Answers to Essay Questions 1 In the background of rising oil prices and current economic conditions, Singapore Airlines (SIA)

announced that it will remove the economy seats from its non-stop flights to the United States. If economy-class travellers want to fly Singapore Airlines to America, they will have to stop over in Frankfurt, Tokyo or Taipei, increasing travel time by as much as six hours. The Straits Times, 5 (a) (b) Explain the concepts of price elasticity of demand and income elasticity of demand. Assess the relevance of these elasticity concepts in explaining SIA's decision to discontinue its non-stop economy-class flights to America.
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Mar 2008 [10] [15]

(a) State definition and formula for PED and YED: PED measures the degree of responsiveness in quantity demanded but w.r.t a change in the price of the good itself, ceteris paribus.

YED measures the degree of responsiveness in quantity demanded but w.r.t a change in the income of the consumers, ceteris paribus.

Explain significance of sign and value: PED will always have a negative sign due to the law of demand. YED and XED, however, can exhibit both positive and negative signs. Positive YED indicates that the good is a normal good while negative YED indicates that the good is an inferior good. For the value of PED and YED, the greater the value, the greater will be the influence of that factor in affecting the quantity demanded of the good. For e.g. a high PED value implies that the price of the good is a very significant factor in affecting its quantity demanded while a high YED value implies that changes in the level of consumer income will exert a strong influence on quantity demanded Illustrate with diagrams and examples. Knowledge, Application, Understanding and Analysis Level 1 (1-4) Level 2 (5-6) Level 3 (7-10) Largely inaccurate or incomplete explanation of either concept of PED and YED. Explained both concepts in terms of their definitions, graphical representation, significance of sign and magnitude. Accuracy and completeness of analysis will determine marks awarded in this mark range. Applied PED and YED concepts to examples. Used factors affecting PED and YED to explain examples given.

(b) Explain the impact of rising oil prices on SIA. Rising oil prices petrol is a significant input for airlines, cost of production for SIA increase SS curve of SIA services shift upwards assuming Dd remains the same, equilibrium price increase and output falls profits will fall if (TR TC) falls Explain why the demand for business class seats is less price elastic than the demand for economy class seats.

 Therefore SIA is able to pass on the increase in petrol cost to business class passengers in terms of higher prices less than proportionate fall in quantity demanded TR increase. Discontinue economy-class seats and replacing them with business class seats may be an attempt by SIA to raise price and TR. Assuming total cost remain unchanged, SIAs profit is maximised. Therefore PED is relevant in explaining SIA decision. If income of SIA passengers remain unchanged, then YED is not relevant in explaining SIA decision. However, if there is a substantial increase in oil prices over a sustained period of time raises firms COP and GPL high inflation, price instability discourage consumption, investment and international trade (rising transportation cost) global economic slowdown consumers income falls demand for air travel falls. Extent of fall in demand for SIA services depend on YED. Since business class travelers are typical business men who travel out of necessity and economy class travelers are holiday makers who may see oversea tours as a luxury, demand for business class seat is less income elastic than the demand for economy class seats. Therefore demand for economy seats will fall more than the fall in demand for business class seats. Increasing the no. of business class seats and reducing the no. of economy class seats will help to reduce the extent of overall fall in the demand for SIA services and reduce the fall in TR. Assuming constant total cost, this will maximise SIAs profits. Therefore YED is also relevant in explaining SIAs decision if there is an economic slowdown triggered by the rising oil prices. Evaluation: PED and YED concepts are relevant to the extent that surrounding economic conditions do not change drastically to affect the PED and YED values and that they can be measured accurately and kept up-to-date. SIA may also take other factors into consideration when making its decisions besides the value of PED and YED. Knowledge, Application, Understanding and Analysis Answers are mostly irrelevant and contain a few valid points made incidentally in an irrelevant Level 1 context. (1-5) Analysed the effects on SIAs prices and consumers income due to increase in oil prices and Level 2 current economic conditions. Analyse the impact on quantity demanded and total revenue. Link (6-8) decision to SIA profit maximising motive. Level 3 (9-11) Levels E1 (1-2) E2 (3-4) Able to distinguish the different effects on quantity demanded and total revenue for economy class seats and business class seats. . Link decision to SIA profit maximising motive. Description Judgment on relevance of both elasticity concepts with little or no justifications. Judgment on relevance of both elasticity concepts that is well justified.

Four manufacturers of a traditional Chinese cupcake (Fa Gao), thought they could have their cake and eat it as well. The four, among the biggest manufacturers of Fa Gao and which together corner half the market here, had agreed to jointly raise the selling price of the cakes. The collusion landed them in hot water with the competition watchdog. Adapted from The Straits Times, 16 April 2008
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(a) (b)

Explain the factors that affect the above pricing behaviour. Discuss the view that collusion is not beneficial to society.

[10] [15]

(a) Introduction: State that the pricing behaviour is a form of collusive pricing behaviour typical of firms in an oligopolistic market structure. Body: Explain how the characteristics of the Fa Gao market fit the features of an oligopolistic market: Few dominant firms [As seen from extract The four, among the biggest manufacturer of Fa Gao and which together corner half the market here] Homogeneous or differentiated product [Product which is Fa Gao would tend to be more homogeneous, with minor differences in terms of quality and taste.] Significant barriers to entry [Barriers to entry into the Fa Gao market is likely to be less restrictive. There may be some forms of barrier to entry in terms of control over suppliers of raw materials by the big four, large capital required for baking equipments and threat of predatory behaviour by the big four.] Mutual interdependence of firms [This is evident as seen from the collusive pricing behaviour described in the extract.] Price rigidity and non-price competition [These are not clearly evident in the extract; hence elaboration of this point is not really required.]

State that due to mutual interdependence of firms, there isnt one fixed theory to explain the price & output decision of an oligopolistic firm. Whether there is collusive pricing behaviour in an oligopolistic market depends on the following factors: Number of firms in the market The lesser the number of firms in the market, the more likely the oligopoly is to be a collusive one. Hence, since there are only a few dominant firms Hence, in a market where there are fewer dominant firms, we would expect price & output behaviour to be rather collusive and to move in tandem to achieve maximum profits for all parties involved. If there is a clear market leader in the industry (e.g. Microsoft), due to its large market share, reputation for keen market sense, then the price & output of firms in this industry is likely to follow that of the priceleadership model. If costs structures are largely similar, then we would expect a more collusive price & output behaviour in the industry. If the good or service tends to be more homogeneous, and if the oligopolistic market structure tends to be more of a non-collusive one, then we would expect a greater emphasis on price competition (i.e. price wars) than on non-price competition. However, if the good of service is more heterogeneous in nature, then we would expect more non-price competition and price rigidity instead.

Existence of market leader -

Similarity of cost structures amongst firms -

Nature of good or service -

 Possibility of entry by new firms If possibility of entry by new firms is relatively low, then we would expect more collusive behaviour amongst existing firms. If market conditions are stable, then it is easy to verify if members of a collusive agreement has cheated (i.e. produce more than given quota) or not. Hence, the more stable the market conditions, the more collusive we would expect of firms behaviour.

Stable market conditions (less ability and incentive for collusive members to cheat) -

Conclusion: Similar to firms in other market structures, we would expect a firm in oligopoly market structure to be profit maximizing as well i.e. fix price & output level whereby MR=MC. Such collusive pricing behaviour is however unique to oligopolistic firms due to the mutual interdependence of firms. Knowledge, Application, Understanding and Analysis Identified the market structure as an oligopoly with features well explained in context of Fa Gao market in Singapore. Explained clearly the pricing behaviour in terms of price-leadership L3 theory. Identified the market structure as an oligopoly but features not well explained. Did not L2 explain clearly the pricing behaviour in terms of price-leadership theory. Shows some knowledge of collusive behaviour without any reference to oligopoly market L1 structure. (b) Introduction: State that collusion effectively means that firms will act like a single firm, thus collectively, they have greater monopoly power. Thus, collusion effectively means less competition in the market. Body: Beneficial to Society Research and Development Progress With collusion, firms will be able reap greater supernormal profits. Hence firms will have greater ability and incentive to invest in R&D. Hence, dynamic efficiency is achieved and society benefits. Consumers may benefit from possibly lower prices of goods & services in the future, as well as better quality of goods & services. Reap Internal EOS If collusive firms gain greater market share and thus expand their scale of production, then these firms are able to reap internal EOS in terms of technical EOS (e.g. cars manufacturing), administrative EOS (most industries), marketing EOS (e.g. movies, sports apparel), financial EOS. Consumers will benefit if cost savings is passed on to them in terms of lower prices. Detrimental to Society Consumer Exploitation Collusion means that oligopolistic firms cooperate & operate collectively as a monopoly to restrict production & push up prices. Hence equilibrium price is higher, and equilibrium output is lower. This results in a fall in consumer surplus.

7-10 5-6 1-4

Allocative Inefficiency problem is worsened Profit-maximising output at MR=MC, and given that oligopolistic firms gain greater monopoly power, PMR with collusion. Hence, output level moves further away from the allocative efficient output at P=MC. Society will lose due to the greater deadweight loss incurred due to this increase in allocative inefficiency.

Establish stability in the market In industries that face unstable market conditions (highly fluctuating demand and supply conditions), then collusion can help firms establish stability in the market. Eliminates wasteful competition For example, firms will not spend huge amounts on advertising which do not benefit consumers and society much.

Diseconomies & X-inefficiency With greater market share and scale of production post-collusion, these large firms may incur higher unit cost if diseconomies sets in. As collusion results in lessened competition, society will lose out as possibility of X-inefficiency increases. However, the remaining non-collusive firms still pose strong competition to the collusive firms (contestable markets), then X-inefficiency may be quite minimal [Evaluation].

Conclusion: Make a conclusive stand as to whether benefits are likely to outweigh costs to society. A possible conclusion would be to state that collusion will be largely detrimental to society, especially in markets such as the Fa Gao market, benefits from EOS and R&D is likely to be limited. This is because the intent of collusion is meant to restrict output and raise prices, and thus causing loss of consumer welfare and worsening of allocative inefficiency problem. Knowledge, Application, Understanding and Analysis Benefits and costs of collusion are well elaborated and answer is balanced and supported with L3 a range of contextual examples. L2 L1 Elaborated on the benefits and costs related to collusion but answer tends to be one-sided. No or minimal contextual examples given. Shows some knowledge of the benefits and costs related to collusion but little or no elaboration.

9-11 6-8 1-5

Allow up to 4 marks for Evaluation For an evaluation based on economic analysis that leads to the conclusion. E2 E1 For an unexplained judgment, or one that is not supported by analysis.

3-4 1-2

Beijing has settled on a plan to ground half of its cars to alleviate air pollution and traffic congestion in the Chinese capital during the August Olympic Games. The temporary limit barred cars with licence plate numbers ending in odd or even numbers from entering the city on alternate days. The Straits Times, 24 January 2008
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(a) (b)

Explain how the situation described above is an example of market failure. Discuss whether this partial banning of cars from entering the city is the best solution to alleviate air pollution and traffic congestion in Beijing.

[10] [15]

(a) Define market failure to be the failure of free markets to allocate resources in a socially optimal and efficient manner. Externalities are said to exist when the actions of producers or consumers affect not only themselves but also third parties, other than through the normal workings of the price mechanism. Externalities can be either positive or negative and would cause a divergence in either the marginal social benefit (MSB) and marginal private benefit (MPB) or marginal social cost (MSC) and marginal private cost (MPC) or both. Existence of externalities will thus result in social inefficiency because individuals (road users) normally only consider the private costs and benefits of their decisions. They largely ignore, or are unaware of, the wider social costs and benefits of their actions. Hence, without government intervention, existence of externalities would lead to either over-production and consumption or under-production and consumption of the good or service. For example, whether someone decides to drive the car to work or not depends on what he views as private benefits which may include saving transport time and not having to wait with uncertainty for public transport. Private costs of use of the road would include cost of petrol and car depreciation costs. Assume that MSB=MPB (no positive externality). Explain how the use of roads generates external costs, such as environmental and congestion costs. Environmental costs can include health problems and higher health care costs while congestion costs include loss of productivity as time spent on the road being trapped in a traffic congestion could have otherwise being spent on more economically productive activities. Where there are external costs, MSC > MPC. Explain, using a diagram, how the use of road space without government intervention would occur at MPB = MPC, since external costs will be ignored by the road users. This will result in an over consumption of road space at a quantity where MSC>MSB which is not socially optimal. Analyse the dead-weight loss to society using a diagram.
Cost/ Benefit MSC = MPC + MEC MPC MEC

PSE PP

Fig. 1: Negative Externalities

Overproduction & over-consumption (QP > QSE) DWL = area ABC

QSE

QP

Qty

Knowledge, Application, Understanding and Analysis Level 3 Clear explanation of the MSB-MSC framework. The best candidates are expected to clearly establish why the market failed resulting in allocative inefficiency and DWL. Relevant theories and diagrams (7-10) with examples are used to aid explanation. The candidate is able to apply examples in context of the question. Level 2 (5-6) Undeveloped explanation (e.g. diagrams used without much depth in analysis or inaccurate diagrams) is likely to be observed. The weaker candidates in this band are likely to answer solely from a theoretical view point without clearly answering the question in explaining with examples on how carbon emissions creates external cost which leads to market failure. For an answer that has some basic correct facts (e.g. vague definitions, statement that there is overproduction/consumption) without elaboration. The MPB = MPC framework AND the use of the MSB = MSC framework is likely to be briefly mentioned or not at all by the candidates.

Level 1 (1-4)

(b) Since there is an urgent need to cut pollution and congestion before the commencement of the Beijing Olympic Games, this method of banning cars from the streets may be the best way to address the problem as the number of cars on the road will be reduce by about half almost immediately. There will be an immediate cut in congestion and pollution in the city which will facilitate the successful organization of the Olympic Games. The marginal benefits of this measure (in terms of reduction of pollution and congestion, leaving a positive impression on the foreign visitors during the Games and boosting China image as a tourist and business destination, etc) may outweigh the marginal cost. (drivers who cannot drive into the city is made worst off, additional cost to businesses which are affected by the ban, etc). Analyse using a diagram, how this method will reduce the no of road users in Beijing by about half to achieve a more allocative efficient outcome. [MPC falls for the case whereby student argues fall in number of SS of cars or MPB falls for the case whereby student argues fall in number of road users. **Check the labeling of diagram or axes to determine accuracy of diagram.] However, the government may have difficulty in measuring the monetary value of MEC and hence have difficult in assessing what is the optimal no. of cars to be allow on road to maximize societys welfare. Illustrate with a diagram how cutting the no. of cars by half may not reduce the DWL area completely or may even create a bigger DWL due to under consumption. Even if the govt does cut usage of roads towards a more optimal amount by banning some cars, the use of road space in this case is rationed based the random allocation of car plate numbers and it does not always allow the drivers who has the highest valuation of driving in the city to use their cars. This will result in a misallocation of scarce road space to users who may not value it most and therefore societys welfare may not be maximized. Commuters who are rich enough to own multiple cars with licence plate numbers ending in both odd and even numbers can easily get around the ban by driving the relevant car. May not be effective in reducing the number of cars entering the city. Suggest and explain one other method to reduce road usage that will result in a more efficient outcome compared to banning some car from entering the city. E.g. petrol taxes, some form of road pricing system (toll booths on roads entering the city or ERP or restricted zones), increasing attractiveness of public transport, better urban planning, etc.

A temporary ban on some cars from entering Beijing may be the best method in the short run as it can achieve fast results. However, it may not be the most efficient way to solve the traffic congestion and pollution problem in Beijing in the long run and other measures are required to address this problem.

Knowledge, Application, Understanding and Analysis The existing policy of banning cars from the city and other possible policy solutions are clearly Level 3 explained and compared. Analysis and evaluation is clearly relevant to the context given. (9-11) Level 2 (6-8) Level 1 (1-5) Levels E1 (1-2) E2 (3-4) Some attempt at explaining how policy of banning cars from Beijing and other policies will work to solve the market failure problem. Answer may show little or no application to the context given. Answers are mostly irrelevant and contain a few valid points made incidentally in an irrelevant context. Description Judgment on whether banning cars from the city is the most appropriate policy with little or no justification. Comment on whether banning cars from the city is the most appropriate policy with justification. Judgment criteria are clearly stated and elaborated. *Note that if no alternative polices is proposed, not possible to achieve E2 marks.

India, which is keen to sign a Free Trade Agreement (FTA) with China, is increasingly open to foreign competition and is attracting increasing amounts of overseas funds. The economy was boosted by growth in the tourism and financial sectors, and a strong manufacturing performance. High oil prices and sluggish exports failed to dampen growth. BBC News, 30 November 2005 Explain how changes in injections may affect a countrys ability to achieve sustained economic growth. [1 0] Discuss the extent to which the use of monetary policy may be preferred over other macroeconomic policies in achieving the macroeconomic aim of sustained economic growth in India. [1 5]
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(a) (b)

(a) Define sustained growth: non-inflationary stable economic growth 2. Explain what is meant by an injection into the circular flow of income Assuming a 4-sector economy, an increase in injections may come from an increase in I,G,X Explain the multiplier effect of an increase in injections by means of a numerical illustration and a diagram. Explain how actual growth takes places given an increase in national income. Explain that an increase in I would also generate potential growth through capital stock accumulation and increases in productive capacity which is beneficial in promoting low stable price levels to sustain growth. For a descriptive answer with some basic correct facts about injections but little/no attempt in explaining effects on economic growth. For an ability to explain the effects of changes in injections on actual economic growth by means of the multiplier process and/or some reference to potential growth. For an excellent ability to explain the effects of changes in injections on both actual and potential growth. The use of the multiplier principle is evident. Expect an ability to recognise the importance of maintaining low stable prices in sustaining economic growth.

L1 1-4 L2 5-6 L3 7-10 (b)

Define monetary policy Identify the economic conditions that India is facing and state that the use of monetary policy over other macroeconomic policies like FP, supply-side policies and exchange rate policies needs to be considered in context of the economic conditions of increasing openness of the economy (to trade, FDI and hot money flows) and high oil prices. Explain the use of MP needs to be considered with the aim of sustaining Indias economic growth, i.e striking a balance between maintaining price stability while supporting economic growth. In the case of India it is likely to face inflationary pressures from the following: cost-push inflation effects high oil prices, rising liquidity due to increase in overseas funds in the form of hot money and FDI inflows. At the same time, economic growth in India has not been slowed despite slow growth in X and the high oil prices. Given the above situation, it is likely that monetary policy in India to have a contractionary stance to curb rising price pressures while the trade-off in terms of slower economic growth can be accommodated. However, the M.P has to be complemented by other macroeconomic policies to achieve the long-run objective of sustained growth.

Explain the use of contractionary MP using the Keynesian indirect transmission mechanism: Reduction in MS (eg. Central bank increases cash reserve ratio) leftward shift of MS along LP function raises lowers I (downward movement along MEI function) lowers AD Explain effect on price stability and actual growth using the AD-AS framework. Explain also that a rise in r would also lower C and reinforce the effects of lowering price levels and dampening actual growth. Evaluate the effectiveness of MP: interest elasticity of LP and MEI, size of K, degree of control central bank has over commercial banks etc. Comment that M.P is unable to directly curb imported inflation caused by rising oil prices. Need for appropriate polices like exchange rate and fiscal policies. India can allow its rupee to appreciate to a level sufficient to cushion against rising imported price pressures lower price of oil and oil related imports (in home currency) lowers cost of production rightward shift of SRAS lowers GPL (explain and illustrate with AD-AS diagram) Evaluate the use of exchange rate policies. India can employ fiscal measures like reducing customs and excise duties on oil to soften the impact of rising oil prices. Fiscal policies targeted at the supply-side could also be used to combat cost-push inflationary pressures and raising potential growth: maintaining govt. development expenditure to improve infrastructure to attract FDI and expand productive capacity. Evaluate the use of FP policies. Explain the use of SS-side policies: raising productivity levels through manpower policies, restraining wage growth through wage guidelines lower unit labour cost reduce cost-push pressures. Evaluate the use of SS-side policies. Explain the use of trade policies: e.g. FTAs to raise X growth and raise FDI raise actual growth/potential growth. Evaluate the use of trade policies. Conclusion: Contractionary monetary policy is likely to be adopted by India in the short-run to alleviate inflationary pressures and maintain low stable prices without significantly lowering economic growth. However, it has to be complemented by a policy mix of FP, SS-side and trade policies in order also achieve potential growth while maintaining price stability over the long-run.

L1 1-5 L2 6-8

An answer that shows some knowledge on the use monetary policy in achieving economic growth. For explanation of the use of monetary policy in achieving economic growth for India. Expect an ability to explain the use of other macroeconomic policies although analysis lacks depth and weak application to context. Answer is unlikely to demonstrate clear application of polices in achieving both low stable prices and strong economic growth in the question context, i.e the concept of sustained growth is not accurately grasped and weak appreciation of the context. Limited evidence of evaluation. For an excellent explanation and detailed analysis of the use of monetary policy and at least 2 other relevant macroeconomic policies in achieving sustained economic growth in India. Answer clearly demonstrates confident grasp of the concept of sustained growth and sound appreciation of the context. Good depth of evaluation. For an unexplained assessment. For a judgment or evaluative assessment based on sound economic analysis.

L3 9-11 E1 1-2 E2 3-4

Discuss the view that a strong Singapore dollar policy has been the most appropriate policy in overcoming the main economic problems faced by Singapore in recent years.

[25]

Explain what is meant by a strong S$ policy: Gradual and modest appreciation of the S$ under a regime of a managed float system where the S$ given is an upward bias against a trade-weighted basket of currencies of its trading partners and competitors. Both the slope and the upper limit of the trading band is adjusted to allow the appreciation of the S$. Identify the main economic problems facing Singapore in recent years in the context of a small and open economy, export oriented: 1) Surge in global commodity prices contributing to imported inflation, 2) structural unemployment due to rapid shifts in comparative advantages arising from globalisation, 3) slower than expected economic growth and weaker exports due to slowing growth in key economies like U.S, E.U and Japan. State stand that a strong S$ policy has been effective in curbing imported inflation to maintain price stability but it has to be complemented by a package of polices to address the main economic problems facing Singapore. Explain how a strong S$ policy overcomes the problem of imported inflation. MAS can and has intervened in the Forex Mkt by buying up S$ to engineer a rise in the external value of the S$. This raises the demand for S$ and causes an appreciation of the S$. By allowing the gradual and modest appreciation of the S$, the MAS seeks to combat the threat posed by imported inflation. Appreciation of S$ lowers price of imported raw materials, commodities and finished products in domestic currency lowers domestic price level. This is especially important given the high import content of its exports. lower prices of imported inputs lowers cost of production lower cost-push inflation (caused by surge in global commodity prices) shifts SRAS to the right lowers GPL. Explain how a strong S$ policy can enhance FDI by giving investors confidence in the Singapore dollar as expected future returns on I is likely to retain its value raise AD enhances actual growth in SR (explain and illustrate with diagram). In LR, benefits potential growth.

Explain how a strong S$ policy may have beneficial effects on economic growth. -

Limitations of a strong S$ Overly strong S$ reduces Singapores export price competitveness Increase in Px more than proportionate fall in Qty DDX (given PEDX>1: justify by referrring to the nature of Singapores exports) worsening B.O.T fall in AD fall in actual growth and employment. Explain illustrate with AD-AS diagram.Conflicts with other macroeconomic problems of slower economic growth. However, strong S$ by lowering price imported inputs can have benefical pass through effects on export prices amd positive effect on actual growth in the long-run. Ability of MAS to maintain a strong S$ policy also depends on MAS having sufficient foreign exchange reserves to conduct its exchange rate policy. This has so far been not a problem owing to the large trade `surpluses of Singapore in recent years.

Strong S$ however cannot respond to problems of structural unemployment created due to the dynamic nature of comparative advantage in light of globalisation, especially with the rise of emerging economies like China and India. Structural unemployment which is essentially a skills mismatch problem poses a threat to low skilled workers in declining industries, which a strong S$ is unable to address. Appropriate SS-side policies would need to be employed.

Explain relevant SS-side policies to address structural unemployment:

Mkt-oriented polices: Manpower policies to retrain and upgrade skills of workers facing the threat of structural unemployment. E.g. Skills Redevelopment Programme for InfoComm to retrain displaced workers for employment in InfoComm sector, WDAs Workforce Skills Qualification (WSQ) programme to train workers in sector specific skills, job redesign to make jobs more attractive to workers especially among the older workers. Deepen Singapores capabilities in existing key clusters such as electronics, chemicals and marine engineering, and biomedical sciences. Identify and develop new growth industries for job creation to develop new comparative advantages: E.g. Environment and Water sector, Interactive Digital Media sector. By focusing on the above sectors and moving to new areas of comparative advantage, it is intended that more employment opportunities can be created in tandem with the appropriate manpower policies to retrain workers for employment in such industries. Evaluation: Time lag needed to retrain workers, retention of skills learnt and transference to job may not be apparent, cost of financing training. Time lag needed to develop new growth industries.

Strong S$ alone is insufficient in attracting and retaining FDI in the face of competition posed by globalisation. Explain policies to attract and retain FDI to ensure sustained economic growth: Keeping business costs low by having a flexible wage system and ensuring that wage growth do not outpace productivity growth. Comment on role of NWC in setting wage guidelines. Evaluation: Wage-guidelines are voluntary not necessarily followed by private sector. Wages not only factor contributing to business costs. Reluctance of pte sector to implement flexible wage system especially in times of tight labour market situation. FP with supply-side effects: (a) increase G on physical and social infrastructure spending, spending on R&D, education provide conducive environment to support foreign investors increase FDI incentive raise FDI (b) lower T cuts in corporate taxes to raise the rate of return from I for foreign investors increase FDI incentive raise FDI Evaluation: Strain on government budget. However, with prudent fiscal policy enabling Singapore to achieve healthy budget surpluses over the years, impact is less significant. Moreover, the raising of GST rates by extra 2% has enabled the government to broaden its tax base and help to cushion the loss of tax revenue from lower corporate taxes. Such policies to attract and retain FDI not only enhance actual growth but also potential growth.

Explain relevant policies to enhance Singapores export competitiveness to boost actual growth. Signing of FTAs to increase Singapores export markets and increase X Develop new areas of comparative advantage to better complement emerging economies like China and India: e.g. Biomedical, logistics services, environment and water purification, tourism etc. increase X growth Increase productivity, process innovation to lower unit cost raise export price competitiveness Improve product quality to raise export demand.

Evaluation: LR policies, unable to achieve immediate effects owing to time lags. Cost of innovating and product improvements may reduce profit margins in SR. Conclusion: Given the small and open nature of the Singapore economy, it is imperative that a strong S$

policy be maintained to keep out imported inflation to achieve price stability so as to sustain economic growth. However, exchange rate policy cannot act alone but a policy mix of supply side policies, FP and trade policies need to be employed to address the other economic problems/potential trade-offs as well. Where the answer is mostly irrelevant and contains only a few valid points made incidentally in an irrelevant context. L1 1-9 For an answer that shows some knowledge of exchange policy and/or one other policy targeted at the macroeconomic problems. The question has not been properly grasped, and there is inadequate development of analysis AND application. For an accurate but undeveloped explanation of the use of exchange rate policy for Singapore and 1 other relevant policy in addressing the main economic problems faced by Singapore in recent years. Little reference to the nature of the Singapore economy. No attempt at evaluation. Expect an accurate though undeveloped explanation of the use of exchange rate policy for Singapore and at least 2 other relevant policies in addressing the main economic problems faced by Singapore in recent years. Expect a good knowledge of the facts and theory of the question. Clear evidence of the ability to present a logical and reasoned analysis. Good attempt at examining the appropriateness of exchange rate policy weighed against the use of at least 2 other policies for Singapore set in the context of the main macroeconomic problems in recent years and the underlying nature of the Singapore economy. Good attempt at evaluation by providing a clearly reasoned structure to the whole answer. Expect a thorough knowledge of facts and theory with an excellent ability to describe and explain this in a precise, logical, reasoned manner. Excellent attempt at examining the appropriateness of exchange rate policy for Singapore set in the context of the main macroeconomic problems and the underlying nature of the Singapore economy. E1 1-2 E2 3-4 Mainly unexplained judgment. Judgment or evaluative assessment based on sound economic analysis.

L2 10-14

L3 15-21

On the trade front, Singapores network of 13 Free Trade Agreements (FTAs) with countries ranging from USA to China has exposed Singapore to a myriad of benefits like tariff concessions and faster entry into markets. Adapted from www.iesingapore.gov.sg

(a) (b)

Analyse the impact of such Free Trade Agreements on Singapore. To what extent can the policies currently adopted by the government help Singapore cope with the negative impact of such Free Trade Agreements?

[12] [13]

(a) Introduction Definition of FTA Purpose of signing FTAs: to increase exports through the removal or reduction of trade barriers and to facilitate trade as well as capital flows between member countries, in order to achieve economic growth and development among member countries. This may bring about potential positive and negative impacts on Singapore economy.

Body Positive impact from FTAs: Allows for specialisation of goods that the countries have a comparative advantage in explain the gains from specialisation and trade using theory of CA gain in terms of increase in world output and consumption Consumers can obtain lower priced goods because Singapores trading partners could produce them more efficiently due to their comparative advantage More varieties of goods and better qualities of products increase consumer welfare Increased trade links with member countries provide competition for domestic producers a boost to efficiency of production and quality of products Domestic producers gain from an enlargement of export markets reap internal economies of scale from larger production (particularly for small domestic market like Singapore) increase X revenue Tariff concessions result in relatively cheaper exports from Singapore, therefore resulting in increase X demand increase X revenue Along with trade creations, more foreign investment (long term capital inflow) inflows (from US and China etc) as well possibility creating a surplus in BOP together with increased exports (as Singapore has already minimal tariffs before FTA hence the increase in imports from tariff reduction would be small) With a potential BOP surplus, it is likely that exchange rates will appreciate external stability Increase in AD through increase in consumption, investment, net exports increase in production through the multiplier process increase NY, employment and SR growth (if economy is operating below full employment) Show AD-AS curve From capital inflow technology transfer to domestic economy from foreign investments as well as increases in capital accumulation allows Singapore to increase productivity, increasing productive capacity in the economy, hence achieving LR ec growth. Show outward shifts in PPC or LRAS curve

Negative impact from FTAs: Singapore will face higher levels of structural unemployment in industries such as manufacturing, that are in direct competition with other lower cost trading partners due to the loss of CA decline in production levels less hiring of labour increase in structural unemployment as workers are not equipped with relevant skills to match up to the newly created industries with comparative advantage Increasing trade and capital flows encourage advancement in technology and increasing productivity of factors of production economy growth but, less workers are required due to the increases in technology and productivity levels jobless growth With increases in AD due to increase in net X and I dd pull inflation if Singapores operating close to Yf Increase in NY through improved X revenue could lead to more M expenditure worsens CA balance if the increase in M expenditure is greater than increase in X revenue. (given that in Singapore, the MPM is very high, increases the likelihood of CA deficit) Coupled with the possibility of increase LT capital outflows due to greater opportunities in member countries, this could result in BOP deficit. Higher reliance on M may also make us more vulnerable to the threat of imported inflation. And overreliance on X might make Singapore more vulnerable to external shocks. Higher income disparities may be observed as workers in exporting industries are likely to see higher incomes while those that focus in producing for domestic sectors are likely to see incomes falling.

Conclusion Increase signing of FTAs, with its reduction and removal of trade barriers brings along benefits and threats as well as conflicts in attainment of Singapores macroeconomic goals. Nevertheless the LR benefits tend to outweigh the SR drawbacks and Singapore governments policies to mitigate the negative effects of FTAs further justify the signing of FTAs with other countries. Level 1 2 3 Descriptors Sketchy explanation of both positive and negative impact of FTAs One sided discussion or underdeveloped two sided discussion Thorough discussion of both the positive and negative impact of FTAs which includes both micro and macro effects. Mark range 1-4 5-8 9-12

(b) Introduction: Briefly mention the fact that increased trade and capital movements due to FTAs signed between Singapore and its trading partners have resulted in conflicts in attainment of some of its micro as well as macro goals. Hence, the Singapore government has put in place some demand as well as supply management policies to help Singapore cope with these problems. Body In view of the threat of dd pull inflation due to the strong growth in X and I (FDI), as well as the threat of M inflation due to increased M expenditure, - Singapore government has put in place the exchange rate policy of adopting a gradually appreciating SGD to keep Pm relatively lower reducing possibility of M inflation and at the same time, preventing excessive increases in X dd through our strong SGD reducing excessive increases in AD reducing dd pull inflation. Evaluation: But, while our strong SGD was able to help us cope with inflation problems due to FTAs, it may result in conflicts in attainment of macro goals of healthy BOP and SR growth. the strong SGD makes M goods relatively cheaper in SGD and may therefore encourage further

increases in M expenditure (assuming PEDm > 1) worsening the BOP deficit Loss of X competitiveness in the SR through the strong SGD may result in adverse effects on growth (assuming PEDx > 1)

- Nevertheless, Singapores exchange rate policy has always been successful in helping Singapore cope with M inflation and Singapore has always been facing BOP surpluses even with the strong SGD, as the negative impact on growth ( from the loss of X competitiveness) is insignificant in the SR as PEDx < 1 in the SR, and in the LR, due to our reliance on M of raw materials in our production, the lower COP ( as a result of the relatively cheaper M raw materials) restores our X competitiveness, thus increasing X revenue in the LR. In view of the BOP deficit and dd pull inflation Singapore government has in place the CPF policy (high savings) that helps to ensure that consumption levels are kept in check reducing the threat of excessive consumption which may worsen the BOP deficit as well as dd pull inflation. Evaluation: this ss side tool has been relatively successful so far since Singapore has always been facing BOP surpluses and inflation had been kept relatively low and stable with the help of other complementary dd & ss management tools. In view of structural unemployment Singapore has adopted manpower policies (retraining and education eg. Skills Development Fund) to equip workers with new skills so as to increase their occupational mobility and to fit them into new industries that were created. Singapore government also spearheads R&D projects to develop new areas of growth and comparative advantage (CA) in the face of the erosion of Singapores CA in an attempt to search for new markets that require employment of more workers.

Evaluation: Such ss side policies materialise only in the long run as it takes time to train workers and to find new CA. And the increase in G on retraining and R&D can be inflationary in the SR. Besides, success of retraining efforts depends on the motivational levels of workers involved. In view of the threat of FDI diversion Singapore government has in place expansionary FP through the reduction in corporate and income taxes in order to attract FDI and foreign talent. Government also increases G spending on the provision of world-class infrastructure (physical and telecommunications) in order to increase business competitiveness, attracting FDI.

Evaluation: FP has been relatively successful in attracting FDI and foreign talent Emphasis on capital accumulation through FDI and increase in transfer of skills and expertise through foreign talent results in both AD and AS shifting rightwards, thus achieving low inflationary sustained growth. But government may incur budget deficits due to the loss in tax revenue and higher G expenditures. To attract FDI, government needs to ensure that our corporate tax rates remain competitive against that of our neighbouring countries eg HK.

In view of threat of over-reliance on X and increased vulnerability in face of external shocks Singapore government takes a LT view towards this issue by encouraging SMEs to venture overseas so as to reduce the dependence of our current account (CA) on BOT.

Evaluation: With our SMEs investing abroad, these investment incomes will in the LR increase Singapores CA so as to balance or offset any BOT deficits due to our reliance on X dd in face of external shocks. Also

helps to reduce our vulnerability to changing international conditions. Conclusion Given the conflicts in attainment of Singapores goals in the face of more FTAs signed with other countries, policies adopted by Singapore have been relatively successful in dealing with these conflicts. Our policy package of dd and ss management policies have enabled us to target our employment levels and growth rate, which can be compatible if the government is able to identify the type of new industries to develop/or expand and increase the occupational mobility of factors. Our inflation rate is kept under control and the BOP is not a problem at present. Level L1 L2 L3 Descriptors Sketchy explanation of policies to curb with negative impact of FTAs. Good analysis of policies to curb negative impact of FTAs, not necessarily well evaluated and applied to context of Singapore. Thorough analysis and evaluation of at least 3 policies to cope with negative impact of FTAs wrt Singapores context. Mark range 1-4 5-6 7-9

Evaluation An unexplained judgment or one that is not supported by economic analysis. E1 E2 For an evaluative discussion that is based on economic analysis and relate to Singapore context.

1-2 3-4