EJC Econs 2021 A-Level H2 P1 Q2 SAMS

Suggested Answers for 2021 A -Level H2 P1 Qn 2: The Impact of Foreign Direct Investment (FDI) Flows in South-East Asia (a) State what is meant by foreign direct investment (FDI) and identify the component of the balance of payments accounts in which FDI is recorded. [2] FDI is long-term capital flow which reflects the sale and purchase of real assets (e.g. manufacturing plants, factories, acquisition of existing firms, equipment, etc.) between a country and the rest of the world. It is recorded in the capital and financial account of the BOP. (b) (i) Explain the opportunity cost of investment expenditure that uses domestic funds. [2] Opportunity cost refers to the benefits of the next best alternative foregone. funds for investment expenditure, it competes for loanable funds within the country, hence resulting in opportunity costs in terms of consumption expenditure foregone when consu mers find it more expensive/harder to borrow from banks. (ii) Using a production possibility curve diagram, show the impact of infrastructure improvements in a country such as Singapore or Vietnam. [2] The infrastructure improvements in a country such as Singapore or Vietnam includes an improvement in transport which would improve the efficiency of resources such as labour and capital. This causes the PPC to shift outwards from PPC1 to PPC2 as the ability to produce capital goods and consum er goods given infrastructure improvement has increase d, reflecting an increase in productive capacity. (c) Explain how the current account of the balance of payments of Singapore or Vietnam is likely to be affected in the long run by increased FDI. [6] The current account of the balance of payments records the value of exports and imports of both goods and services (balance of trade) and international transfers of capital (net income transfers and net current transfers). Increased FDI brings about actual growth and potential growth . As sustained growth is achieved, there is price stability as general price level falls. This improves export price competitiveness. Assuming demand for Vietnam’s exports is price elastic, this improvement in export competiti veness will bring about a more than proportionate rise in quantity demanded, hence export revenue (X) rises, improving Vietnam’s balance of trade and hence current account balance in the long run.

However, the increased FDI also brings about rise in Vietnam’s real national income. With greater purchasing power to purchase more goods and services, not only from the domestic market but also from international market. The rise in import expenditure would worsen Vietnam’s current account balance in the long run. Or Increased FDI brings about an improvement in production methods, leading to a lower unit cost of production of goods. This increases export price competitiveness, ceteris paribus. If demand for exports is price elastic, this improvement in export competitiveness will bring about a more than proportionate rise in quantity demanded, hence export revenue (X) rises, improving Vietnam’s balance of trade and hence current account balance in the long run. On the other hand, increased FDI could result in a worsening of the current account in the long run. As mentioned in Extract 6, China has been the largest contributor to Vietnam’s FDI inflows. This mean that owners of FDI will repatriate their profits earned back to their home countries such as China , recorded as an outflow of income transfers. This would worsen current account in the long run. Overall, the impact of increased FDI on the current account of the balance of payment is dependent on the relative impact on balance of trade and outflow of income transfers. (d) Discuss whether broad export diversity or specialisation in a narrow range of exports is more likely to be beneficial for an economy engaged in international trade. (CLT) [8] Approach Command Word Discuss whether: Balanced answer + EV Start Point Encourage domestic investment vs. Encourage investment from external sources End Point Beneficial for an economy Content and Context Content Broad export diversity Specialisation in a narrow range of exports Context Economy engaged in international trade Introduction Both export diversity and specialisation in a narrow range of exports bring about benefits for an economy engaged in international trade. Body Specialisation in a narrow range of exports is beneficial The benefits of free trade is based on the Theory of Comparative Advantage states that trade between nations is beneficial to all if each specialises and trades according to its comparative advantage. A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost. With speciali sation, there is a more efficient allocation of resources and increase in total world output for the same amount of resources. The differences in factor endowments mean that specialisation and trade will make it possible for a country to consume outside it s production- possibility curve (PPC) i.e. able to enjoy higher material standard of living.

With specialisation and trade, the country will now have a larger export market, bringing about higher export volume and hence AD increases. This increases real national income via the multiplier effect, leading to actual growth, as well as lower demand-deficient unemployment as demand for labour increases. This also improves the BOT position. Trade also allows a developing country to obtain imports of higher quali ty factors of production, thereby increasing the productive capacity of a country, leading to potential growth. Trade allows the sourcing of factors of production from lower -cost economies, leading to an increase in SRAS and lower cost-push inflation. Broad export diversity is beneficial However, some countries may be highly specialised in a narrow range of products. As mentioned in Extract 6, Vietnam’s exports to the US growing faster than its overall exports. This would mean that Vietnam is dependent on the US to a large extent on the export revenue from these products to buy the imported goods that they need. If US were to impose tariffs on Vietnam’s exports to the US, the fall in demand for Vietnam’s products will have serious repercussions on AD and hence on her national income and employment, as well as on net exports and hence on current account balance. Such instability can be reduced b y diversifying into the production of a variety of largely unrelated products. According to Extract 5, export diversity refers to the range of goods and services produced and exported, and is measured by the number of different types of products exported. To do this, domestic Vietnamese firms must be protected from foreign competition. Otherwise, they will not be able to compete because of their relative inefficiency due to a lack of comparative advantage. In additional, broad export diversity allows a coun try to reduce the negative impact on its exports when an import tariff is placed on its selected exports. Evaluation Broad export diversity is more likely to be beneficial for an economy engaged in international trade than specialisation in a narrow range of exports. This is evident from Extract 5 that trade growth potential is dependent on economic dynamism and export diversity proving that broad export diversity is more beneficial for an economy. This is especially important in the uncertain global climate where there is growing global trade tensions which necessitates an economy’s ability to shift its focus to different industries when one is threatened. Mark Scheme Level of Response and Descriptors Marks L2 Developed analysis of specialisation and broad export diversity is beneficial for an economy engaged in international