a result of the falling national income. Ceteris paribus, material standard
of living will decrease.
EV: however, non-material SOL could increase in light of negative growth. As firms cut back on
production, there is lesser pollution emitted.
14
(ST: worsening of government finances) With negative growth and higher unemployment, there
will also be a worsening of government finances. As personal incomes fall when labour become
unemployed, the fall in taxable income would mean that there is a fall in personal income tax
collected by the government. Furthermore, the higher unemployment would mean that the
government will have to spend more on unemployment benefits. This rise in government spending
and fall in tax revenue would worsen the finances of the government. This is a negative
consequence as fewer resources will be available to be used in other areas such as healthcare or
education leading to a fall in non-material SOL.
(LT: fall in investment) If the failure to achieve these aims is sustained over a long period, there can
also be some long term consequences in terms of less investment and little or no potential growth.
For example, consumer and business confidence may decrease resulting in a fall in consumption
and investment expenditure respectively. Consumers may be unwilling to spend due to possible
unemployment as a result of the negative outlook of the economy. Likewise, firms may be unwilling
to invest due to falling consumption which means a fall in demand for their goods and services. The
fall in investment expenditure would further exacerbate the negative growth but more importantly
may result in a fall in productive capacity in the economy if the amount of capital goods produced
is insufficient to cover the amount of wear and tear (depreciation) on older capital goods. This is a
negative consequence as it may result in inflationary pressure from P1 to P2 as AS shifts to AS2.
(Specific consequence of unhealthy balance of payments) Having a balance of payments deficit can
also result in some specific consequences such as an increase in foreign debt. A balance of payment
deficit may be sustained by foreign borrowing, both private and government, which will have to
repaid in the future. This result in lower future standard of living. Additionally, with a free floating
exchange rate system, the worsening current account could mean a fall in demand for the domestic
currency which results in a depreciation of the currency. This may not be good as this deteriorates
the terms of trade as the price of exports has decreased while the price of imports has increased.
More goods have to be exported to support a given amount of imports.
Conclusion:
In general, there is likely to be many negative consequences, both short and long term, of failing to
achieve these macroeconomic aims. However, there may be a positive consequence which is a
reduction in inflationary pressure. For example, if an economy has been facing high rates of demand
pull inflation, a fall in aggregate demand may lower the inflationary pressure.
It is also important to consider the extent and duration of the failure to achieve these aims. If the
economy is unable to achieve these aims for a sustained period of time, the consequences
highlighted are likely to be more severe especially in the long run with poor consumer and business
confidence likely to lead to long term negative consequences.
Introduction:
Failure to achieve the above three macroeconomic aims may have serious negative and thus it is
important to consider the various factors that contribute to negative economic growth, high
unemployment and a balance of payment deficit. These factors can be divided into both domestic
and international factors and the aim of the essay is to consider which is more likely to cause the
failure to achieve the aims.
15
Devt 1: Domestic Factors

(1) Domestic Interest Rates (2) Domestic Inflation Rate
An increase in interest rates is a domestic factor that can lead The level of domestic inflation is a
to negative economic growth and high unemployment. With domestic factor that can impact
higher interest rates, the cost of borrowing has increased and the balance of payments.
thus households are less likely to spend on big ticket items such Assuming an increase in inflation
as housing or cars leading to a fall in consumption. Also, higher rate that is relatively higher than
cost of borrowing will mean that more investment projects are other countries, it could mean
not profitable and thus the volume of investment falls from V1 that goods exported from such
to V2. This is illustrated by the MEI in figure 2 whereby a rise in countries would be more
interest rates from R1 to R2 is a leftward movement along the expensive compared to goods
MEI. Investment expenditure falls. from other countries. Thus, the
country’s exports are less export
competitive. A higher price would
mean that the export revenue
would decrease assuming that
the demand for exports was price
elastic.
Meanwhile, imported goods
would be relatively cheaper, and
thus households will switch from
consuming domestically
produced goods to imported
Figure 2: MEI goods assuming they are
substitutes. The increase in
As both consumption and investment expenditure are demand for imported goods
components of aggregate demand, it will result in a fall in AD would result in an increase in
which is represented by a leftward shift of the AD as seen in imports expenditure.
figure 1. Assuming the economy is not at full employment, a This would lead to a worsening of
leftward shift of the AD will result in a fall in real GDP from y1 the current account which
to y2 and thus negative economic growth. Also, as the national consists of export revenue minus
output has fallen, the demand for labour should fall too import expenditure.
resulting in a fall in employment. Furthermore, it will reduce export
revenue which impacts aggregate
Evaluation of interest rates: The extent to which domestic demand thus leading to negative
interest rates is a factor depends on the interest rate elasticity economic growth and
of the MEI. For example, a country like Singapore has a demand unemployment.
for investment which is interest rate inelastic as domestic
interest rates do not influence the investment decision by firms Evaluation: However, it is
who are mostly foreign MNCs which do not borrow locally for important to consider not only
their investment. Therefore, in Singapore, domestic interest the domestic rate of inflation but
rates are likely to be an insignificant factor. also how it compares in relation
to other countries inflation rate,
especially importing countries or
countries that are competing in
similar exports. An increase in the
rate of inflation may not lead to
failure to achieve the macro aims
if the rate of inflation is higher in
the other countries. Relatively,
16
their goods would be more

expensive.
Other domestic factors:

1. Fall in consumer/business confidence
Devt 2: International Factors
(1) Exchange Rate (2) Recession in trading partners
An appreciation of the exchange rate is an international factor A recession in trading partners is
that may result in failure to achieve the three macroeconomic another international factor. For
aims. Firstly, with an appreciation, it will result in an increase example, when Singapore’s
in PX (foreign currency) and fall in Pm (domestic currency). significant trading partner, US, is
Assuming the Marshall-Lerner condition holds (PEDx + in a recession whereby there is
PEDm >1), an appreciation will lead to a fall in (X-M), thus negative economic growth, it
worsening current account. Ceteris paribus, this will worsen would mean that the purchasing
the balance of payments. power of individuals in the US
Next, an appreciation of the currency will also make exports would have fallen. This reduces
more expensive in the domestic currency, assuming PEDx>0, their demand for goods and
the demand for exports will fall resulting in a decrease in export services including exports from
revenue. This results in a fall in aggregate demand leading to Singapore assuming normal
negative economic growth and unemployment (Figure 1). goods. Singapore’s export
revenue thus decreases leading to
Evaluation: An appreciation may not immediately lead to a a fall in AD, negative economic
failure to achieve the aims especially so in the short run as the growth and unemployment.
Marshall-Lerner condition may not hold. In the short run, due Furthermore, there is a worsening
to difficulty in changing contracts between firms, of the current account and thus
PEDx+PEDm<1, and the result of an appreciation is an the balance of payments.
improvement in the current account and consequently the
balance of payments.
Other international factors:

1. Gain in CA by trading partners
Synthesis/Judgment:
As many economies are becoming increasingly globalised, whereby there are increased volume of
trade in goods and services, capital and international movement of labour, it is likely that
international factors such as exchange rates and the growth or recessions in other countries play a
more important role. This is due to their impacts on export revenue and import expenditure which
usually make up a large proportion of the balance of payments and also aggregate demand in
globalised economies.
[Extent depends on openness of economy] However, the extent to which international factors
cause the failure to achieve the macro aims is dependent on the openness of the economies. More
open economies such as Singapore are more likely to fail to achieve these macro aims due to
international factors such as changes in exchange rate and recessions in other countries. This is
compared to less open economies such as US. This is because any changes to these factors are likely
to cause large changes in the export revenue in the country due to the relatively large external
demand in Singapore compared to its domestic demand. Domestic factors such as interest rates
mainly affect the domestic demand which has a smaller impact in the economy.
[Depends on the specific macro aim] Between the 3 macroeconomic aims listed in the question, it
is clearly the balance of payments which is almost entirely impacted by international factors due to
17
its focus on flows of monetary transactions into and out of the economy. In comparison, the other
2 macro goals can be generally impacted by both domestic and international factors.
[Depends on ability of the government to correct the macro problems] Besides domestic and
international factors, it may be also useful to consider the ability of the government to intervene to
achieve the 3 macroeconomic aims. For example, governments which have limited resources may
not be able to achieve the aims due to an inability to intervene using demand management or
supply-side policies. This makes the economy more likely to fail to achieve their macro aims.
18
5. On 1 September 2011 the Monetary Authority of Singapore (MAS) reported that inflationary
pressures remained strong because of the tight labour market, high consumer spending and
rising global commodity prices.
(a) Explain how the factors mentioned above will lead to inflationary pressures remaining strong.
[10]
(b) Discuss alternative economic policies that the Singapore government might consider adopting
to alleviate these inflationary pressures. [15]
Introduction:
Define strong inflationary pressure: Inflationary pressure refers to demand and supply side
pressures which cause a rise in general price level (GPL). When inflationary pressures are strong in
an economy, it could result in inflation where there is a sustained and inordinate increase in general
price levels
Identify factors causing strong inflationary pressures

1. Demand-pull factors arising from high consumer spending
2. Cost-push factors arising from tight labour market and rising global commodity prices.
Development:
Explain and illustrate demand-pull inflationary pressure

Demand–pull inflationary pressure is caused by a rise in AD when economy is close to or at full
employment. The high consumer spending in 2011 suggests and increase in Cd and results in AD
increasing since AD = Cd + I + G + X and Singapore is operating close to full employment. This is also
due to the fact that there is a tight labour market which suggest that almost all the resources have
been already employed. The excess demand cannot be met because existing resources are fully or
almost fully employed.
Adjustment process:
When AD increases to AD2, at the original GPL, P1, a
shortage of of goods and services is created, exerting an
upward pressure on GPL and a run-down of inventories.
Firms increase production to meet the increased
demand. They do so by hiring more FOP i.e. workers.
However, given that available resources are getting
scarce there is increased competition for factors of
production. Firms need to bid up factor prices. At the
same time, the increase in GPL leads to a fall in quantity
demanded for all goods and services, seem as a
movement up along AD2. A new eqm is reached at E2
where GPL has increased to P2 and real output increases
to Yf.
These adjustments will bid up the GPL, causing demand–pull inflationary pressure as shown in
figure above. Further increases in consumer spending and hence increase in AD2 to AD3 will lead
to a further increase in GPL to P3 without any increase in real output.
19
Evaluation: However, as Singapore is a small economy, domestic demand takes up a smaller

proportion of AD. Thus the increase in consumer spending may not have a significant impact on
↑AD thus resulting in limited inflationary pressure.
Explain and illustrate cost-push inflationary pressure

Cost-push inflationary pressure is defined as a situation when there is an increase in the unit cost
of production independent of changes in AD. In the figure below, we can see that the economy is
initially at equilibrium at GPL P1 and real output Y1.
Causes of cost-push inflationary factors in SG:

Tight labour market
- Tight labour market could be due to factor immobility
and shortage of skilled labour. Pattern of demand
changes resulting in a contraction of the related
industry (sunset) and expansion in another industry
(sunrise). The demand for labour falls in contracting
industry and rises in expanding industries
- If prices and wage rates are inflexible downwards in
the contracting industries, and prices and wage rates
rise in the expanding industries, the overall wage level
will rise
- When wage rates increase faster than the
productivity increases, unit costs of production
increases.
- This results in a fall in short run AS to AS2 resulting in an increase in GPL to P2.
Alternative: Students can analyse that a tight labour market suggests that the economy is near full
employment whereby any ↑AD will result in ↑GPL. Again, another alternative is to link to wage
push inflation.
Rising global commodity prices

- However, the rising global commodity prices would result in a further increase in unit COP.
Singapore has limited natural resources and thus it imports a lot of raw materials as well as
finished products. As global commodity prices rise, it leads to imported inflationary pressure.
The increase in world price of raw materials  further increase in unit COP  AS falls further
to AS3  GPL increase further to P3.
- Evaluation: Since Singapore depends heavily on imports even for basic necessities like oil and
food items, imported inflationary pressure is quite significant. However, in recent years, due to
government policy to limit the amount of foreign labour into the economy, the labour market
has tightened resulting in significant rise in the unit COP for many firms. Thus both factors have
led to significant increase in the rate of inflation in SG.
Conclusion:
Singapore being a small economy, rising global prices will result in cost-push inflationary pressure
which is imported. Also SG being an open economy with a large volume of trade, there has been
significant structural changes in the economy which has caused a significant change in the pattern
of demand for goods. This, coupled by the tight labour market has pushed up the unit cost of
production. Overall the cost push inflationary pressures have remained strong owing to these
20
factors. However, the high consumer spending is an insignificant factor of inflationary pressure due
to the small size of domestic demand relative to aggregate demand. Thus, overall the cost push
inflationary pressures are stronger than the demand pull inflationary pressures.
Introduction
Keeping inflationary pressures low is one of macroeconomic objectives. Most economists and
policy makers consider inflationary pressure to be low if it is in the range of 0-3% annual changes in
consumer price index (CPI). Strong inflationary pressures in Singapore have adverse impact on the
level of investment, thereby slowdown economic growth. It also erodes price competitiveness of
exports, thereby worsens Balance of payments. Thus there is a need to curb inflationary pressures.
Development
(A) Revaluation of SGD helps to lower strong inflationary pressure in Singapore:
1. Revaluation of SGD curbs cost push inflationary pressure (addresses the rising global
commodity prices):
Revaluation of SGD is a deliberate policy by the Monetary Authority of Singapore (MAS) to
strengthen the external value of SGD under its managed floating exchange rate regime.
Analyze how it works: Referring to figure 2, initially there is cost push inflationary pressure arising
from rising global prices shown by an increase in GPL from P1 to P2. A revaluation of SGD causes a
fall in the price of imports in domestic currency (SGD). It can lower inflation rate by lowering
imported inflation in three ways. Firstly, a rise in the external value of SGD will make imports
cheaper in SGD. A fall in the price of imported raw materials puts downward pressure on the price
level by lowering the costs of production, reducing the price of finished imports. Secondly, the price
of imported finished product will also be lower in SGD. Finally, lower imported prices means there
is more competitive pressure on domestic firms to keep their prices low. AS curve shifts to the right
from AS3 to AS2. GPL falls from P3 to P2, ceteris paribus reducing imported inflationary pressures.
Evaluation:
Revaluation primarily dampens cost push inflationary pressure originating from imported inflation.
The import content of domestically produced goods is very high in Singapore. Revaluation will be
highly effective as imported inflationary pressure keeps the cost push inflationary pressure strong.
2. Revaluation of SGD curbs demand pull inflation:

Analyze how it works: Refer to figure 1. Initially there is some demand pull inflationary pressure in
the economy shown by an increase in GPL from P1 to P2. Revaluation of SGD will result in an
increase in Px (foreign currency) and a fall in Pm (in domestic currency). Assuming ML condition
holds (PEDx + PEDm >1), this will bring about a fall in (X-M) and thus AD.
In addition, imported goods are now cheaper. By substitution effect, this will cause the demand for
domestically produced goods to fall, causing C to fall. This will dampen the high consumer
spending.
Since AD= C + I + G + (X-M), with a fall in (X-M) and C, there will be a fall in AD from AD2 to AD1 and
this will reduce demand pull inflationary pressure in the economy by reducing GPL from P2 to P1.
Evaluation:
The extent to which demand pull inflation falls depends on the extent to which AD falls. This
depends on the extent to which X and Cd falls.
21
The extent by which C falls depends on the degree of substitutability between domestically
produced goods and imported goods. If they are close substitutes, then the fall in import prices in
SGD will bring about a significant reduction in demand for domestically produced goods and thereby
a significant fall in C and hence AD. This will increase the effectiveness of revaluation of SGD in
curtailing demand pull inflation.
Overall evaluation of revaluation of SGD to maintain price stability:

However, the policy makes our exports less price competitive and it also encourages greater import
of goods and services. This will worsen Singapore’s BOT position and thereby worsen BOP position,
c.p.
(B) Supply side policies (addresses the tight labour market):

The government can use supply side policies to maintain price stability. They can be effective in
reducing cost push inflation due to structural rigidities arising from tight labour market.
Analyze how it works:

Workers receive relevant training in skills and become more mobile across industry enabling
labour movement from sunset to sunrise industry. SS of labour increases in sunrise industry
which causes a downward pressure on wages and reduces unit COP for producers.
• Draw DD-SS Dig for Labour market of sunrise industry ( Double Shift case) → draw initial
increase in DD → result in higher wages W1 → draw subsequent increase in SS ( after training)
→ result in wages falling from W1 to W2 → unit COP falls  AS rises  GPL falls (figure 2)
• Hence, when structural rigidities cause cost push inflationary pressure; supply side policies
will be the most appropriate policy to achieve price stability.
Evaluation:
Supply side policies are costly that require significant investments that have a high opportunity cost.
Funds allocated for these policies will imply lesser funds available for other developmental projects
such as transport and healthcare, thus leading to a fall in non-material SOL. If the benefit gained
from the SS-side policies is less than the loss of benefit from what would have been spend on
transport/healthcare, it would mean a less allocative efficient outcome. The outcomes of supply
side policies are seen only in the long run and often these outcomes are uncertain.
(C) Contractionary Fiscal Policy (addresses high consumer spending):

To curb demand pull inflationary pressure, a contractionary fiscal policy can be used. For example,
Singapore government can increase personal income tax rate. This causes a fall in disposable
income of households, fall in purchasing power hence a fall in Cd. AD falls as Cd is a component of
AD. Ceteris paribus, there will be a fall in GPL (figure 1). This reduces demand pull inflationary
pressure.
Evaluation:
Contractionary fiscal policies are targeted at reducing Cd, I and/or G all of which constitute domestic
demand. Since domestic demand contributes to only 25% of Singapore’s AD, any policy that impact
only domestic demand will have limited impact on AD. This reduces the effectiveness of FP in
maintaining price stability in Singapore.
Conclusion:
[Criterion: Nature of SG as a small and open economy] Given the small and open nature of
Singapore economy, revaluation of SGD, despite its limitations has been a major and effective policy
in maintaining price stability since inflationary pressure in SG is mostly imported. It is also effective
in curbing demand pull inflationary pressure arising from high consumer spending. This thus tackles
22
2 of the 3 sources of inflation discussed in part (a). However, it does not address the root cause of
the cost push inflation due to structural rigidities. Thus, it may have to be complemented together
with supply side policies to maintain price stability.
23
6. On 14 October 2011 Premier Wen Jiabao of China called for joint international efforts to combat
rising trade protectionism, which he said was damaging the world economy amid on-going
global economic turbulence.
Source: China Daily, 15 October 2011
Discuss whether the use of protectionist policies can ever be justified during a period of worldwide
economic recession or whether governments should follow Premier Wen’s advice and adopt a
policy of greater free trade. [25]
Introduction:
• Define “Worldwide economic recession” at least 2 quarters of negative economic growth

affecting countries all over the world
• In response, governments can either (1) adopt protectionist policies or (2) combat
protectionism and adopt greater free trade
• Define “Protectionism”
• [What is it?] deliberate policy to erect trade barriers in order to shield domestic
industries from foreign competition.
• [Purpose] The aim is to switch expenditure, both domestic and foreign, to goods and
services produced by the domestic economy.
Development 1: Analyse the impact of a worldwide economic recession
With a worldwide economic recession

• ↓NI in many economies due to ↓confidence
• ↓PP  ↓Demand for all goods and services
including imports, assuming YED>0 (normal goods)
• ↓Demand for exports from trade partners (US) 
↓X
• ↓AD as AD=Cd+I+G+X
• Assume: Economy is near full employment
• Adjustment: surplus of Y2Y1  inventories
accumulate  signals to firms to ↓production 
real output ↓ to Y2 with no change in GPL
Evaluation: Other impacts

• Worldwide economic recession  ↓business and consumer confidence  ↓I and Cd 
further ↓AD  further contraction of the economy
• ↓I  ↓capital accumulation  may lead to ↓productive capacity and ↓potential
growth  ↓LRAS
24
Development 2a: Justify why protectionism may be justified in

a recession
Analysis of Demand Deficient UE
• A fall in real output  fall in demand for FOP such as
labor  Fall in ADL to ADL2
• However, due to contractual agreements, wages are
sticky downwards  wages remain at W1
• Results in Demand deficient unemployment of L2L1
Analysis of Tariffs  link to UE

The govt can use a tariff to reduce the extent of the UE
• Govt imposes a per unit tariff of P1P2
• ↑unit COP for foreign firms  ↓world supply to
Sw + tariff  ↑P to P2
• ↑ domestic qty SS from Q1 to Q2 as consumers
switch their expenditure from imports to
domestically produced goods
• ↑domestic production  ↑demand for FOP such
as labor  ↑ADL to ADL3  ↓demand deficient
UE to L3L1
• Other impacts: ↑material wellbeing  ↑SOL
Evaluation: Effectiveness of tariff depends on PES

• The more price inelastic the supply, the
smaller the ↑qty SS given the same tariff
• [Reference diagram] With a relatively more
price inelastic SS  the ↑qty ss is smaller 
only Q1Q5 instead of Q1Q2
• This will lead to a smaller shift in ADL 
smaller impact on ↓UE
Development 2b: Costs/Problems of protectionism
Domestic Impacts
1. Society’s welfare, Consumer Welfare
• The use of a tariff will result in a deadweight loss to society

• Consumer welfare has worsened due to higher price and lower output
• The ↓consumer surplus (area a+b+c+d) due to ↑price and ↓output is not matched by an
↑producer surplus (area a) due to ↑price and ↑qty ss  DWL of area b+d
2. Impacts other domestic industries

• Imposing a tariff  ↑P of the good  other dom. Industries may require the good as a
FOP  ↑unit COP  ↑P  loss of price competitiveness  goods relatively more
expensive  ↓qty dd  leading to UE created in other industries
• Example: Steel tariffs imposed by US led to negative impacts on other US industries such
as the automobile industry  loss of jobs in other sectors.
Impacts on world economy
25
3. World multiplier effect

• Imposing a tariff  qty of imports↓  X of trading partners↓  ↓AD of trading
partners  negative growth and ↓NI
• ↓PP of trading partners  ↓Demand for imports from US  ↓X  further negative
growth in US and worsens UE
• [respond to signpost] This eventually will “damage the world economy” as not only is US
impacted, but other economies as well.
Evaluation: Impact is worsened if countries retaliate

• Trading partners may retaliate in response to US protectionism  impose tariffs on US
imports into their countries
• ↓Xus  ↓AD  ↓real output  ↓ADL  worsens demand deficient UE
• Also brings the economy further into recession.
Development 3a: Justify why govts should adopt a policy of greater free trade
Benefit of Free trade according to Theory of CA

• Greater free trade will be mutually beneficial to economies assuming they specialise
and trade in the good they have C.A. in and the terms of trade lies between the dom.
Opportunity cost ratios.
• Assume:
• 2 countries  US and China with different factor endowments. US is relatively
abundant in capital goods while China is relatively abundant in low skilled labor.
• Assume each country allocates half its resources into producing each good: Cars
and Rice.
• China has a comparative advantage in rice production since the opportunity cost for 1 unit
of rice produced is 1/2 cars whereas for USA it is 3 cars.
• USA has a comparative advantage in car production since the opportunity cost for 1 unit
of car produced is 1/3 rice whereas for China it is 2 rice.
• Given the abundance of labor and relative lack of
capital in China, the opportunity cost of producing a
labor intensive good in China is only 0.5 cars forgone
while for USA, in producing a labor intensive good, she
sacrifices a lot more cars (2 cars). In other words, the
labor in USA, if placed in car production, could have
produced a lot more cars because USA had more
capital for the labor to work with.
• US is currently producing 30 cars, 10 rice
• The PPC for US has a slope of 3 (3 cars has to sacrificed
for each unit of rice produced)
• US specialises in producing cars allocates all its
resources to car production producing 60 cars
• Assume a TOT of 1 car for 1 rice  slope of TPC is 1.
• US can potentially exchange its 60 cars for 60 rice
• Overall Benefits: The economy is able to consumer outside its PPC  ↑qty of goods that
can be enjoyed by an economy  ↑material wellbeing  ↑SOL
• Though not analysed in this essay, China will likewise benefit in a similar manner.
Development 3b: Limitations of pursuing greater free trade
Limitations of Theory of CA  Labour Immobility
26
• We assume that FOP are perfectly mobile between both industries

• However, in reality, there is some degree of labour immobility  labour used in the rice
industry may not be able to work in the car manufacturing industry due to a lack of
relevant skills
• Results in structural unemployment  costs to the govt and economy
• Limits the extent of the benefit of free trade
• Thus, may not be useful in times of recession as it may exacerbate the problem of
unemployment
Other problems with ↑free trade – volatile growth

• With greater free trade, economies become even more interconnected  greater
susceptibility to impacts from other economies
• Focusing on free trade will results in large dependence of export revenue for economic
performance
• In times such as a worldwide economic recession  larger negative impact on growth and
employment compared to economies that are less open to free trade
Conclusion:
Depends on ability to use alternative policies to address the impact of the recession
• Protectionism results in many problems such as loss of consumer welfare as well as the
world multiplier effects which reduces the effectiveness of protectionism
• In a recession, a government with available resources should look at alternative policies
such as an expansionary fiscal policy which seeks to boost AD through ↑G or ↓T
• This mitigates the effects of the worldwide recession and may be able to boost confidence
in the economy and the economy can focus on ↑ free trade
• However, not all economies have the resources to do so and some may have to use
protectionism to minimise the negative impact of the worldwide recession in the short
term.
Depends on ability to mitigate the problems of free trade

• A government can reduce structural UE through education and retraining  mitigates the
problem of free trade  therefore govt should focus on free trade as it is more able to
reap greater benefits
• [Answer the question] Depending if the govt is able to implement alternative or other
policies, protectionism may not be justified in the long run and economies need to focus
on greater free trade
Impact on minority vs majority

• Protectionism is not justified as the protection only seems to benefits a small minority
from the protected industries while a majority of consumers (who have to pay a higher
price) and related producers (who require the higher priced good as a FOP) are negatively
impacted.
Short term vs Long term net impacts

• Although protectionism can reduce the problems of a recession, its effects are short term
and eventually in the long term due to the world multiplier effect or retaliation by other
govts, the benefits will be cancelled out by its challenges. In contrast, even though there
may be some short term challenges to greater free trade, in the long run it will have a
large net benefit overall.
27
• [Answer the question] Protectionism thus cannot be justified in the long run and
economies need to focus on greater free trade
28

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2013 H2 A Level Essays

1. Economics assumes rational decision – making by consumers, firms and government.

Suggested ans for b

Thesis: Rational decision making can result in an efficient allocation of resources

• Via the price mechanism, consumers and

Private benefits of merit good underestimated:

External benefits of merit good not considered:

[explain how market dominance leads to market failure]

Anti-thesis 2: Rational decisions by govts might lead to an inefficient allocation of resources

Subsidies are transfers from the

Source: http://www.ura.gov.sg/pr/text/2011/pr11-135.html, accessed 28 October 2011

Explain 2 factors leading to an increase in demand for housing

b. Cost of borrowing (mortgage interest rate)

Long run supply: Availability of land

The increase in ss of housing to SS2 will

Basic condominiums: For basic

State the combined impact of the

Level Knowledge, Understanding, Application & Analysis Marks

Suggested ans for a:

1. Explain key cost concepts

2. Analyse the impact of ↓demand

• Firm is now earning subnormal profit of C2cdP2

3. Explain shut down condition

4. Explain the LR equilibirum

Suggested ans for b:

Recession  fall in Yd  fall in consumer’s purchasing

Assuming firms (oligopolistic & MC) are currently

Firms will shut down in the short run if AR < AVC to

[explain LR eqm for MC firms] If existing MC

The nature of the good determines the vulnerability

(a) Explain the consequences of failing to achieve these aims [10]

Suggested ans for a:

Suggested ans for b:

Devt 1: Domestic Factors

their goods would be more

Other domestic factors:

Other international factors:

Suggested ans for a:

Identify factors causing strong inflationary pressures

Explain and illustrate demand-pull inflationary pressure

Evaluation: However, as Singapore is a small economy, domestic demand takes up a smaller

Explain and illustrate cost-push inflationary pressure

Causes of cost-push inflationary factors in SG:

Rising global commodity prices

Suggested ans for b:

2. Revaluation of SGD curbs demand pull inflation:

Overall evaluation of revaluation of SGD to maintain price stability:

(B) Supply side policies (addresses the tight labour market):

Analyze how it works:

(C) Contractionary Fiscal Policy (addresses high consumer spending):

Source: China Daily, 15 October 2011

• Define “Worldwide economic recession” at least 2 quarters of negative economic growth

Development 1: Analyse the impact of a worldwide economic recession

With a worldwide economic recession

Evaluation: Other impacts

Development 2a: Justify why protectionism may be justified in

Analysis of Tariffs  link to UE

Evaluation: Effectiveness of tariff depends on PES

Development 2b: Costs/Problems of protectionism

1. Society’s welfare, Consumer Welfare

• The use of a tariff will result in a deadweight loss to society

2. Impacts other domestic industries