YISHUN JUNIOR COLLEGE

JC2 PRELIMINARY EXAMINATION 2009

H2 ECONOMICS 9732/01
PAPER 1 27 August 2009
TIME 2 hours 15mins
Additional Materials: Answer Paper

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READ THESE INSTRUCTIONS FIRST

Write your name and CTG on all the work you hand in.
Write in dark blue or black pen on both sides of the paper.
You may use a soft pencil for any diagrams, graphs or rough working.
Do not use highlighters or correction fluid.

Answer all questions

At the end of the examinations, fasten all your work securely together.
The number of marks is given in brackets [ ] at the end of each question or part
question.

This paper consists of 9 printed pages

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Question 1
The Inflation Tsunami

Extract 1: Singapore's inflation hits 25-year high

Singapore's annual inflation rate hit a 25-year high of 6.6 percent in January, according to
Department of Statistics (DOS) data released on Monday. The inflation rate, as indicated
by the consumer price index (CPI), was the highest since the 7.5 percent hit in March 1982.
The Ministry of Trade and Industry (MTI) issued a statement along with the DOS data,
saying the year-on-year jump in inflation in January was in line with the official inflation
forecast of 4.5-5.5 percent for 2008.

The DOS said the jump in inflation was due largely to an 11.1 percent spike in housing costs
recorded after a revision to values of public housing. Housing costs, which account for 21
percent of the consumer price index, have the third-largest weighting after food and
transport/communication. Food prices, which carry the largest weighting in the CPI, rose 5.8
percent in January from a year earlier. Transport and communication costs rose 6.9 percent
between January 2007 and January 2008, driven by soaring global fuel prices and higher
taxi fares. Higher petrol prices also contributed to a rise in transport costs for food. This,
coupled with higher global food prices, means more expensive grocery bills.
Source: Channel News Asia, www.channelnewsasia.com, 25 February 2008

Extract 2: UK inflation soars to 5.2%

Inflation unexpectedly soared to 5.2% last month, the highest in 16 years, after power
companies hiked gas and electricity bills.
The annual rate in the consumer prices index (CPI) was up from 4.7% in August and the
highest since the series began in January 1997. The figures are expected to mark the peak
in the spiralling cost of living seen this year.
The main reason consumer price inflation topped 5% for the first time was sharp rises in
utility bills. Electricity prices were 30.3% higher on a year ago while gas prices soared by
49.9%. The annual rate of inflation for energy and other household bills hit 15%, the highest
since January 1989.
A separate measure, the Retail Prices Index (RPI) - which includes mortgage payments and
is more commonly used for wage bargaining and pension payments - reached 5 per cent in
July, up from 4.6 per cent, which is the highest level since July 1991.
The rise in the RPI spells good news for pensioners and those receiving benefits.
September's RPI is commonly used by the government to calculate pension increases for
the coming year. Pensions usually rise by 2.5% or in line with the headline RPI, whichever
is higher.
Paul Kenny, general secretary of the GMB union, said: “Inflation is impacting on the
economy differently in different sectors”.
“Food manufacturing, for example, is being squeezed, leading to severe job losses. Other
sectors like oil and energy are printing inflation by hiking prices."

Source: Adapted from The Guardian , http://guardian.co.uk, 14 Oct 2008

and My Express , http://express.co.uk 12 Aug 2008
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Figures 1 & 2: Inflation & Unemployment in the UK and Singapore

Figure 1: UK

U n e m p l o ym e n t R a te ( % )
7 A n n u a l r a te o f i n fla ti o n ( % )

4
%
3

2008*

2009*
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007
Year

7 Figure 2: Singapore

6
5
4
% 3
2
1
0
-1
2008*

2009*
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Year

* estimates
Note: - Annual Rate of Inflation calculated based on annual percent change in average consumer prices
- Unemployment Rate calculated based on Total Labour Force

Source: IMF W orld Economic Outlook Database, www.imf.org, Oct 2008

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Extract 3: Inflation in other economies

In a further twist to the global inflationary spiral, Indian inflation has shot into double figures,
reaching 11 per cent last month, its highest in 13 years. As in China, where inflation is
nearing double digits, much of the recent increase in prices has been due to rising fuel costs
after the withdrawal of state support.
In Vietnam, where the year-on-year rate of consumer price inflation reached 19.4% in March,
various factors such as a general overheating of the domestic economy, an undervalued
exchange rate and inappropriate monetary policy have added to the impact of rising food
prices in fuelling inflation.
Of other major economies in Asia, only South Korea, Taiwan and Malaysia reported inflation
of under 5% in their most recent data release.
The rise in inflationary pressures could hardly have come at a worse time in the global
economic cycle. In Asia, there are already fears over the extent and impact of the US
slowdown on these export-dependent economies. Ideally, central banks in these economies
would be cutting interest rates to support domestic demand at a time when exports are
forecast to slow. However, cutting interest rates when inflation is rising is risky. As a result,
central banks are faced with the unappealing option of either keeping interest rates on hold,
or raising them. Moreover, owing to lower interest rates in the US, this is likely to lead to a
further widening in interest-rate differentials between rates in Asia and those in the US. This
will put further upward pressure on Asian currencies, most of which have been steadily
appreciating against the US dollar over the past year.
Source: Adapted from The Independent, www.independent.co.uk, 21June 2008
and The Economist, www.economist.com, 15 Apr 2008

Figure 3: Consumer price inflation Figure 4: Emerging economies’ *

in emerging economies (%) Nominal GDP growth and interest rates (%)

* Average of ten biggest economies

Note: 2008 are forecasted figures

Source: The Economist, www.economist.com, 22 May 2008

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Questions
(a) (i) With reference to Figures 1 & 2, compare the trends in consumer prices between
the UK and Singapore over the period 1998 – 2007. [2]
(ii) To what extent does the information in Figures 1 & 2 suggest that there is a stable
relationship between inflation and unemployment in the UK and Singapore? [4]

(b) Using AD/AS analysis, explain how higher global fuel prices have contributed to a rise in
consumer prices in the Singapore economy. [3]

(c) Using extract 2 and your own relevant knowledge, discuss the possible conquences of
inflation on the UK economy. [8]

(d) (i) Explain one possible link between changes in short term interest rates and nominal
GDP growth rates in the emerging economies as shown in Figure 4. [3]
(ii) Assess whether central banks in these economies should adjust their interest rates in
the face of rising inflation and an expected slowdown in the US economy. [10]

[Total: 30]
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Question 2
The ‘vroom’ industry — Boom or doom?

Extract 4: Emerging Markets Beckon World Carmakers

Imagine a rapidly growing economy in which billions of increasingly affluent citizens cannot
wait to buy their first car and take to the freedom of the open road. No, this isn't a
multinational auto executive's fantasy: it is the reality of China and India. As demand starts
to stagnate in the West's mature and saturated automotive markets, the East's full growth
potential is becoming apparent to the world's carmakers.
The statistics are tantalising. In China and India, with populations of 1.3 billion and 1.1
billion, respectively, fewer than 10 in 1,000 driving-age inhabitants currently own a car. Yet
purchasing power in these two countries is strengthening significantly, as shown by 2006-
2020 GDP growth forecasts of 5.5% per year in India and 5.2% per year in China.
Source: BusinessWeek, www.businessweek.com, 20 March 2006

Extract 5: Plight of the big car makers

Today's controversies over high petrol prices and fuel-guzzling SUVs in the huge American
market offer only a partial picture of the future facing the industry as a whole. It may well be
fully mature in markets such as North America, Europe and Japan, where over-capacity
continues to sap profitability. But the industry is set for huge expansion with the motorisation
of China and India. Within a few years China will replace Japan as the second-largest
national market after America. Some experts predict that over the next 20 years more cars
will be made than in the entire 110-year history of the industry.
Garel Rhys, director of the Centre for Automotive Industry Research at Cardiff University in
Britain, says this growth will create the need for 180 new factories, each producing 300,000
cars (and light trucks) a year — in effect, almost doubling the production capacity of the
global industry to over 110m units annually. Today's car plants, he says, will need to be
“renewed, retooled, refurbished and replaced to remain competitive. There is nowhere for
the inefficient to hide.”
That is a bleak message for today's established big producers, many of which have merged
their way to giant status, but remain chronically hampered by legacy costs and operating
problems and could now be beaten by new entrants and competitors that have eschewed
the merger game. The new car industries springing up in China and India will account for
most of tomorrow's extra production. As their output starts to reach markets around the
world, the question is: which of today's big carmakers will be hurt the most? Eventually the
question could be an even tougher one: which will survive?
Source: The Economist, www.economist.com, 8 September 2005
 7

Figure 5: Number of big manufacturers in the

passenger car industry, 1980 - 2001

Source: Adapted from The Economist, www.economist.com, 2 September 2004

Figure 6: Global Vehicle Production,

by alliance group, 2004 (million units) Figure 7: Operating Margin*, 2004 (%)

* The ratio of operating profit divided by net sales

Source: Adapted from The Economist, www.economist.com, 8 September 2005

 8

Extract 6: Counterfeit cars in China

Copying in China goes far beyond fake DVDs, watches and handbags. “We can copy
everything except your mother,” goes a saying in Shanghai.
Of all the products to copy, however, a car is surely the most complicated. Cars consist of
around 6,000 precisely manufactured components made from a range of different materials.
For a car to be cheap, reliable and long-lasting, says conventional industry economics, these
parts need to be put together in factories with huge volumes, lots of expensive machinery
and many well-trained engineers.
So it came as a surprise when counterfeit cars started to appear in China eight years ago.
What was once a trickle has since become a stream. Toyota's badge, Honda's name (which
became “Hongda” for motorcycles) and Nissan's bumpers have all been the subject of legal
wrangles.
So far, such legal action by foreign firms has proved nearly useless. The many writs, threats,
injunctions and court cases have become embroiled in slow-grinding legal machinations,
been thrown out on technical grounds or failed because foreign firms had not properly
registered their designs. Foreign carmakers are reluctant to make too much of a fuss, lest
they be excluded from a fast-growing market or generate unwelcome negative publicity.

Source: The Economist, www.economist.com, 4 April 2007

Extract 7: Other issues

Earlier this month Germany's carmakers were hit by new emission limits proposed by the
European Commission. There were howls of protest, not least from Angela Merkel, the
German chancellor. So the proposed ceiling was raised a little, to 130 grams of carbon
dioxide per kilometre to be met by 2012. This still left the makers of many of the world's
most prestigious cars with the most work: in the European Union only six German-made
models meet the target, but 34 of those made by competitors do. Moreover, of all the cars
on sale in Germany that pump out more than 200g of carbon dioxide per kilometre, most are
German.
This is not a happy state of affairs for a country that likes to lead the way on the
environment. Nor does it bode well for Germany's biggest industry, which employs one in
seven of the country's manufacturing workforce. Germany's carmakers should benefit from
spreading their escalating costs of research and development across a greater volume of
vehicles. But attempts to drive into mass markets have failed, with BMW's disastrous
takeover of Britain's Rover Group and DaimlerChrysler's marriage now facing divorce.
In the past, premium carmakers have tended to assume a certain level of price-insensitivity
among their clientele. But a new sensitivity is emerging. Buyers' tastes are changing and
they have increasing qualms about the environment.
Source: The Economist, www.economist.com, 22 February 2007
 9

Questions

(a) (i) Describe the relationship between the scale of production and the operating margin
of the car manufacturers. [2]
(ii) Explain two possible reasons for this relationship. [4]

(b) Explain why the number of big manufacturers in the passenger car industry has
declined over the period from 1980 to 2001 as shown in Figure 5. [3]

(c) Using the data, discuss the factors influencing a foreign car manufacturer’s decision to
invest in China. [5]

(d) How far can it be concluded from the data that the global market for cars manufacturing
is oligopolistic? [6]

(e) With reference to the information where possible, assess whether the new emission
limit proposed by the European Commission will have impact on the micro and macro
goals of the German government. [10]

[Total: 30]