2013 DHS H1 EC Ans Scheme

1 DUNMAN HIGH SCHOOL H1 Preliminary Examinations 2013 Economics 8819 Answer and Mark Schemes

2 Suggested Answers Case Study Question 1 (a) Using Figure 1, compare the trend in food and fuel prices between March 2001 and March 2011. [2] This question requires candidates to describe the 1. similarity in the general trend observed for food and fuel prices over the stipulated period, and 2. difference in the trend Generally, both increased [1], but fuel price rose and fell more sharply than food prices. [1]  1 mark for similarity and 1 mark for difference (b) With reference to Extract 1, explain why the Thai government must intervene in setting up infrastructures as such canals and flood control systems for a more efficient allocation of resources. [4] This question requires candidates to 1. identify that these infrastructures exhibit the characteristics of public goods 2. explain how these public goods cause the market to fail, which justifies why the Thai government must intervene to achieve a more efficient resource allocation  Infrastructures such as canals and flood control systems are public goods that exhibit the characteristics of non-rivalry and non-excludability.  Non rivalry – A good is non-rivalled in consumption when the consumption of the good by one person does not diminish the quantity available for others to consume and benefit from. When the canals and flood control systems are built, all citizens who live in the vicinity of these infrastructures benefit from reduced risks of flooding, and such benefits will not be reduced with every additional consumption. Thus the marginal cost (MC) of preventing flooding via construction of infrastructures to an additional resident within the country is negligible. Since the allocative efficient outcome is at price = MC, where the value (price) that consumers place on these infrastructures is the same as the cost of the resources used to produce an additional unit for additional consumption, the price to charge for an efficient allocation of resources to the production of these infrastructures should be at zero.  Non excludability – A good is non-excludable when it is impossible or prohibitively expensive to prevent or exclude anyone including non-payers from consuming the good once it is produced. When these infrastructures are built, it is likely that there is less risk of flooding during the monsoon season. Even if one does not pay for these infrastructures, he / she will still be protected from flooding risks. Since there is enjoyment of protection without paying, this leads to the problem of free-riding, which is supported by the evidence in Extract 1 “a good that cannot be confined to those who have paid for it”.  Under the market forces, there will be no provision of these infrastructures because the price mechanism is unable to function, since consumers are not willing to pay for these infrastructures due to the ability to free-ride. This means that there is no effective demand for these infrastructure s, causing profit-motivated producers to have no incentive to produce these infrastructures at all since there is no revenue to be earned, leading to no supply of these infrastructures by the private producers. This leads to complete market failure where there is zero production of infrastructures such as canals and flood control systems.

3  However, these infrastructures are desirable and beneficial to the society. Therefore, since the free market fails to allocate resources efficiently within the economy as no resources are allocated to the production of these infrastructures which leads to severe welfare loss for the society, the Thai government which acts in the interests of her citizens must intervene in setting up these infrastructures to bring about a more efficient allocation of resources.  2 marks for a well-developed explanation on each characteristic of public good  Cap at 3 marks without referring to evidence and / or not applying to the context of infrastructures such as canals and flood control systems (c) With reference to Extract 1 and Table 1, to what extent will the Thailand flood bring about harmful effects on its macroeconomic performance? [6] This question requires candidates to 1. identify and explain the impact of the Thailand flood on the 4 macroeconomic goals 2. sieve out the relevant information from the case materials to determine if the harmful impact is to a large or small extent Macroeconomic performance – need to link to 4 macroeconomic goals Thesis: harmful effects to a large extent  As seen from Extract 1, the Thailand flood has claimed more than 300 lives and may lead to long-term loss of foreign direct investment (FDI) due to a lack of adequate infrastructure to handle flooding and poor governance that hurt Thailand’s reputation as a reliable and conducive business environment for foreign investors. With a reduction in quantity of resources as well as a loss of FDI results in less transfer of technology and management expertise respectively, these will cause the aggregate supply (AS) to shift from AS 1 to AS2, reducing the productive capacity of Thailand’s economy from Y f1 toY f2. Potential growth is thus hindered. Also, a fall in FDI causes aggregate demand (AD) to fall from AD 1 to AD 2, there exists a surplus leading to accumulation of inventories, and firms producing capital goods cut back production in the next production cycle. In the process, less workers are employed (rise in cyclical unemployment) who receive lower factor incomes, resulting in income-induced consumption to fall, thereby reducing AD further to AD 3. This is the reverse multiplier effect, which continues until the initial fall in injections equal total fall in withdrawal s. The final outcome is a rise in cyclical unemployment from Y1Yf to Y3Yf.  Furthermore, the Thailand flood is likely to have destroyed capital machinery in factories, hence disrupting the production of goods and services, causing firms to incur heavy losses. In order to minimise losses, firms lay off workers as evidenced from ‘14,000 companies employing more than 600,000 workers were forced to shut AD2 AD3  AD1  AS2    a                                 b    Y3    Y2    Y1  Yf2  Yf1  GPL  Real NY  AS1

4 down’, especially the computer disk dr ive industry and the automotive industry which is one of the hardest hit industries. Given that the former is a leading exporting industry, Thailand’s balance of trade (BOT) is expected to worsen as well. Coupled with a fall in FDI from 2010 to 2011 as seen from Table 1 where the net inflow of FDI fell both in percentage and absolute terms, the financial account of the balance of payments (BOP) declines, worsening Thailand’s BOP. Anti-thesis: harmful effects to a small extent  According to Table 1, between 2008 and 2012, exports increased by the greatest percentage (5.6%) in 2011. Even though the leading export industry – computer disk drive industry was hit by the flood, exports did not face an adverse impact. Ceteris paribus, BOT improves.  Components of AD – private consumpt ion expenditure and gross fixed capital formation still increased both in absolute and percentage terms albeit the Thailand flood. This is further supported by the rise in real GDP in 2011, which shows that economic growth did not decline despite the flood.  In the subsequent year 2012, Thailand received more net inflows of FDI both in absolute and percentage terms, reflecting that foreign investors still had confidence in Thailand economy, and still deems Thailand as an attractive investment country. Thus, potential growth is unlikely to be hindered, and the financial account of BOP improves. In conclusion, the Thailand economy is affected adversely by the