2008 TPJC H2 Economics Prelim Exam Answers

1
TPJC Economics / 2008 / H2 Preliminary Examination / Paper 2 1

TAMPINES JUNIOR COLLEGE

Preliminary Examination 2008

ECONOMICS 9732/02

Higher 2
Paper 2 (Essay)

Monday 25 Aug 2008 08 00 10 15 (2 hours 15 mins)

READ THESE INSTRUCTIONS FIRST

Write your name and civics class in the spaces provided on the answer paper.

Answer three questions in total, of which one must be from Section A, one from
Section B and one from either Section A or Section B.

Write your answers on the separate answer paper provided.

Write the question numbers of the questions you have attempted on the cover
sheet.

At the end of the examination, fasten all your work securely together.

The number of marks is given in brackets [ ] at the end of each question or part
question.

You are reminded of the need for good English and clear presentation in your
answers.

You may answer with reference to your own economy or other economies you
have studied where relevant to the question.

This question paper consists of 3 printed pages and 1 blank page.
2
Answer three questions in total

Section A

One or two of your three chosen questions must be from this section

1 The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub,
offers a wider range of goods than the typical FairPrice supermarket, and
includes new lines like electronic products and fashion wear.

(a) Explain how the scale of a firm influences its costs. [10]

(b) Assess the relevance of price elasticity of demand, income elasticity of
demand, cross elasticity of demand to the supermarkets in Singapore. [15]

2 (a) Explain how, in economic theory, a firm in a perfectly competitive
market determines the price and output that would maximise profit.
[8]

(b) Discuss whether this model of market structure is the most
appropriate to explain the behaviour of firms in Singapore. [17]

3 A new carbon capture and storage technique known as carbon
sequestration is being developed. This involves capturing greenhouse gas
pollution from power stations and locking it deep beneath the ground.

(a) Explain why greenhouse gas pollution from power stations are
likely to cause market failure. [8]

(b) Assess the policies that the Singapore government currently adopts
to overcome this market failure and consider whether the
government should finance the development of new technology
such as carbon sequestration. [17]

3
Section B

One or two of your three chosen questions must be from this section

4 The Singapore economy continued to expand at a healthy pace of 6.7% in
the first quarter of 2008. Employment expanded strongly, increasing by
68,000. Oil and food prices have risen more rapidly and are
expected to continue to increase. Consumer price inflation trended
upwards to 7.5% in June 2008.
Source: MTI, 10 July 2008

(a) Explain the likely causes of inflation in an economy. [10]

(b) Discuss whether monetary policy is the best policy to curb inflation
in Singapore. [15]

5 The two casinos set to open in the Integrated Resorts in Singapore are
part of the governments longstanding effort to reorient the economy
toward higher-value service industries like tourism and biosciences as it
loses manufacturing competitiveness to China.
New York Times, 19 April 2005

Explain the rationale for the above policy and discuss whether it is the
best policy to achieve the governments macroeconomic goals in a
globalised world. [25]

6. (a) Using economic theory, explain why there are gains from free
trade. [10]

(b) Discuss how exchange rate changes may affect a countrys
international trade. [15]

Suggested Approach
Essay Question 1

The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub,


(b) Assess the relevance of price elasticity of demand, income elasticity
of demand, cross elasticity of demand to the supermarkets in
Singapore. [15]

Part (a)

Introduction
A firm refers to a business unit which employs productive resources to produce
goods and services. Scale of firm is characterised by the amount of capital outlay
/ fixed assets, employment size and the levels of output / market share. In
Singapore, the employment size of the Small Medium Enterprises does not
exceed 200 workers and fixed assets not exceeding S$15 million.

Development
As a firm increases its scale of production, it is able to enjoy cost advantages -
internal economies of scale. Internal Economies of Scale are lower unit cost
achieved by a firm when it expands its output or enlarges its scale of production.
The internal EOS arises within the firm as a result of its own expansion and are
independent of the size and expansion of the industry.

Internal Economies of Scale (require to explain only two)
1. Marketing / Commercial Economies
A large firm buys its raw materials in bulk and large discount are often
offered by the suppliers. Instead of buying from the wholesaler, the large
firm can buy directly from the producer. For example, a supermarket can
obtain its meat, egg supplies, vegetables and fruits directly from the farms
at a discount while an independent stall at the wet market may have to
obtain his supplies from the wholesaler.

In selling a large volume of output, the firm may be able to use more
expensive but more cost-effective advertising. In other words, advertising
cost will be spread out. A firm such as NTUC Fairprice supermarket with a
nationwide market can afford to advertise in the papers, etc, to bring its
product to the notice of potential buyers whereas a small firm may not
have the capacity to advertise. Though such firms may spend large sums
on advertising, their advertising costs per unit sold may be well below
those of a small firm.


Advertising costs can spread over a large volume of sales. Moreover, the
large firm can save on advertising costs as the same advertisement helps
to promote its range of products and not just one product.

2. Administrative / Managerial Economies
As the scale of a firm increases, specialists can be employed to manage
the firm. In other words, division of labour can be introduced into tasks of
management. Different experts can be employed to take charge of
planning, production, accounting, sales promotion and personnel
management. Efficiency in management thus can reduce unit costs in
large firms.

3. Financial Economies
A large firm is often able to obtain finance more easily or on better terms
than a smaller firm. Its larger assets and greater selling potential provides
banks with greater security and makes it possible for them to provide
loans at lower rates of interest. The larger firm can also raise substantial
capital through public issue of shares.

4. Risk- bearing Economies
Large firms are in a better position to spread risks. Furthermore, large
firms have greater opportunities for reducing risk through the
diversification of markets or products. Thus, if sales drop in one market, a
large firm can still rely on sales in other markets to compensate for the
loss or if one product becomes unpopular, the firm can make up for the
loss from its sale of other products. In the case of FairPrice Xtra
hypermarket, it offers a wide range of goods and includes new lines like
electronic products and fashion wear.

Diseconomies of Scale (require to explain only one)
When a firm enlarges its scale beyond the minimum efficient scale, it may
experience diseconomies of scale where the unit cost increase.

1. Management problem
As a firm continues to expand, coordination and control become more
difficult. Communication becomes a time-consuming process, so that
decisions are inevitably delayed. In addition, communication in a large firm
tends to be one way; i.e., a superior will pass on to his subordinates
something to do without discussing the matter with them. One-way
communication often leads to ill-feeling and misunderstanding.

2. Financial Problems
When a firm is very large, it requires a lot of capital to finance further
expansion. It may be possible for the firm to obtain such finance only from
sources which charges increasingly higher rates of interest.

3. Marketing Problems
When a firm becomes too large, it will experience difficulties in finding
sufficient demand for the commodity it produces. After a certain point is
reached, expansion of the existing market can be achieved only by huge
expenditure on advertising and publicity.

External EOS(required to explain only one)
Large as well as small scale firms are able to enjoy external economies of scale.
External EOS are cost savings enjoyed by individual firms as a result of the
expansion of the industry as a whole. These economies are independent of the
firms own output and are outside the control of the firm. External economies are
possible to an industry as a whole when most of the firms in a particular line of
production comprising the industry are concentrated in one area, i.e. when
localization of industry occurs.

1. Economies of Concentration
These are mutual benefits to be derived when the firms in a particular
industry are concentrated together and the industry expands.

Development of infrastructure & marketing facilities
When an industry is first set up in a new area, transport, amenities (like
water, electricity, telephone facilities) and marketing facilities (for the
purchase of materials and sale of the product, specialized warehousing
and banking) may not be well developed. With the entry of firms leading to
expansion of the industry, it is possible for transport and marketing
facilities to be developed. Thus, individual firms need not build their own
road system and generator. This will help to cut down unit cost of
production. For example, in Singapore, the Ang Mo Kio Hub or IMM
building housed a large number of retail outlets including supermarkets
which enjoy the well-developed transportation (MRT and SBS Transit) and
other amenities.

2. Economies of Information
The development of the industry often leads to the development of
research facilities to improve the existing production techniques and the
publication of specialist journals. It becomes possible to set up research
associations which will carry out research work on behalf of individual
firms and publish the results for all firms to use. Such researches are of
enormous advantage to the industry as a whole but far too expensive for a
single firm to undertake unaided.

Conclusion
In conclusion, the large scale production enjoys internal EOS as AC decreases.
However, when a firm enlarges its scale beyond the minimum efficient scale, it
may experience diseconomies of scale where the unit cost increase (AC
increases). The external EOS are enjoyed by both the small and large scale
firms. Besides cost advantages, the scale of the firms also influences its revenue.
Firms must be large enough to capture a bigger market share and therefore able
to exert market power to set prices or output in order to increase its revenue.

Part (b)

Introduction
Supermarkets, like all other business organizations, conduct their day-to-day
business with the aim of maximizing their profits, ie. Revenue Cost. The use of
the 3 concepts of elasticity of demand helps the supermarkets to maximise its
TR. Some supermarkets may see growth maximising and expansion of market
share as their long term objectives.

Development
Explain how each concept may be relevant to the supermarkets seeking to max
TR

1. Price Elasticity of Demand
Usefulness
Ep measures the degree of responsiveness of the quantity demanded
of a good with respect to its price changes, ceteris paribus. It is useful
in helping the firm to determine the price that should be set to
maximize its TR.

Application
Most of the items sold one supermarket are available in other
supermarkets. Examples, rice, meat, ice cream, daily essentials etc.
Due to the availability of substitutes, we shall consider the case of Ep >
1. In this case, the supermarket should decrease price to maximize
TR. (diagram). A fall in price will lead to a more than proportionate
increase in quantity demanded, therefore increasing its TR.

Supermarkets should make its demand more price-inelastic so as to
increase price and capture more revenue. This can be done through
branding, promoting customer loyalty through discount privileges, link
points etc.

2. Cross Elasticity of Demand
Usefulness
EAB measures the degree of responsiveness of quantity demanded of
good A to a change in the price of good B, a related good, ceteris

paribus. It is useful in helping the supermarket to decide what
strategies they should adopt in response to a price change of a related
good (substitutes or complements) in order to maximise its total
revenue.

Application
If EAB high & positive (due to availability of substitutes)
Supermarkets need to take note of rivals pricing policies & strategies.
In the short run, if their rivals reduce price, supermarkets might have to
follow so that demand will not fall drastically. In the long run, in order to
reduce the degree of substitutability, supermarkets should differentiate
its product from rivals. E.g. creating unique services like delivery

EAB high & negative. Strong complements like salad and
seasoning.
Supermarkets can offer bundled packages at attractive prices to
increase customer base

3. Income Elasticity of Demand
Usefulness
Ey measures the degree of responsiveness of quantity demanded of a
good to a change in the income, ceteris paribus. It is useful in helping
the firm to determine its strategies and what to stock up in different
economic situations in order to maximise its total revenue.

Application
Ey is positive
During economic boom or end of the year where most people receive
their bonus, the supermarket could advertise more aggressively the
luxury goods which are income elastic (Ey > 1). Examples are
organic and premium food items. This is because during periods of
increasing income, the demand for luxury goods will increase by more
than proportionate. By exploiting on the higher Ey, the supermarkets
could increase its TR thus increasing its profits, ceteris paribus.

At the same time, supermarkets need not stock up too much income
inelastic goods (Ey <1) such as daily essentials as the increase in
demand is less than proportionate to the increase in income. There is
afterall physiological limit to how many loaves of bread and rice one
can consume even for someone very wealthy. Instead, the additional
income is more likely to be spent on manufactures like electronic
products and fashion wear.

Implication on growth and sales
Relying on the sale of staple items like bread and rice means that
supermarkets will see only very slow growth in the demand for their

products as consumers income rise. By diversifying, offering a wider
range of goods and includes new lines like electronic products and
fashion wear, supermarkets can benefit from exploiting their higher
income elasticity of demand and experience a more rapid growth in
demand and sales revenue.

In Singapore, some supermarkets exploit the high Ey by setting up
premium outlets in high income residential area that supply premium
food items to meet the demands of the high income group.

Ey is negative
Supermarket could promote inferior goods (some house brands)
during periods of decreasing income (recession, increase in tax rates).

Evaluate the relevance of the 3 concepts and its limitations
All the 3 concepts of elasticity of demand are relevant to the supermarkets to a
certain extent. The concept of price elasticity of demand can be considered as
useful in that it explains the price rigidity of supermarkets as oligopolistic firms
which are mutually interdependent. As a result, supermarkets may be hesitant to
increase or decrease the price of its products, they may instead follow the price
set by the most dominant firm in the industry. Cross elasticity of demand is also
useful as there are several supermarkets in the industry. Each supermarket is
watchful over the strategies that their rival supermarkets are engaging in. They
will tend react accordingly so as not to lose their customers. Income elasticity of
demand is especially useful in the long run where the economic situation and
income of the consumers changes. By offering a wide range of goods also
serves to meet the changing consumer patterns resulting from rising affluence,
the focus here is, therefore, on income rather than price as a determinant of
demand.

However, there are limitations with using elasticity concepts.

Difficulty in estimating elasticity values
Firstly, it is the ability to gather accurate data for analysis. Furthermore, precise
figures might not be so readily available and even if they were, historical trends
may not be adequate to correctly predict future ones. A normal good today might
be an inferior good tomorrow. The data therefore must not be obsolete as the
economy and preferences are not static but dynamic.

Ceteris Paribus assumption does not hold
Secondly, there are other factors that might be taking place concurrently, thus
influencing the outcome predicted using the elasticity concepts. For example,
even if there is a reduction in price for a price elastic good, its revenue may end
up falling if other factors (eg. a change in taste and preference) cause the

demand to fall at the same time. The assumption of ceteris paribus is rarely true
in real life and so elasticity estimates may be unreliable.

Elasticity values explain the effect on Demand & TR but did consider TC
Thirdly, demand elasticity concepts are only useful in explaining the changes in
demand and revenue. The long term survival of a firm however depends on its
profits. In other words, supermarkets must also keep a close watch on their costs
especially as it expands its scale.

Conclusion
In the short run, the supermarkets may still use the 3 elasticity concepts to
increase its total revenue although there are limitations. Supermarkets being
oligipolistic firms, in the long run, they may be concerned with building up barriers
to entry to increase their market share to increase their profits. By offering a wide
range of products, supermarkets position themselves as a one-stop shopping
place which provides convenience for customers, which enables them to capture
a wider market thus increasing their profits. At the same time, they are
maximising the use of their floor space, thus lower average cost. In so doing,
they are building barriers to entry preventing new firms from entering into the
industry.

Mark Scheme
Essay Question 1
The new S$12 million FairPrice Xtra hypermarket, at Ang Mo Kio Hub,
(b) Assess the relevance of price elasticity of demand, income elasticity
of demand, cross elasticity of demand to the supermarkets in
Singapore. [15]

Part (a)
Knowledge, Understanding, Application, Analysis
L3 For a well-balanced answer with both internal EOS (2), DEOS (1) and
external (1) economies of scale. Analysis is largely accurate and
expressed rigorously. Only internal EOS and DEOS, no ext EOS up to
8m

8 - 10
L2 For a correct but underdeveloped explanation.
Only internal EOS (3), no DEOS and no external EOS, up to 7m

4 7
L1 For an answer that shows some knowledge of internal economies of
scale as cost advantages enjoyed by large scale production. Some
conceptual errors.
1 3

Part (b)
L3 A well-balanced answer with both application of elasticity concepts and
consideration of other factors. Analysis is largely accurate and expressed
rigorously.
Good application of all 3 elasticity concepts & little or minimal evaluation
cap at 9
9 11
L2 Ability to apply elasticity concepts in analysis
Low L2 application of elasticity concepts (7 8)
High L2 a largely accurate application of elasticity concepts (5 6)
Two elasticity concepts only cap at 8
One elasticity concept only cap at 5
5 8
L1 Mere definition of elasticity concepts. An answer that is more descriptive
than analytical. May be laced with serious conceptual errors.

1 4
Allow up to 4 additional marks for Evaluation
E2 Ability to assess the relevance of the elasticity concepts and recognize
the cost considerations for supermarkets. Recognise the exploitation of
Ey on growth and sales. Attempt to write a reasoned conclusion to the
question.
3 4
E1 Attempt at evaluating the limitations of the use of elasticity concepts in
the supermarkets in Singapore.
1 2

Suggested Approach
Essay Question 2
(a) Explain how, in economic theory, a firm in a perfectly competitive
market determines the price and output that would maximize profit.
[8]

Part (a)

Introduction
In general a perfectly competitive market is characterized by the fact that no
single firm has influence on the price of the product it sells. A perfectly
competitive market has several distinguishing characteristics: there are many
buyers and sellers in the market; the commodity sold is homogeneous; there is
free entry and exit from the industry; perfect mobility of factors of production;
transport costs are assumed to be negligible; both buyers and sellers are
independent in their decision making and there is perfect knowledge.

Development
1. Explain that a perfectly competitive firm is a price taker
Due to the fact that there are many buyers and sellers in the market and a
homogeneous product, no single buyer and seller can control the market
and therefore has no influence over the market price of the product.
Examples of perfectly competitive firms are vegetables stalls and money
changers. Price is determined by the market forces of demand and supply
and each has to accept whatever price that is prevailing in the market.
Both the sellers and buyers are price-takers and there is only one market
price at any one time. It is not possible for the seller to increase the price
of the product by reducing his output as his clients can easily turn to other
sellers. Similarly, no single buyer can have the ability to reduce price as
he is only of the many buyers. Because of the vast number of buyers and
sellers, buyers do not receive any preferential treatment. In addition,
because the commodity is identical in the eyes of the consumers and they
will not be able to tell whether the product comes from firm A, firm B or
firm C. Products from different firms are perfect substitutes for the
consumers, therefore, they are not prepared to pay more than that is
prevailing in the market. Because of the homogeneity of the product, no
firm can increase or decrease the price of its product above or below the
market price without serious effects on its sales. If the seller were to
increase price, he will lose all his customers as they can turn to other
firms. Therefore, a perfectly competitive firm is a price taker and hence its
demand curve (AR) is a horizontal straight line and also MR = AR = price.

2. Explain the determination of equilibrium output to maximize profit
As a perfectly competitive firm is unable to determine price, it will seek to
determine the output that will maximize its profits. There are two
approaches to achieving profit maximization. Firstly, the total output
approach where the firm aims to produce the level of output at which (TR-
TC) is maximum. The second approach is the marginal approach where
the firm maximizes its profits by producing up to the level of output where
MC = MR. (MC must cut MR from below). MR refers to the change in a
firms total revenue arising from the sales of one more unit of the product
while MC refers to the increase in the total cost arising from producing the
one more unit. If MC > MR, reduce output; If MC < MR, increase output.

Figure 1 shows a perfectly competitive market where the equilibrium price
and quantity are determined by the interaction of the market demand and
market supply. OP is the market-clearing price and this price is then taken
by each of the firms. Because the market price is constant for each unit
sold, the AR curve also becomes the MR curve. A firm maximizes its
profits when MC = MR. The equilibrium output for the firm is thus OQe ie,
the firms sells OQe quantity at OP price.

With reference to Figure 2, profit maximising or equilibrium occurs when
MR = MC at OQe where the last unit of output adds on as much to the
firms revenue as it does to the cost. Therefore the profits cannot be
increased further and thus the firm has achieved maximum profits. At
OQ1, where MC < MR, the firm can increase its profits by expanding
production to OQe since the additional cost arising from producing one
more unit is less than the additional revenue from the sales of one more
unit. On the other hand, at OQ2, where MC > MR, in order to maximise
output
Cost,
Revenue,
Price
AR =MR =P
output
Price
D
S
P
Figure 2: A Perfectly Competitive Firm Figure 1: A Perfectly Competitive Market
E
Q
O
O
MC
E P
e

Qe
e
Q2 Q1

profits, the firm should cut down production to OQe as the additional cost
arising from producing one more unit is more than the additional revenue
from the sales of one more unit.

Conclusion
In the short run, a firm in a perfectly competitive market is unable to determine
the price, it will seek to determine the equilibrium output that would maximize
profit by producing at MC = MR. In the long run, due to freedom of entry and exit
of firms in the industry, the PC firm will have to adjust its output accordingly. In
the worst scenario, where the AR < AC in the long run, the firms will have to shut
down. However, perfect competition is a static model and the assumptions are
most unlikely to be found in the real world.

Part (b)

Introduction
Singapore is a small and open economy with firms of different models of market
structure in the service and manufacturing sectors. There are four basic types of
market structures: perfect competition; monopolistic competition; oligopoly and
monopoly. They may differ in their behaviour through price and non-price
competition as they seek to maximize profits.

Development
1. Explain the Behaviour of Perfectly Competitive Firms in Singapore
Perfectly competitive firms are price takers as there are many buyers and
sellers. They do not engage in non-price competition due to the
homogeneity of the products. Examples of perfectly competitive firms are
vegetables stalls and money changer. There is freedom of entry and exit
of firms as it does not require much start-up cost to set up the vegetable
stall or money changer. Any firm can enter or leave the industry at anytime
it chooses. If the industry is making supernormal profits, new firms can
enter. Similarly, any existing firm can leave if the industry is making
losses.

The commodity is identical in the eyes of the consumers and they will not
be able to tell whether the product comes from firm A, firm B or firm C. In
the case of money changers, the money that is changed is the same be it
from money changer A or money changer B. Products from different firms
are perfect substitutes for the consumers, therefore, they are not prepared
to pay more than that is prevailing in the market. Because of the
homogeneity of the product, no firm can increase or decrease the price of
its product above or below the market price without serious effects on its
sales. If the seller were to increase price, he will lose all his customers as
they can turn to other firms.

Each firm has an insignificant share of the market and therefore has no
influence over the market price of the product. Price is determined by the
market forces of demand and supply. Firms are price-takers, i.e. they
accept the prevailing price in the market. As the price is set by the industry
and each firm takes the price as given and can sell as much as he wants
at the prevailing price, there is no need to consider the actions of other
firms. Hence the firms are mutually independent.

Evaluation
The perfectly competitive firm model is not the most appropriate model to
explain the behaviour of firms in Singapore due to its unrealistic
assumptions. The products are not perfect substitutes for example, even
though there are many vegetable stalls, the freshness of the vegetables
may vary from stall to stall. Due to imperfect information, the prices among
the various vegetable stalls or money changers may vary. Firms will not
enter an industry if they are unaware of the supernormal profits currently
being made, or if they underestimate the demand for the particular product
they are considering selling. Even if they know of the supernormal profits
and would want to enter the industry, there may be some barriers to entry
for example; one has to obtain the license to set up the business. In
reality, pure perfectly competitive firms do not exist.

Due to imperfect knowledge and imperfect substitutes of products and
services as well as the existence of barriers to entry, the more appropriate
models of market structure would be the monopolistic competition and
oligopoly. In Singapore, the behaviour of monopolistic competition are
commonly exhibited in the service sector such as the Food and Beverage
industry (egs restaurants and hawker stalls). Other examples are hair
salons and fashion retail outlets. On the other hand, the behaviour of the
oligopoly are commonly exhibited in the manufacturing sector such as
automobile industry and electronics industry. Other examples are petrol
retailing, supermarkets, banking and telecommunication service providers.

2. Explain the behaviour of Monopolistic Competitive firms in
Singapore
There are many monopolistically competitive firms in the service sector.
As a result, none of them is large enough to dominate the industry.
Consider the number of hair salons, restaurants, hawker stalls, optical
shops, spas, beauty salons and fashion retail outlets that are commonly
found in a Singapore. The barriers to entry are generally weak. Although
the monopolistic competitive firms has some influence on the price of the
service or product they are selling, they avoid price competition as they
are small in size and may not have the financial means to survive price
wars. Engaging in price competition is thus detrimental to them, as such,
they engage in non-price competition through product differentiation and
other strategies so as to boost their sales and increase their profits.

a. Product differentiation
Each firm's product is slightly different from the others in the industry, i.e.
their products are close (though not perfect) substitutes egs clothings from
Mango, Zara and Forever 21 etc. The firms highlight the differences in
their products which may be real or imaginary. This is to influence
consumers preference and demand for their product. Because of product
differentiation, each firm is able to carve out a share of the market for
themselves. If each were to increase its price each will not lose all its
customers unlike perfect competition. In this sense, each of these small
firms is said to have some monopoly power and hence faces a slightly
downward sloping demand curve (though more elastic as compared to the
case of a pure monopoly).

b. Non-price competition
The firms engage in non-price competition. Since each firm produces a
similar but somewhat different product from the other firms in the industry,
it has to emphasize the difference in order to increase sale. This is known
as 'non-price' competition. It takes many forms. "Service with a smile" or
"Buy $20 worth of Brand X and get a glass bowl free" are common
examples. Advertising (promotional advertising) in local newspaper,
shoppers' guides, online and other media outlets is common.

3. Explain the behaviour of Oligopoly in Singapore
An oligopoly is a market with only a few dominating sellers which is
common in the manufacturing sector in Singapore, such as the automobile
industry and electronics industry. Other examples of oligopolistic firms are
Singtel, Starhub and M1 dominating the telecommunication market; Shell,
Esso and Caltex in the retailing petrol industry; Cold Storage, NTUC
Fairprice and Carrefour in the supermarket industry.

In pure oligopoly, the few firms produce a homogeneous product (eg
petroleum). In imperfect or differentiated oligopoly (eg automobiles
different makes of cars), there is product differentiation through the use of
established brand names and trademarks. (Toyota, Honda, Nissan)

Oligopolistic firms engage in price and non-price competition to enlarge
their market share and thus increase their profits.

a. Price Wars
Oligopolistic firms such as those in the petrol retailing industry in
Singapore (Shell, Esso, Caltex) often engage in a price war. The individual
firms outdo each other in price undercutting in an attempt to drive some of
the firms out of the industry so that the remaining firms may each have a
larger share of the market. Thus, the price of the product may even fall
below the average variable cost of the firm in the short run (in the case of

predatory pricing). Survivors of intensive and prolonged price wars are
likely to be those firms with larger resources.

b. Collusive Behaviour
To prevent a costly price war, a common price is often tacitly agreed upon
by all firms in the industry. Oligopolistic firms may get together and agree
to cooperate in setting prices and output levels. For example, SingTel,
Starhub and M1 may agree on certain price range for the
telecommunication services packages. They do so to maximise the
industrys total profit. In Singapore, the Competition Law is put in place to
prohibit anti-competitive activities that unduly prevent, restrict or distort
competition among firms.

c. Price rigidity
Because of the existence of only a few large players, the firms in such a
market structure are heavily mutually interdependent. Actions by one firm
will trigger off retaliatory / defensive measures by the other firms. For
example, when one petrol company reduces the price of the petrol, its rival
will follow suit. But when one increases the price of petrol, no one will
follow. Either way, a firm is unable to increase its market share and TR by
raising or lowering the price of its products. As such, prices may be rigid at
a particular level no firm wants to be the first to adjust the price.

d. Non-price competition
They engage in non-price competition through advertising, different
packaging, better services and free gifts are some examples of
promotional gimmicks firms resort to promote product recognition; product
complexity and product proliferation.

i. Product recognition
A potential new entrant typically must introduce its product into a
market where the products of existing firms are already well-known
and established in the minds of consumers. A sizable advertising
campaign is then needed which may mean that a very high cost is
involved. In Singapore, brand consciousness is prevalent.

ii. Product complexity
For products such as automobiles, television sets, refrigerators,
stereo equipment and many others, the very complexity of the
product requires that consumers have more information about the
product. It is not enough to recognise the product but also to know
about the availability and quality of product service. Therefore,
unless a new entrant into the industry is able to guarantee such
service network, it may find great difficulty in entering. Consumers
will buy from those with extensive and established dealer network
which can handle major services and other product related

problems. Some examples in Singapore are the firms selling
computers (Fujtsu, Acer, IBM etc) and cameras (Canon, Fuji,
Panasonic) as they are service centres that provide after-sales
services.

iii. Product proliferation
Each firm in the oligopolistic industry may produce many variations
of the same product for example Nissan produces cars which have
two doors or four doors, different colour combinations, different
engine sizes and even station wagons. So each firm is able to
capture and preserve its respective share of the automobile market
from entry of new firms. A potential new entrant has to compete
with the many kinds of automobiles already in existence.

The oligopolistic firms often engage in R & D to further enhance its
product recognition, complexity and proliferation. They are able to
do so as they are large and enjoy economies of scale. Such a
behaviour further builds up barriers to entry preventing new firms
from entering. This enables them to enlarge their market share and
increase their profits.

Evaluation Contrasting Monopolistic Competitive and
Oligopolistic firms in Singapore

Monopolistic competition market structure is an appropriate model
in the service sector, for example the Food and Beverage industry
and other businesses where personalised services are required
such as the beauty care spas, hair salons etc. Such firms remain
small as there is not much scope for them to expand to enjoy
economies of scale. Also, it is relatively easy to enter and leave the
industry due to its weak barriers to entry such as low capital set up
for a hawker stall or hair salon.

On the other hand, oligopoly market structure is an appropriate
model in the manufacturing sector, for example the automobile
industry and electronics industry. There are few large firms
dominating the industry for example in the automobile industry, the
large players are Toyota, Honda and Nissan. There are strong
barriers to entry in such industries with much scope for exploitation
of economies of scale for example technical economies of scale.

4. Explain the behaviour of monopoly in Singapore
A monopoly is a market structure in which a single producer controls the
whole supply of a commodity which has no close substitutes. An example
in Singapore is the Singapore Power supplying utilities to the whole
country. This is a case of a natural monopoly with a downward-sloping

long run average cost curve over the entire range of market demand. This
means that the lowest average total cost is achieved if one firm serves the
entire market. As there is only one firm, they do not engage in price or
non-price competition. However, with the support of the government, they
do engage in R & D to further improve on their product and services.

Conclusion
Perfect competition is not an appropriate market structure to explain the
behaviour of firms in Singapore. Instead monopolistic competition and oligopoly
are more appropriate as their behaviour are exhibited in the service and
manufacturing sectors. The people prefer choices and variety whenever possible
which monopolistic competitive and oligopolistic firms provide. However,
essential goods and services such as utilities are often produced by natural
monopoly with government intervention to ensure that the poor are provided for.
Also, to prevent the abuse of monopoly power, the government has set in place
anti-trust laws and Competition Act to enforce healthy competition that will benefit
the society at large.

Mark Scheme
Essay Question 2
(a) Explain how, in economic theory, a firm in a perfectly competitive
market determines the price and output that would maximize profit.
[8]

Part (a)
L3 For a well-developed answer, illustrated with correct and well-labeled
diagram of PC firm and PC market.

6 - 8
L2 For a correct but underdeveloped explanation.
No mention of key features or its link to PC as price taker.- up to max
of 5m

3 5
L1 For an answer that shows some knowledge of the key characteristics of
perfectly competitive market. Some conceptual errors.

1 2

Part (b)
L3 A well-balanced answer recognizing that perfectly competitive market is
not the most appropriate to explain the behavior of firms in Singapore.
Analysis is largely accurate and expressed rigorously that the more
appropriate models of market structure are monopolistic and
oligopolistic competition.
10 13
L2 Ability to explain why PC is not the most appropriate and suggest the
more appropriate models of market structure to Singapore by supporting
with relevant examples. Correct but lacks in-depth analysis.

5 9
L1 Listing of features of market structures and examples. An answer that is
more descriptive than analytical. May be laced with serious conceptual
errors.
1 4

E2 Ability to justify that the more appropriate models of market structure are
monopolistic and oligopolistic competition and write a reasoned
conclusion to the question.
3 4
E1 Ability to recognize perfectly competitive market is not the most
appropriate to explain the behavior of firms in Singapore. Some attempt
to justify the different types of market structures in Singapore.
1 2

Suggested answer
Essay Q3
A new carbon capture and storage technique known as carbon
(a) Explain why greenhouse gas pollution from power stations are likely
to cause market failure. [8]
government should finance the development of new technology such
as carbon sequestration. [17]


>> Step 1: definition

The power stations, through the burning of fossil fuel, adds on to
greenhouse gas emission. This is a clear case of negative externality --
negative effects of production or consumption which fall on people other
than the producers or consumers.

>> Step 2: use examples

The external cost includes more frequent and more severe hurricane
damage, reduction in fish catch due to the global warming. When there is
a negative externality, the community bears costs additional to those
borne by the individual firm or consumer. The MSC of the activity exceeds
the MPC. The negative externality is said to drive a wedge between MSC
and MPC.

>> Step 3: why it constitutes market failure

In the absence of any government intervention, negative externality
creates a resource misallocation problem as producers will produce up to
the point where marginal private benefit equals marginal private cost,
ignoring the external cost of their actions. As producers do not face the full
cost of their actions, they will produce in excess of the socially optimum
level.

>> Step 4: graph


The private equilibrium is at Q
pte
where MPB = MPC. Here, marginal
social cost (aQ
pte
) exceeds marginal
social benefit (bQ
pte
), i.e. production
of the last unit adds more to societys
costs than to its benefits and the
society would be better off with
reduced production. In fact, to
maximise societys welfare,
production should be reduced to the
point where MSB = MSC. The
welfare loss arising from the over-
production is given by the area abc.

The market fails because pareto
optimality has not been achieved at
Q
pte
.

Part (b)

The main thrust through which Singapore reduces GHG is through improving
energy efficiency. With an improvement in energy efficiency this allows the same
output to be produced using lesser energy input.

Approach 1: Answers organised according to the source of energy use

Main fuel consumption comes from the following activities
power stations (51%)
industries (31.7%) and
transport (15.8%)

In terms of electricity consumption
industries (43%)
buildings (31%)
households (18%)

GHG emissions can be cut by reducing fuel and electricity usage in these
activities

i. Reduce GHG emissions in power generation
1. Natural gas has replaced oil as the major fuel used by power stations.
2. The by-product of power generation heat is harvested and sold to
industries that require heating in a process known as cogeneration.
This reduces the need for additional electricity to generate heat.
Cogeneration facilities and the firms will therefore have to be sited in
close proximity to each other.

Evaluation
As power stations are the main fuel consumers, cutting GHG emissions of
power stations have the greatest leverage and is effective. However, there
must also be efforts to control power usage by the end users

ii. Reduce GHG emissions in industries & buildings
The most energy intensive industries in Singapore are the petroleum
refining, petrochemical, electronics and pharmaceutical industries which
are of strategic importance to the economy. Energy-efficiency is thus a
cost-effective means of improving the competitiveness of Singapores
industries.
1. Energy Efficiency Improvement Assistance Scheme funds up to 50%
of energy appraisals for buildings and industrial facilities. The energy
appraisal can identify degraded plant components that contribute to
overall efficiency losses and enable a company to take the necessary
corrective actions.

2. A tax allowance is given to capital spending that results in more
efficient energy utilization
3. From 2008 onwards, all new buildings and existing buildings
undergoing major retrofitting works with gross floor areas above
2000m3 must meet the Green Mark certified standard (a green building
rating system) with a possibility of enjoying cash incentives. Design
features such as natural ventilation, natural light and vegetation can be
added and the air-condition system configured to reduce energy use.
4. Singapore Certified Energy Manager Programme to train a pool of
specialists energy managers, equipping them with the technical skills
and competencies needed to plan and implement energy efficiency
managers for companies.

Evaluation
This encourages investment and R&D into energy efficient methods of
production.

iii. Reduce GHG emissions in motor vehicles
1. Fighting vehicle emissions through ERP and providing better public
transport system
Vehicles stuck in traffic burn more fuel. ERP, by reducing
congestion, reduces the burning of fuel by motor vehicles.
2. The Green Vehicle Rebate is given to buyers of green vehicle
This reduces the relative price of green vehicles, encouraging more
people to substitute these green vehicles with petrol-based
vehicles.
3. Fuel economy labels inform buyers on the vehicles fuel economy,
helping car buyers choose fuel-efficient car models.
The labels help to close the information gap for car buyers.

Evaluation
ERP does not discriminate between the oil guzzlers and the fuel-
efficient vehicles but imposes the same tax on all types of vehicles.
This is clearly inefficient. To correct the negative externality, drivers
should be taxed an amount equivalent of the marginal external cost.
This gets the drivers to internalize the external costs thereby cutting
down their driving. To this end, owners of oil guzzlers should be taxed
at a higher rate to reflect the high GHG emissions of their vehicles to
get them to reduce driving or to switch to more fuel-efficient vehicles
which are taxed less heavily.
Despite the rebates, hybrid vehicles are still more costly than petrol-
based vehicles and this may deter buyers. The recent increase in oil
prices, however, has made the investment in hybrid vehicle cost-
effective and encouraged more to make the switch.

The labels not only attract buyers who want to continue to drive but are
looking for greener vehicles but drivers who are looking for savings
from more fuel-efficient cars. This further reduces GHG.

Approach 2: Answers organised according to the nature of policy

Policies to tackle negative externalities can be categorised into:
Market-based solution
Command-and-control
Bridging information gap

Market-based solutions:
Use of taxes & subsidies to get prices right, i.e. so that prices reflect the true
benefits & costs and private equilibrium will be in line with the socially efficient
output.
Subsidies / tax allowance to buyers of green vehicles
Subsidies / tax allowance for firms to engage in R&D
Raising the electricity tariffs in line with higher fuel costs
Petrol & diesel taxes

Command-and-control solutions:
Green Mark certification standard

Bridging information gaps:
Education & campaign on the ways to conserve electricity
Mandatory energy-efficiency labels for air-conditioners and refrigerators
Singapore Certified Energy Manager Programme to train a pool of specialists
energy managers

Others
Promoting renewable energy, by investing in R&D and test-bedding to
improve their performance and cost-effectiveness. This includes the setting
up of research institutes, provision of funds and test-bedding platforms
International cooperation e.g. sharing of technology and best practices

whether the government should finance the development of new
technology such as carbon sequestration

In general, countries can reduce their GHG emissions in the following ways:
increasing energy efficiency;
using less carbon-intensive fuels; and
increasing carbon 'sinks' such as forests

Carbon sequestration is an example of carbon sinks where CO2 is captured and
stored, offsetting the countrys emissions.


Whether the government should finance the development of any new technology
depends on its estimation of the benefits against the cost.

While there are overall benefits to carbon sequestration, actual benefits to
Singapore may be somewhat limited as most of the benefits are external. Carbon
capture technique to reduce the GHG concentration in the atmosphere, slowing
down the global warming, benefiting all countries. And while the benefits are
diffused, the costs are likely to be high, particularly since the technology is only in
its infancy. In so far as the costs outweigh the benefits to Singapore, the
government can do better by spending on alternative projects.

Even if the benefits exceed the costs, the case may not be strong enough to
justify spending on carbon sequestration. Such spending involves an opportunity
cost the government could have used the funds on other projects. To
determine whether the government should finance the development of a
technology such as carbon sequestration, it needs to weigh the net gains from
carbon sequestration to the net gains from alternative projects e.g. improving
energy efficiency & using less carbon-intensive fuels (e.g. LNG instead of petrol).

Other than reducing GHG emissions, the move towards improved energy
efficiency has other benefits. In addition to greenhouse gas emissions, the
burning of fossil fuels also generates air pollutants such as sulphur dioxide and
particulate matter. By adopting more efficient technologies or practices we can
reduce these pollutants and improve air quality as well. Improving energy
efficiency will result in overall cost savings to businesses, helping Singapore to
maintain its competitiveness in the long term. Right now, Singapore is almost
totally dependent on imported fossil fuels for her energy needs. Through
improvement in energy efficiency, Singapore will be less reliant on imported fossil
fuels (making the economy less vulnerable to increase in the international prices
of these fuels) and defer the need for installing new energy infrastructure.

Mark Scheme
Essay Q3
A new carbon capture and storage technique known as carbon
(a) Explain, with examples, the meaning of private costs and external
costs. [8]
government should finance the development of new technology such
as carbon sequestration. [17]

Part (a)

L3 For an answer that clearly explains the spill-over effects on the
third party and the impact on resource allocation, all in the context
of the power generation. Effective use of graph to explain resource
misallocation and welfare loss.

7 m effective use of graph
8 m need to explain the significance of MSC > MSB and the
reason for over-production (that private decision-making ignores
the external costs).
7 8
L2 For an accurate though undeveloped explanation of the theory
There is evidence of an ability to identify facts, some ability at
graphs, fair ability to apply the concept of negative externality in the
context of power generation.
High L2 noted and explained the divergence between MSC and
MPC, noted the divergence between MSB and MSC though there
was no reference made to the graph. Noted the area of welfare
loss with weak attempt at explaining.
Low L2 showed the divergence in the graph without explanation
4 6
L1 For an answer that shows some knowledge but does not indicate
that the meaning of the question has been properly grasped. Basic
errors of theory or an inadequate development of analysis may be
evident.
Mainly definitions with graph that is drawn but not explained.
1 3

Part (b)

L3 Use of sound economic analysis to explain at least 3 policies and
their limitations with constant reference to the Singapore context
Weigh the costs and benefits of financing the development of
new technology against alternative measures of emissions
[Answer to the first part largely theoretical in nature with limited
reference to the context + good attempt to consider the 2
nd
part of
the question - up to 10m]
10
13
L2 Attempts to use economic analysis
Explanation of policies and their limitations
Answers at the top end of the mark range need to make some
reference to the Singapore context & weigh the costs and
benefits of financing the development of new technology
[Answer to the first part largely theoretical in nature with limited
reference to the context + feeble attempt to consider the 2
nd
part
of the question - up to 7m]
5 9
L1 Answers are descriptive
Ability to list policies but the economic analysis of the policies is
lacking or erroneous.
1 4

E2 Judgement based on analysis, providing a reasoned conclusion
based on well-considered comparison. Shows awareness of
Singapores constraints and how this favours one policy over
another.
3 4
E1 Mainly unexplained judgements. Analysis is largely evaluative but
lacking in comparison, providing an unconvincing conclusion.
1 2

Suggested answer
Essay Q4
The Singapore economy continued to expand at a healthy pace of 6.7% in
68,000. Oil and food prices have risen more rapidly and are expected
to continue to increase. Consumer price inflation trended upwards to 7.5%
in June 2008.

in Singapore. [15]

Part (a)

1. Introduction
Define inflation
- Inflation is defined as a situation in which there is a sustained and
inordinate increase in the general price level

2 main types of inflation in industrialised economies
- demand-pull & cost push inflation/imported inflation

2. Demand-pull inflation
- It is a situation where AD persistently increases and is greater than AS
when the economy is near or at full-employment. When AD rises and is in
excess of AS, consumers will be willing to pay a higher price to get the
goods and services they want. Businessman would take advantage of the
situation and raises the prices of their goods and services. This causes
an upward surge in prices of gds and services.

- Use AD-AS diagram to explain

Price Level
AS
Y
F
P
0
P
2
AD
0
AD
2
AD
1
P
1
NY
Fig 1

Figure 1 illustrates an in AD from ADo to AD2, pulling GPL upward
without any in real output. So a persistent in AD will generate a
sustained & inordinate in GPL

- Keynesian economists believe any increase in the components of AD
will cause demand-pull inflation, i.e increase in C (rising incomes,
economy continued to expand), I (business confidence, tax incentives), G
(expansionary FP) and net exports (opening up of export markets, more
FTA, globalization). The more inelastic the AS, the greater the increase in
the GPL.

When is AS inelastic? When there are structural rigidities
This is common in developing countries due to the presence of structural
rigidities like shortage of capital or skilled labour or inflexible government
policies that hamper an in AS. Demand-pull inflation occurs alongside
with structural unemployment. AS is unable to respond to in AD.

- Monetarists believe that demand-pull inflation is due to an increase in
money supply. At full employment, increase in money supply increase
in spending increase in AD

3. Cost push inflation
- Define cost-push inflation: Cost-push inflation is defined as a situation
when there is a sustained in the cost of production.
- Using AD-AS diagram, explain how persistent increase in costs can lead
to cost-push inflation

- Figure 2 shows the economy if initially at price P1 and output Y1. An in
the cost of production will shift the AS curve to the left from AS1 to AS2 to
AS3. Consequently a persistent in costs will shift the AS curve leftwards
resulting in a sustained in GPL from P1 to P3 and national output drops
from Y1 to Y3.
P
3
NY
0
P
1
Y
1
Y
3
AD
1
AS
2
AS
1
P
2
Y
2
Fig 2
P
3
NY
0
P
1
Y
1
Y
3
AD
1
AS
2
AS
1
P
2
Y
2
Fig 2
Price level
AS3


- Explain sources of cost-push inflation
o Increase in prices of imported inputs [such as oil price hike] and
consumption goods & services
Crude oil is an important input for industrial production, generation
of power and electricity, for petrol and diesel as well as
manufacture of plastic by-products. Thus demand is price inelastic.

Higher production cost SRAS fall cost-push inflation if firms
pass the higher production cost to consumers by increasing their
prices higher cost of living

o Wage push inflation
When trade unions bargaining for wages in excess of productivity
increase increase unit cost of production firm pass on the
higher cost by raising prices increase prices of final g&s trade
unions demand for further wage increase so as to maintain the real
income of its members firms experience higher production costs
if give in to demands of trade unions wage price spiral as the
process may repeat itself with trade unions asking for another
round of wage increment

o Tax-push inflation
GST is inflationary because GPL independently of the state of
demand. (note: this is a one-off increase after which GPL stabilizes
at the higher level)

4. Conclusion
Inflation is usually multi-causal. Once inflation is underway, it is not
easy to identify the underlying cause.

Part (b)

1. Introduction
- In Singapore, exchange rate is used as an instrument of its monetary
policy
- Define exchange rate
It refers to the external value of a currency in terms of another currency
[OR exchange rate is defined as the price at which one currency
exchanges for another]
- State your stand:
Exchange rate policy is one of the effective policies, but not the best. It
is necessary to consider the nature or causes of inflation.

- Interest rate policy has limited effectiveness as Singapore has a small
domestic DD and our interest rate has to move in tandem with the interest
rates of our major trading partners. Moreover, changes in interest rates
would cause changes in the exchange rate. Thus, it is not possible to
control both.

2. Thesis:
Explain how a modest and gradual appreciation of S$ can help to
curb inflation
The MAS policy is to maintain a modest and gradual appreciation of S$.
[Managed Float exchange rate, measured against a trade-weighted
basket of the currencies of her major trading partners].

Singapore lacks natural resources and with a small domestic market, is
highly dependent on foreign market for her exports of its finished products
and imports of raw materials for its production process and many final
consumption goods and services.

As the oil price hike and rising food prices are expected to continue, a
modest and gradual appreciation of S$ can help to buffer Singapore
against imported inflation and dampen the impact of imported inflation

It reduces inflation via changes in import prices
Appreciation of S$ imported crude oil and factors of production are
relatively cheaper reduces production costs reduces prices of locally
produced final goods that make use of imported factors of production
curb inflation.

Appreciation of S$ reduces the price that domestic consumers have to
pay for imported goods curb inflation

It reduces inflation via changes in aggregate demand
Appreciation of S$ raises the price of Singapores exports in terms of
foreign currencies, thus making our exports less competitive. Assuming
the demand for our goods is price elastic, the increase in export prices will
bring about a greater than proportionate decrease in quantity demanded,
reducing TR
X
. Appreciation of S$ lowers the price of imports in Sing dollar
terms. Again assuming elastic demand, the decrease in import prices will
bring about a greater than proportionate increase in quantity demanded,
increasing TE
M
. Overall, net exports fall, relieving dd-pull inflation.

Viewed in another way, domestic demand will be reduced by the
substitution effect as lower prices for imports decrease the demand for
locally-made goods. This will lower demand-pull inflation on domestically
produced goods.

Lower domestic prices could also result in less likelihood of workers
asking for higher wages.

Evaluation:
o Transmission Lags
It takes time for changes in the exchange rate to work its way through
the economy depending on the speed and extent with which importers
and retailers pass through the price changes to consumers and the
structural features of the economy.

o Maintenance of a Large Foreign Reserve
Large foreign reserves have to be maintained by MAS to support the
exchange rate policy and to build investor confidence in the strength of
the Singapore Dollar. In the LR, the foreign reserves may be depleted.

o Exchange rate policy may not be effective in curbing demand pull
inflation, tax push inflation or wage push inflation, arising from an
increase in increasing aggregate demand or money supply.

3. Anti-thesis:
Explain how SS-Side policy can help to curb inflation
Inflation can also be induced by insufficient growth in productive capacity
and structural rigidity and thus requires supply side policies. Singapore
government implements a range of supply side measures to curb cost
push inflation and demand-pull inflation.

i) Promoting education and training
Promoting education and training will increase productivity. This will help
increase supply of goods at a lower cost of production. With the
availability of skilled labour and various fiscal measures, such as cuts in
corporate taxes, Singapore is an attractive centre for FDIs. The increase
in productivity and inflow of foreign direct investments will raise the
productive capacity of the economy, thus increasing long run AS. Hence,
cost push inflation can be curbed. The expansion of productive capacity
also allows prices to stay constant even as AD rises, thus relieving
demand-pull inflation.

Evaluation:
It requires long gestation period before the returns on investment are
seen. Moreover, it requires time for workers to obtain education and skills.
The transfer of training into actual productivity gains need to be
considered. There is also a lack of incentive for private companies to send
workers for training.

The cuts in corporate taxes in order to attract investment have resulted in
the government raising indirect taxes such as GST in order to avoid a

budget deficit. Increases in indirect taxes are regressive and may increase
income inequality.

ii) Increasing availability of substitutes
Reduce dependence on crude oil as the only energy source and diversify
to alternate forms of energy, e.g. liquefied natural gas. The availability of
substitutes raises the price elasticity of oil and reduces imported oil
inflation

Evaluation:
It is a long term measure. Despite the painful lessons from the global oil
crisis of the 1970s, Singapore and many other countries are still heavily
dependent on crude oil. For a number of reasons, it may not be viable or
cost effective to generate nuclear, solar and thermal energy in Singapore.

iii) Using short run policy
This involves the government varying its expenditure and taxation to help
to lower the cost of production. Fiscal spending (increase G) to subsidize
oil importers on condition that they will not pass on higher energy costs to
the rest of the economy and consumers. Together with an increase in AS,
demand-pull inflation could also be curbed.

Evaluation:
This will benefit oil consumers in the short term. Moreover, the Singapore
government has the means to subsidize because it has accumulated
substantial fiscal reserves over many years. But over the long term, the
appropriateness and sustainability of continuing to use taxpayers money
to compensate a few oil-importing firms becomes questionable. Such
government intervention distorts the market. Also, subsidies will delay oil
producers to switch to alternative energy and the adoption of energy-
efficient technology, resulting in deadweight loss of providing subsidies.
The Singapore government would thus avoid giving subsidy.

4. Anti-thesis:
Explain how incomes policy can control wage push inflation
Keep business cost low by keeping labour costs under control and flexible,
e.g wage adjustments in line with productivity growth, CPF adjustments,
maintaining good tripartite relations, lower corporate taxes.
National Wage Council sets guidelines recommending that wages
increase in tandem with productivity increases. In this way, wage push
inflation is controlled.
Evaluation:
However, productivity increases may vary across different industries and
hence a guideline recommendation may not be applicable to all industries.

5. Conclusion
The exchange rate policy, despite its limitations, has been successful in
curbing imported inflation to some extent. A modest and gradual
appreciation of S$ is able to reduce inflationary pressure and allows the
economy to sustain its competitiveness. As inflation is usually multi-
causal, the government needs to implement other policies such as SS-
side policies, incomes policy and FP. While short term measures may not
be viable if the oil prices were to continue to increase in the near future,
long term policies will be the more appropriate measures to take to ensure
sustainable price stability. For any policy to be effective in curbing
inflation, there is a need to continually monitor the major root causes of
inflation.

Mark scheme
Essay Q4
The Singapore economy continued to expand at a healthy pace of 6.7% in
68,000. Oil and food prices have risen more rapidly and are expected
to continue to increase. Consumer price inflation trended upwards to 7.5%
in June 2008.

in Singapore. [15]

Part (a)

L3 Well-developed explanation of the causes of demand-pull, cost
push & structural rigidity inflation, supported by well-drawn
diagrams. Suggest a range of likely reasons for changes in both
AD & AS.
8-10
L2 Undeveloped explanation of demand-pull & cost push inflation,
supported by well-drawn diagrams
4-7
L1 For an answer that shows some knowledge of the causes of
inflation. Smattering of ideas.
1-3

Part (b)

L3 Well-developed explanation & analysis of how a modest and
gradual appreciation of S$ can curb inflation. Answers that gave a
range of policy measures to tackle its inflation that is multi-causal.
Answers that explain limitations of each policy.

At least 3 measures [Exchange rate policy & 2 other policies].
9-11
L2 Undeveloped explanation & analysis of a modest and gradual
appreciation of S$ can curb inflation. Brief explanation of 2 other
policies in Singapore.
2 measures in Singapore answer showing well-developed
explanation & analysis 8 marks.
5-8
L1 For an undeveloped answers that describes policies in Singapore
to curb inflation.
OR
For an answer that explains policies to curb inflation, but policies
are irrelevant to the Singapore economy.
1-4

Allow up to 4 marks for Evaluation
E2 Evaluations and judgements based on economic analysis, such as
a modest appreciation of S$, characteristics of small & open
economy. Recognizes the importance of exchange rate policy in
curbing imported inflation.
Accept alternative judgements, e.g. in the LR, supply-side policies
will be more effective in curbing inflation and minimise trade-off of
other policies.
3-4
E1 Judgments are mainly unexplained and unsupported by economic
analysis. Shows awareness of limitations of policies and that there
are other policies that could be used.
1-2

Suggested answer
Essay Q5
The two casinos set to open in the Integrated Resorts in Singapore are part
of the governments longstanding effort to reorient the economy toward
higher-value service industries like tourism and biosciences as it loses
manufacturing competitiveness to China.
Explain the rationale for the above policy and discuss whether it is the best
policy to achieve the governments macroeconomic goals in a globalised
world. [25]

Explain the rationale to reorient the economy toward higher-value
services industries

Loss of comparative advantage
Many countries, including Singapore, have lost their comparative advantage
in manufacturing to China with its abundant supply of labour who are willing to
work for long hours at relatively low wages.

Effect on the macroeconomic goals
The shift in comparative advantage has repercussions on both investment
and exports:
i. China has emerged as a more attractive destination for FDI, giving
Singapore a miss. Firms operating within Singapore are also shutting
down their facilities here and relocating to China.
ii. With its lower cost of production and an under-valued yuan, exports from
China are also cheaper relative to those from Singapore. Assuming a
close degree of substitutability, demand for exports from Singapore will
experience a greater than proportionate decrease as the relative prices
increase.
If nothing is being done about it, the loss of investment and export
competitiveness may result in worsening BOP, an excess supply of the
Singapore dollar in the foreign exchange market and a downward pressure on
the Singapore dollar.
For a country that relies on external demand to fuel its growth, the decline in
FDI & export revenue will bring about sharp decline in the overall level of AD.
Depending on the initial situation of the economy, a decline in AD may or may
not be welcome. If the economy is facing demand-pull inflation, a decline in
AD helps to curb the inflation. If the economy is not facing risk of over-
heating, the reduction in AD may throw the economy into a recession with NY
falling and UN rising. [graphs]

Explain the move to develop higher-value service industries like tourism and
biosciences
In view of the loss of comparative advantage in manufacturing, one solution is to
move the resources into areas where Singapore has a potential comparative
advantage as part of the countrys economic restructuring.
The government hopes that investment and exports from the higher-value
services industries will help to compensate for the loss in manufacturing and
continue to provide growth and jobs for the local economy.

The range of possible policies

Policy to deal with the competitive
pressure of globalisation
Evaluation
Develop higher-value service industries
like tourism and biosciences
This involves the government
investing in the provision of
infrastructure and training facilities.
Fiscal incentives such as tax breaks
could also be given to selected
industries. For example, the
government has built the Biopolis to
house the various research
institutes and laboratories and
expanded intake into biosciences
courses at the polytechnics and
universities.
The government might also relax
certain rules. For example, the
government has, for the first time,
allowed casinos in the two
integrated resorts.

Increase G, I and X
Improvement in CA and KA
balance
Increase in dd for Sing dollar ER
appreciation
Increase in AD increase in NY
and reduction in UN (reinforced by
the multiplier & accelerator effects)
Increase in AD may be
inflationary in the SR
Increase in AS in the LR non-
inflationary growth
Long gestation period many
years and months before the
projects are completed and the
facilities are ready
This involves increased
government spending which may
result in budget deficit. Fortunately,
Singapore has reserves
accumulated from past surpluses.
This helps to avoid deficit-financing
problems such as crowding-out
effect and higher national debt.
May result in structural UN in the
SR as workers who lose their jobs
in the manufacturing sector do not
have the relevant skills to be re-
employed in the service industry
Depends on attitude of workers
towards the training. Even as more
training opportunities in
biosciences are made available,
students may not necessarily enroll
in these courses, depending on
their interests. In many developed
countries, physical sciences and
engineering courses are losing in
popularity to the softer options like
liberal arts and social sciences.
Compared to the countries in the
region, Singapore has limited
tourism resources e.g. beaches in
Bali, rainforest in Sarawak,
historical relics such as Angkor

Wat. Whether the construction of
the integrated resorts with casinos
will be sufficient to draw tourists is
still uncertain. Besides,
competitors, with their huge
expanse of land, can build many
more of such resorts.
In contrast, the biomedical and
pharmaceutical exports have
shown strong growth. But
biosciences, while helping to create
high-end jobs, do not require huge
labour force. It is also difficult to
train workers with only secondary
school education for jobs as
researchers.
Exchange rate policy
To be competitive with the
emergence of China, MAS can
devalue the Singapore dollar.

Effect on the macroeconomic goals:
P
X
decreases in foreign currency
terms, leading to a more than
proportionate increase in quantity
demanded, assuming dd for X to be
elastic. TR
X
thus increase. At the
same time, P
M
increases in
domestic currency terms, leading to
a more than proportionate decrease
in quantity demanded, assuming
demand for M to be elastic. TE
M

thus falls.
Investment in Singapore will be
cheaper in terms of foreign
currencies, attracting more FDI.
With an improvement in both CA
and KA, BOP improves.
As net exports and I increase, AD
rises, bringing about increase in NY
and employment. The increase in
AD could be inflationary if there are
no idle resources or in the presence
of structural rigidities.
In the SR, dd tends to be inelastic
for reasons such as time required
to collect info on prices & source
for substitutes. As such, the CA
could worsen in the SR can bring
about a contractionary effect on the
AD.
While the weakening Sing dollar
may help to restore the economic
competitiveness somewhat, it puts
Singapore at risk of higher
imported inflation. Given the high
import content of Singapores
exports, the benefits of a weaker
exchange rate on export
competitiveness is also
questionable.
The move by MAS to devalue the
Sing dollar could be countered by
competitive devaluation of the
other currencies.


Evaluation
Supply-side policies
Productivity improvement
Training, R&D, adoption of latest
technology or more efficient
methods of production
Encouraged by fiscal incentives e.g.
subsidies, tax breaks, low interest
loans, etc
Productivity improvement helps to
keep down unit labour cost (wage
cost per unit of output) even as
wages are higher than competitors

Productivity improvement enhances
the economys productive capacity,
shifting the LR AS rightwards.
Economic growth rises while
inflation decreases.
The reduction in inflation improves
export competitiveness. As export
prices fall, assuming dd for X to be
elastic, quantity demanded
increases by a greater than
proportionate amount, adding on to
the overall export revenue and the
CA of the BOP. Productivity
improvement also attracts FDI,
adding on to the KA.
The increase in X & FDI creates
greater demand for S$, pushing ER
upwards.
The FDI also helps to reduce
unemployment and further adds on
to AD in the SR & AS in the LR.
Long gestation period particularly
for R&D
The local pool of research
scientists and engineers is limited.


Evaluation
Incomes and wages policies
Incomes policy, by keeping labour
costs down, helps to lower the
overall cost of production. These
include voluntary wage restraints
and reduction in employers CPF
contribution rate.
Alternatively, the government could
set guidelines on the rate of wage
increases permitted. For example,
wages may not be allowed to rise
faster than the rise in labour
productivity. This helps to check the
unit cost of production in the face of
low-wage competitors.

Effect on macroeconomic goals:
Keeps down COP increase in
SRAS reduce inflation & increase
NY
Lower labour cost less urgent for
firms to resort to retrenchments to
cut costs the maintain profitability
Lower COP attracts FDI & improves
X competitiveness improvement
in BOP and appreciation of ER
For such policies to work, there
must be cooperation among the
government, employers and trade
unions. In Singapore, this tripartite
body is the National Wages
Council (NWC).
The NWC wage recommendations
may have limited effect because
they are mere recommendations
and firms are not obliged to
observe the recommended wage
restraints.
Wages are downward sticky, i.e.
wages tend to rise but not fall in
reality. Firms may be reluctant to
cut wages for fear of impact on
workers morale and productivity.
Another reason is that wage
restructuring to raise the variable
component of wages has limited
success among private employers.
Given that productivity growth
varies across industries and even
between firms of the same
industry, to have one blanket wage
recommendation for all firms may
not be very useful.
Where wages are reduced, this
may spell hardship for the poorest
workers.
The reduction in wages depresses
consumption and may cause NY to
further contract and UN to rise.

Comparison of a range of possible policies

In a globalised world where new competitors emerge and comparative
advantage keep shifting, countries cannot always rely on devaluation to
maintain their economic competitiveness. The use of devaluation weakens
the incentive of domestic firms to innovate and improve on their efficiency in
order to compete. Frequent devaluation will also lead to a loss of investors
confidence. All these impede the LR economic growth of the economy.
Devaluation, is at best, a short-run policy in response to rising competition.
Similarly, where new competitors are constantly emerging, it is neither
realistic nor possible to continuously cut wages to maintain competitiveness.
The overall effect of wages policy on the level of AD and NY is also uncertain.
In contrast, the policy of developing high-value service industries is important
in response to the shifting comparative advantage in a globalised world as
Singapore loses its comparative advantage in traditional manufacturing, it
needs to develop new areas of growth as a long term survival strategy. By
moving up the value chain, this helps Singapore to avoid direct competition
with China. However, the problem with picking winners is that government
may not identify correctly the industries with the potential to develop
comparative advantage. Picking the wrong winners results in resource
misallocation and a lower standard of living.
Despite the potential risk, the policy of developing higher-value service
industries seems to be the best bet in a globalised world where comparative
advantage are shifting rapidly as new competitors constantly emerge.
However, one must note that it is not the movement towards higher-value
service industries per se but constant economic restructuring that keeps the
economy one step ahead of its competitors.
Other than developing new areas of growth, existing industries can maintain
their competitiveness through productivity improvement. After all, in terms of
manufacturing wages, China is not the lowest. Wages in Bangladesh and
Vietnam are even lower but China is able to continue to draw investment and
outsell these other countries due to its more efficient infrastructure, higher
labour productivity and the huge size of its domestic market. While the
domestic market of Singapore is small, the eventual formation of the ASEAN
Free Trade Area (AFTA) enlarges the size of the market, making it an
attractive destination for FDI.

Mark Scheme
Essay Q5
The two casinos set to open in the Integrated Resorts in Singapore are part
of the governments longstanding effort to reorient the economy toward
higher-value service industries like tourism and biosciences as it loses
manufacturing competitiveness to China.
Explain the rationale for the above policy and discuss whether it is the best
policy to achieve the governments macroeconomic goals in a globalised
world. [25]

L3 A clear understanding of the effects of the emergence of China
on the Singapore economy.
Well-balanced argument which considers at least 2 other policies
that the government can adopt to deal with the problems of
globalisation, their effects on the 5 macroeconomic goals and the
limitations.
High L3 There must be a clear link between the policies and
globalisation.
15
21
L2 High L2 Ideas are explained rigorously with evidence of sound
economic analysis, for an answer that is lacking in scope but not
in depth. Attempts at answering both parts of the question.
Low L2 ability to apply some economic analysis and relate to
some of the macroeconomic goals. Answer lacking in both scope
and depth.
8 14
L1 Limited understanding of globalisation and the shifting
comparative advantage with the emergence of China as a
manufacturing hub. Answers are largely descriptive rather than
analytical.
1 7

E2 Judgement based on analysis, providing a reasoned conclusion
based on well-considered comparison of alternative strategies.
3 4
E1 Mainly unexplained judgements. Analysis is largely evaluative but
lacking in comparison, providing an unconvincing conclusion.
1 2

Suggested answer
Essay Q6
(a) Using economic theory, explain why there are gains from free trade.
[10]

Part (a)

1. Introduction
Free trade is defined as the exchange and free flow of goods and services
between countries, unhindered by government imposed restrictions or
protectionism measures.

2. Using either the Theory of Comparative Advantage or Demand &
Supply Analysis, explain why there are gains from free trade.

Using Theory of Comparative Advantage
The theory of comparative advantage states that a country should
specialise in the production of the good if it incurs a lower opportunity cost
in the production of that good. It states that even though a country has
absolute advantage over the other in producing both goods, trade will still
be beneficial if the opportunity cost ratios are different.

a. List assumptions of the theory
- Zero transport costs
- No trade barriers
- Perfect factor mobility within the country

b. Details on the theory of comparative advantage
Not required to give tables.
Explanation should include the following:
- Amount of resources
- Opportunity cost ratios, lower cost of production
- How complete or partial specialization will result in higher
production level for both countries and world output
- How TOT is determined [TOT must lie between opportunity costs
ratios]
- How IT, based on acceptable TOT, will result in higher output in the
production of both the products, higher consumption levels & SOL
for both countries.
- Higher world output with free trade
- Free trade enables a country to specialize in the production of
goods & services in which it has a CA, & hence mutual gains from
free trade.


Comparative advantage Lower costs of production High export
competitiveness High exports of that particular good from that
country.
Limitation:
However, the assumptions made in the theory of comparative
advantage are unrealistic.

OR

Using Demand & Supply Analysis
In a perfectly competitive market, the price of a good, which is determined
by the interaction of demand and supply, plays an important role in
influencing pattern of trade and achieving mutual gains.

For simplicity sake, let us assume a two-country scenario: US and China.
With reference to the diagram, the domestic equilibrium price of textiles in
China is lower [at P
1
] than that of US [at P
2
].

In this case, it is cheaper for US to import textiles from China than to
produce it at home. China is the exporter of textiles and US is the
importer of textiles. The price at which trade will take place between
the 2 countries will be between P1 & P2. At P3, imports of textiles by
US exactly equal the exports from China, as illustrated by ab.

Benefits of trade to China:
Compared to the case without trade, Chinese producers are able to
sell more (Q
1
to Q
3
) and charge a higher price (P
1
to P
3
)
increase in producer surplus
Price of
textiles
Quantity
Price of
textiles
Quantity
China US
P
1

0
0
D
a
D
S
P
2
P3
a b b
Q
1
Q
3
P3
Q
2
Q
4

Total welfare
gain from trade

Benefits of trade to US:
Compared to the case without trade, US consumers now get to
enjoy a higher quantity of goods (Q
2
to Q
4
) at a lower price (P
2
to
P
3
) increase in consumer surplus

3. Explain other gains from Free Trade
a. A wider range of goods for consumers greater consumer choices
greater satisfaction of wants higher SOL
b. Free trade enables a country, e.g. China, to specialize in the
production of goods & services in which it has a CA, & hence exploiting
EOS and lower AC which can be passed onto developed economies in
the form of lower prices, c.p.
c. Lower prices of goods & services increase in consumers surplus in
countries that trade.
d. Increased competition stimulates greater efficiency at home. It may
stimulate greater research and development and rapid adoption of
technology, thus lowering production costs which can translate into
lower prices for consumers. Moreover, higher output and greater
variety of goods are made available for consumers, raising SOL.
e. If the domestic market is small, it will not encourage production. With
IT, the size of the market is enlarged. It will act as an incentive to
produce and invest. Exports generate income & employment. The
increase in employment and income creates an increase in demand for
domestically produced goods in the country which further stimulates
the growth of the local industries. Hence, this country gains from
export-led economic growth, higher N & higher SOL.

4. Conclusion
According to the theory of CA, gains from free trade are possible if the
opportunity cost ratios are different. Countries should specialise in the
production of the good if it has a lower opportunity cost in the production
of that good. Gains from trade can also be explained by using the
demand and supply framework.

Part (b)

1. Introduction
Define exchange rate and international trade
Exchange rate refers to the external value of a currency in terms of
another currency [OR exchange rate is defined as the price at which one
currency exchanges for another]
International trade refers to the exchange of goods and services between
countries.

While exchange rate is a significant determinant of international trade, it is
not the only one. There are other factors which could affect trade between
countries.

2. Thesis: ER changes is an important factor affecting international
trade

Explain why exchange rate has influence on a countrys international
trade

It is because a country is usually required to pay in the foreign sellers
currencies. Thus, the cost of an import or export includes the price of the
good and the currency used. At times an export may be relatively cheap,
but a strong currency makes it costly in other countries.

Changes in exchange rates can affect a countrys terms of trade. TOT is
the rate at which a country exchanges its exports for imports. With an
appreciation of the countrys currency, its TOT has improved and is
favourable. For a given amount of imports, the country needs to export
less.

Explain how an appreciation or revaluation of the domestic currency
can affect exports & imports of goods & services

Appreciation of the domestic currency can affect trading of goods and
services between countries. With the appreciation of the domestic
currency, exports are now relatively dearer to foreigners while imports are
now relatively cheaper to locals. When the price of exports increases in
terms of foreign currencies, qty demanded of exports decreases by more
than proportionately, assuming demand for exports to be elastic. This will
reduce TRx and volume of exports. When the price of imports decreases
in terms of domestic currency, qty demanded of imports increases by
more than proportionately, assuming demand for imports to be elastic.
This will increase TEm and volume of imports. This will cause a worsening
of the balance of trade.

Evaluation
However, in the SR, demand of exports and imports may be inelastic.
It takes time to find substitutes or adjust consumption habits. The ER
appreciation will thus bring about an improvement in the trade balance
in the SR.
Also, trading in goods & services may not be that severely affected by
the ER appreciation if firms are able to maintain their export
competitiveness by improving their productivity and cost savings
passed on as lower prices. Moreover, a stronger currency leads to
cheaper imported inputs which aids export competitiveness for firms

that are dependent on imported inputs. Volume of trade may not be
adversely affected. If the country is able to import cheaper capital
goods it will increase her productive capacity in the long run, thus
expanding her exports.

Similarly, revaluation of the currency by the government can also affect
international trade. It is a deliberate action by the government to
strengthen its currency if it is running an undesired trade surplus with
other countries. Revaluation will raise the price of the countrys exports in
terms of foreign currencies and decrease the quantity of exports. At the
same time, it will lower the price of imports in domestic currency and
increase the quantity of imports.

Hence, a strong and persistent appreciation or revaluation of its currency
can erode whatever comparative advantage a country had in some
exports and thus reduce exports.

Converse holds true for depreciation or devaluation of the domestic
currency. With the depreciation of the domestic currency, exports are now
relatively cheaper to foreigners, thus increasing its exports. On the other
hand, imports are now relatively dearer to locals, thus reducing its imports.
[to take note of elasticity considerations]

3. Anti-thesis: Besides ER changes, there are other factors affecting
international trade

(i) Explain how globalisation can affect international trade

Protectionist policies e.g. tariffs and import quotas, in contrast, reduce or
restrict trade flows between countries by artificially raising the prices of
imports. The shift towards globalization however has changed the
economic landscape.

Forces shaping globalization:
A number of innovations have developed to reduce the transport costs
and promote greater trade between countries. For example,
containerisation and bigger ships built makes it easier & cheaper to
transport physical products around the world.
The reduction in transport costs also makes it profitable for firms to
outsource segments of production to different parts of the world
increase trade in intermediate products.

Effect of globalization on international trade:
As a result of the opening up of China, India and Eastern bloc countries,
world markets and opportunities to export have expanded considerably for
advanced economies and developing countries alike.

Developing countries imports have been growing faster than those of
advanced economies.
Share of advanced economies exports going to developing countries
has been on the rise.
Significant increase in the trade between developing countries.
Developing countries share in world exports of skilled goods and
services has been on the rise in recent years.

Free trade agreements (FTAs) such as ASEAN Free Trade Agree and
APEC make imports and exports of goods cheaper via the abolishing or
reduction of trade barriers such as tariffs. FTAs also give the country
greater access to overseas market, potentially increasing its exports. But
FTA is a reciprocal agreement. Signatories of FTAs must also open up
their domestic markets to imports by reduction in trade barriers. This
lowers import prices of raw materials and increase supply of goods and
services, thereby lowering prices of final goods and services for local
consumption and exports.

Formation of trading blocs shifts the pattern and volume of trade between
countries. It stimulates trade between member countries and diverts trade
from non-member nations.

(ii) Explain how demand and supply factors can affect international
trade

a. Demand factors
Demand factors, such as changes in population, income, tastes &
preferences are increasingly important in explaining the pattern of
trade between countries
Examples
Emerging economies such as China: increase in population and
growing affluence increase in demand for many goods and
services, including agricultural products.
Brazil is one of the major suppliers of agricultural products, such as
soya beans, for China opportunity for Brazil to increase its
agricultural production increase volume of trade between Brazil
& China

b. Supply factors
Supply factors such as improvement in technology and innovation
lowers production and increases production efficiency. Other than
factor endowments, technological changes will also affect the
comparative advantage of a country. More output can be produced at
each possible price level, thus expanding volume of trade.

8. Conclusion
Frequent changes in exchange rate can lead to unstable currency and
thus disrupt international trade. Both foreign & local investors and
producers as well as traders are uncertain of future movements in
exchange rates. Thus, it is difficult to make trading plans. In the LR,
economic transactions between countries may be reduced.

Exchange rate is but one of the factors affecting trade flows between
countries. The increase in trade flows is predominantly a global or regional
phenomenon as a result of globalization. As globalization gathers
momentum and trade barriers gradually abolished, international trade
flows of goods or services would be expected to be begin to flow gradually
from countries which have a comparative cost advantage to countries with
a cost disadvantage with the lower priced good in country B being
exported to the high priced country A.

With most nations committed to free trade and with the dismantling of
trade barriers under WTO, international trade flows of goods, services,
capital, and labour will continue to grow as a proportion of world GDP.
This will increase interdependence between countries and their
vulnerability to fluctuations in world trade.

Mark Scheme
Essay Q6
(a) Using economic theory, explain why there are gains from free trade.
[10]

Part (a)

L3 Well-developed explanation and analysis of either the Theory of
CA [using complete or partial specialization and in terms of
opportunity cost] or the Demand & Supply Analysis.
And well-developed explanations of at least 2 other gains from
free trade.
8-10
L2 Undeveloped explanation of either the Theory of CA or the
Demand & Supply Analysis. Shows some understanding that CA
is based on opportunity cost. Explain how TOT is determined.
Also include 2 other gains from free trade, without thorough
explanation.

If answers show one-sided explanation, cap at 7m.
- either well-developed explanations on the Theory of CA/
Demand & Supply Analysis or at least 4 gains from free trade.
4-7
L1 For an answer which contains definitions and listing of facts
concerning Theory of CA, Demand & Supply Analysis and other
gains from free trade. Explain Theory of Absolute Advantage.
1-3

Part (b)

L3 Well-developed explanation & evaluation on how exchange rate
changes and 2 other factors can affect a countrys international
trade.
9-11
L2 Undeveloped explanation of how exchange rate changes and 2
other factors can affect a countrys international trade. Limited
evaluation of how exchange rate changes and 2 other factors can
affect a countrys international trade.

If exchange rate changes & one other factor are explained with
no evaluation, cap at 6m.
5-8
L1 For an undeveloped answer that focus on how exchange rate
changes can affect international trade. Economic analysis is
limited or erroneous.
1-4

Allow up to 4 marks for Evaluation
E2 Evaluative assessment of frequent changes in exchange rate on
international trade. Reasoned judgement on relative importance of
various factors affecting international trade.
3-4
E1 Unexplained assessment of frequent changes in exchange rate on
international trade. Recognise the limitation of various factors
affecting international trade.
1-2

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TPJC Economics / 2008 / H2 Preliminary Examination / Paper 2 1

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