VJC H1 Econ Answer

1    Answers to 2014 H1 Economics Prelim Exam Section A Case Study Question 1: ai) Describe the trend of the world’s cement production from the year 1994 to 2012. Increased (1) at an increasing rate (1). 2m aii) Using demand and supply analysis, account for the trend in the world’s cement production. Rise in demand (2) Cement demand by China has increased exponentially by 437.5% in 20 years, while use in the rest of the world increased by 59.8%. Cement is a raw material used for the construction of new infrastructure (roads, bridges, dams and houses). Fall in supply (2) Sand is used in the production of cement and the increase in price of sand (Extract 1) would cause an increase in Marginal Cost and result in a decrease in supply. As cement demand has risen exponentially in China and China uses 58% of the world demand, rise in demand is likely to be greater than the fall in supply. With demand rising by more than supply, the equilibrium quantity would have increased. (1) From Fig 1 can justify that since production has gone up, quantity sold has increased hence the rise in demand is greater than the fall in supply. 5m bi) What is meant by price elasticity of demand? Price elasticity of demand measures the responsiveness of quantity demanded for the good to a change in its prices (1), ceteris paribus (1) formula also get (1) 2m bii) Explain how the rise in price of sand would affect Singapore’s import expenditure on sand. Total Expenditure (TE) is price of sand x quantity demanded of sand (1). Demand for sand is inelastic as evident by Extract 2 “Singapore is not ready for high tech transformation in construction (1). When the price of sand increased, quantity demanded of sand would fall by a less than proportionate amount, the effect on TE would increase since the rise in TE from the rise in price would offset the fall in TE from the fall in quantity demanded(1). 3m c) Account how the production of sand has resulted in market failure. Market failure is said to occur when the free market does not allocate resources efficiently or does not allocate resources that best satisfies society’s wants. 6m

2    From society’s point of view, there is an over production of sand because of the presence of negative externalities. Negative externalities occur when third parties who are not producing sand are affected adversely. From Extract 1 “major impact on the rivers, coastal and marine ecosystems” and Extract 2 “deplete fish stocks and c ause erosion, risking landslides and flooding”. Analysis of Negative Externalities Diagram Assumption: There are no external benefits (positive externalities), MPB = MSB = DD With the presence of Negative Externalities: (Note the sequence) 1. Negative externalities cause a divergence between MPC and MSC (MSC > MPC). 2. If the output is determined by market forces, profit maximising private producers of sand will only consider their private benefits and costs. The supply curve consequently reflects only MPC. The market will produce where MPC = MPB demand matches supply and the market equilibrium is at output Q. Society will take into account all the costs and benefits, hence social equilibrium will be where MSC = MSB, at output Q*.Hence, market equilibrium output Q is greater than the social equilibrium output Q*. 3. Overproduction of output Q*Q occurs. This additional output Q*Q was produced/consumed as the wrong price signals were given on the supply side, with producers, who look to maximise their profits, only considering MPC (instead of MSC) and their MPB in their decision making. 4. Deadweight loss of Area D is incurred as total social costs (Areas D+E) is greater than total social benefits (Area E) 5. Due to this deadweight loss of area D, output Q is socially inefficient. The sand market has failed to allocate resources efficiently. Level Descriptors L3: 5-6 Able to apply the concept of negative externality to sand and drawing out evidence from the extract to show presence of MEC. L2: 3-4 Explanation of production of sand resulting in negative externality due to the divergence between MPC and MSC leading to over production. If no diagram cap at 4 L1: 1-2 Able to define negative externality and how it results in market failure due to over production

3    d) Using Table 1, comment on whether structural unemployment is the main cause of unemployment in Indonesia. Structural unemployment is caused by structural changes and can be due to a change in the method of production, loss of comparative advantage or change in demand. (1) There seems to be some correlation between Real GDP growth and unemployment rates, when the growth is higher, the unemployment rates are lower (1) In 2009, when growth rates were only 4.9% the unemployment rate was the highest at 7.9% (1) However, even though there has been growth registered, unemployment rate remains high, hence the unemployment in Indonesia cannot be largely demand deficient unemployment but instead Structural unemployment. (1) 4m e) Discuss the statement that “trade liberalisation has made life harder” for Indonesians. Trade liberalisation is the removal of protectionism. Protectionism refers to the partial or complete protection of domestic industries from foreign competition in domestic markets. Whether the removal of protectionism has made life harder for Indonesians depends on the consequences of increased trade on the consumers or producers in Indonesia. The impact can be explored based on the points of efficiency, equity, growth, employment, inflation and BOP equilibrium. 1. Growth Trade leads to actual growth of a country. (A) Export expenditure (X) is a component of AD and with an open economy, X can increase and lead to an increase in AD resulting in an increase in real GDP is the economy is below full employment. As seen in table 2, there has been positive growth for the Indonesia economy and there would be an increase in income for both consumers and producers in Indonesia. This analysis assumes import expenditure (M) remains unchanged or X rose by more than M. 2.Development of infant industries: However, trade also exposes the economy is an inflow of imports, an increase in M can lead to a fall of AD resulting in a fall in real GDP. “Entrepreneurs struggle to compete against cheaper goods produced elsewhere”. Moreover, there may be industries in a country that are in their infancy which have a potential comparative advantage. Protection from foreign competition will allow them to expand and become more efficient and hopefully be able to lower their costs of production to translate to lower prices and hence able to compete with “cheaper goods produced elsewhere”. With the introduction of protectionist measures, a country can protect its export industries (producers) thereby ensuring a positive X and M would be lesser than X thereby resulting in a positive net effect on (X-M) and therefore an increase in AD resulting in an increase in real GDP. (C) 8 m

4    3. Efficiency: Protectionism may cause such industries to become contented and remain internationally uncompetitive and ine fficient. Hence comparative advantage may not materialise. Furthermore, once protection is given it is hard to remove. (E) On the other hand, increased trade (by removing protectionism) results in increased competition which encourages firms to minimise cost and innovate. However, with trade, sometimes there is the failure to achieve social efficiency. This is especially true in the area of the presence of negative externalities. As discussed the export of sand has resulted in market failure and therefore, protectionism can prevent or slow down the environmental damage. Or in extract 3 “further exploiting Indonesia's natural resources” 4. Employment In times of recession, protectionism