2016 JC1 NYJC Promotional Examinations H2 Case Study Answers

2016 Promotional Exam H2 Case Study Suggested Answers (a) (i) Describe the trend of China’s nominal GDP from 2011-2015. Requirements: Using table 1 as the information source, students are to conclude that because of the positive GDP growth figures over the period, China’s GDP is increasing at a decreasing rate. [2] (ii) Using information from the case materials, account for the above trend. Requirements: • Students are to infer that China is undergoing “structural change in the economy” (Ext 1, para 2) towards a consumption-driven economy ➔ economic activities promoting economic growth gives greater priority to domestic consumption rather than exports (albeit the absolute figures for the latter could still be a fairly large contributor to China’s GDP) Suggested Response: • China’s growth “new normal” is the consequence of: i. Lower increases in AD overtime (with AS constant) ▪ The slower rate of increase in AD was due to a slower X demand rise not adequately made up by the rate of increase in consumption expenditure (the main driving force in China’s AD) ➔ causing a subsequently slower cumulative AD rise & growth over time. ii. Lower increases in AS overtime (with AD constant) ▪ The effect on China’s productive capacity from a consumption-driven growth (from mainly services sector) is relatively lower than manufacturing sector driven growth. (Ext 1, para 3) ➔ with a constant AD, the rightward shift caused by services sector would not be as much in magnitude as it would have been due to the growth in the manufacturing sector. [2] (b) (i) Define the term unemployment. Requirements: Student are to show ability to recall the definition or provide an accurate description/meaning of the unemployment concept. [1]

(ii) Using the information provided, identify and explain the types of unemployment that the Chinese economy is facing. Requirements: From appropriate evidence from the case material, students are to show accuracy in conceptual knowledge in matching the identified causes/circumstances in China to the theoretical unemployment types. Suggested Response: • China may face demand-deficient unemployment. Assuming the 2016 contraction of China’s exports of -2.5% (Table 1) is due to a fall in demand by China’s trading partners. China’s export sector may face a situation of output surpluses. To minimize the potential fall in revenue & profits for the sector, employers may react to the declining export demand by reducing their demand for labour. • China faces structural unemployment due to the “rapid structural change” (Ext 1, para 3) of China’s main growth sector from manufacturing to services (Ext 1, para 3). This may increase the likelihood that a skill mismatch between the skills job-seekers (new labour market entrants or those retrenched from other sectors, eg. manufacturing sectors) possess and the skills demanded by employers in the services sectors may occur. [4] (c) Explain how the following policies may affect economic growth in China: (i) cutting interest rates (ii) “ramping up taxes” (Extract 3) [3] [4] Requirements: Students are expected to illustrate the ability to provide an applied analysis of the impact of the 2 MP & FP measures on the concepts of economic growth (actual & potential). Suggested Response: (i) cutting interest rates (a) Affects actual growth: • In the short term, a decrease in interest rates results in increases in C and I which are components of AD, via the k effect, leads to a rise in RNY and rise in actual growth rates. ▪ A decrease in interest rates decreases the cost of borrowing. The decrease in interest rates reduces the returns from savings and lowers the opportunity cost of consumption. This leads to an increase in C. [3]

▪ In addition, expected profitability increases, leading to an increase in I. (b) Affects potential growth • In the longer term, increases in I, brought about by expansionary MP, may also increase AS and thus increase China’s potential growth. Assuming China is on the intermediate range of the AS, the measured economic growth (actual growth) rates would rise again, c.p. • A decrease in interest rates discourages savings, thus, the amount of funds that banks have for lending decreases. This may lead to a decrease in investment level and reduce potential growth. (ii) “ramping up taxes” (Extract 3) (a) Affects actual growth • High income earners: C and I may fall (due to higher direct/income tax imposed on them; broadening of personal taxes) → AD may fall (albeit slightly) • Non-high income earners (poor): C and I will rise being beneficiaries of transfer payments from the income redistribution tax policy ➔ AD may rise ➔ Assuming the AD rise due to the poor/non-high income earners offsets the AD fall by the high income earners ➔ net increase in AD (& the production of goods & services to meet the demand), RNY rises and actual growth rises. • The imposition of a indirect/value-added tax on services would effectively raise the cost of production or cost of making the service available to consumers. This may cause economic growth to fall. Depending on the extent of the shifts, actual EG may increase slightly since the value-added tax may not be substantial (b) Affects potential growth • Ramping up taxes to pay of redistribution may adversely affect potential growth. Increase in direct taxes &/or broadening on the personal taxes imposed on other forms of assets owned would discourage investments in the domestic economy as expected returns to investments are seen to be lower. As such the higher income earners may save & invest in other countries with more attractive personal tax rates, leaving a lower availability of funds and investors to benefit the economy. [4]

(d) With the aid of an AD-AS diagram, explain why China's rate of inflation did not rise as fast to meet the official target of 3%. Requirements: Students are to illustrate using a diagram & accompanying descriptions, their analytical understanding of how despite a rise in actual (mainly AD rise) and potential growth (commonly AS rise), inflation rates are still below the official target. Suggested Response: The inflation rate did not rise to or beyond the official target because China’s growth in AD is "persistently weak demand" whereas its ability to produce is fairly high due to "massive overcapacity" (Ext 2, para 2). Contributing demand reasons After over three decades of double-digit growth, the “new normal” of slower growth is due to the persistently weak demand brought about by the inevitable weakening of its major growth drivers that necessitates structural change in the Chinese economy. This means that despite experiencing positive growth, AD has been rising at a level that is considered not high enough to cause an inflation rate of beyond 3%, c.p. Contributing supply reasons The investments (over this 30-year period influenced by China’s double- digit growth) towards enhancing China’s infrastructure would eventually lead to a massive ability for China to produce goods and services – increasing its productive capacity enormously. The enormous increases in productive capacity (& AS) would has an effect of causing inflation to fall, c.p. The increase in AD coupled with a relatively larger increase in productive capacity or AS, would inevitable mean that China experiences surplus at the existing price level causing the GPL to fall – ie. China would experience a non-inflationary growth where GPL dos not increase beyond its official target of 3%. [4] (e) Discuss whether sustained economic growth will always lead to a higher standard of living in China. Requirements: Students are to show awareness of the concepts of sustained economic growth and