HCI H1 ECONS EssayQ4 ans

HWA CHONG INSTITUTION C2 Preliminary Examination 2016 Higher 1 Economics Essay Question 4 Suggested Answer 4 (a) Explain how benefits to the economy can arise from specialisation and trade. (b) Discuss whether specialisation and trade will always improve the standard of living in a country. Part (a) Suggested Essay Outline Introduction - An economy can benefit from specialisation and trade (exchange) and is explained by the law of comparative advantage. - The Law of Comparative Advantage states that trade or in this question, exchange, can benefit all countries if they specialise in the goods in which they have a comparative advantage in the production of a good, that is, she can produce the good at a lower opportunity cost than another country. Body - State the assumptions Production of textiles and cars before specialization and trade Opportunity Cost of producing 1 unit of Production with: USA: Partial Specialise with 75% resources in cars and 25% in textile Vietnam: Full specialization in textile Consumption after trade by exchanging 12T for 12C TOT: 1T:1C Countries Textiles Cars Textile s Cars Textiles Cars Textile s Cars USA 20 30 3/2 C 2/3 T 10 45 22 33 Vietnam 15 10 2/3 C 3/2 T 30 0 18 12 World 35 40 40 45 40 45  Before specialization, USA produces 20 units of textiles and 30 units of cars which means it has to give up 3/2 unit of cars for 1 unit of textile or 2/3 unit of textiles for 1 car.  On the other hand, Vietnam produces 15 units of textiles and 10 units of cars which means it has to give up 2/3 unit of cars for 1 unit of textiles or 3/2 unit of textiles for 1 unit of car.  This implies that USA and Vietnam have a lower opportunity cost or comparative advantage in producing cars and textiles respectively.  Assuming USA will have partial specialization in cars using 75% of resources and 25% of resources in textiles while Vietnam goes into full specialization in textiles. Specialisation will

results in mass production and enable the firms and industry to grow and thus enjoy both internal and external economies of scale.  USA will produce 10 units of textiles and 45 units of cars and Vietnam will produce 30 units of textiles only.  These countries will agree to trade if the terms of trade lie between: 2/3 cars < 1 textile < 3/2 cars or 2/3 textiles < 1 car < 3/2 textiles. Terms of trade (TOT) measures the rate of exchange of one good or service. The exact terms of trade will depend on the strength of demand and the relative bargaining powers of the countries involved.  Assuming they agree on the terms of trade of 1 unit of textiles to 1 unit of cars and exchange 12 units of textiles for 12 units of cars.  After specialization and trade, USA gains 2 and 3 units of textiles and cars respectively and Vietnam gain 3 and 2 units of textiles and cars respectively. The world output also increases by 5 units each for textiles and cars.  It is clear that after specialization and trade, both USA and Vietnam gain from trade and consume beyond their PPC. Conclusion - Although USA has absolute advantage in the production of both Textile and Cars, USA can benefit from specialisation and exchange if she specialises in producing and exporting the good (Cars) with relatively lower opportunity cost compared with Vietnam and import the good (Textile) with relatively higher opportunity cost compared with Vietnam. Level Descriptor Marks L3 For an explanation which accurately explain how benefits to the economy can arise from specialisation and trade. 7-10 L2 There is attempt to use Theory of Comparative advantage. However, analysis is not well developed. 5-6 L1 Some attempt to answer the question with conceptual errors  Students give benefits of free trade with no reference to CA at all   Some  recognition  of  CA  but  gave  absolute  advantage  numbers  or  answer  is  extremely brief  1-4

(b) Discuss whether specialisation and trade will always improve the standard of living in a country. [15] Introduction Define key terms:  The standard of living refers to the level of material and non-material well-being of an individual or household. The material well-being is measured by the quantities of goods and services consumed while non-material SOL is measured by factors such as the quality of healthcare and education standards, happiness and stress levels. The extent to which a country’s standard of living will improve depends on a few key factors which are both economic and non-economic in nature, which we will discuss in this essay. Thesis 1: Specialisation and trade will result in greater flows of goods and services and economic growth and hence countries enjoy an improvement in its material standard of living. Specialisation and trade has led to a rapid expansion of international trade in goods and services. Countries win when they gain market access for their exports due to trade liberalisation. With trade, the demand for the country’s exports by the rest of the world increases. This will result in a rise in expo rt earnings. Assuming that the rise in demand for exports is higher than the rise in demand for im ports, there will be a rise in net exports causing the aggregate demand to rise. Explain and draw AD/AS diagram The rise in real national output, assuming that p opulation is constant, implies that people in the country are better off because it could be that more goods and services have been produced and made available for consumption. Hence more wants are satisfied. The rise in national income and fall in unemployment will result in higher purchasing power of the people. Thus, with expansion of trade due to trade liberalisation, most exporting countries enjoy a rise in its material standard of living as a result of trade fostering its economic growth and employment. Optional pt: Specialisation and trade might also result in inflow of foreign direct investment which will result in a rise in future standard of living. Greater flow of goods and services may result in transfer of technology. In the long run, the rise in quantity of capital goo ds due to the rise in FDI will result in a rise in productive capacity. This will result in a rise in the country’s LRAS causing the AS curve to shifts from AS 1 to AS2 rise resulting in a rise in full employment level of real national output from Y F1 to YF2. This results in potential economic growth. As a result, the country’s future living standard can be expected to improve due to the ability to produce more goods and services in the future. EV: The level of inflow of FDI depends on the country’s ability to attract it. Countries whose conditions are not favourable for investments will suffer from an outflow of FDI. Eg. Political instability and poor infrastructure development.

Anti-thesis 1: Specialisation and Trade migh t result in structural unemployment which will worsen the country’s material standard of living. With Specialisation and Trade , large numbers of (mainly low-skilled) workers from China and India enter into the global labour force. This results in the loss of comparative advantage in low- end manufactured goods due to outsourcing of jobs. There will be loss of jobs mainly for low- skilled workers and older workers, thus resulting in structural unemployment due to mismatch of jobs as these workers find it difficult to switch to the sunrise industries due to the lack of skills. This results in structural unemployment in the country which worsens the SOL. However, the extent to which a country will suffer from structural unemployment and a fall in material SOL depends on its ability to train workers to take up jobs in the new sunrise industries with the relevant SS- side policies. In Singapore, the government emphasises on continuous upgrading of skills and implemented ma ny training