IJC_2008_H2Econ_Prelim_Paper 1_Q2

H2 Prelim Case Study Question 2 United States and the world economy Suggested Answer

(a) Using Figure 1: (i) Explain what is meant by purchasing power parity. [1] Purchasing power parity is the exchange rate that equates the price of a basket of identical traded goods and services in two countries. (ii) Compare the share of world GDP (at purchasing power parity) of Asia with that of United States and European Union between 1980 and 2006. [2] Share of world GDP of EU and US are declining while the share of world GDP (at purchasing power parity) for Asia is increasing. [1] However the rate of increase for share of world GDP (for Asia is much faster than that of the decline of share of world GDP (at purchasing power parity) in EU and US. [1] (b) Explain two factors that might have caused US dollar to depreciate. [5] Depreciation of US dollars means that the value of US dollars fall against some of the major currencies as mentioned in the extract such as Euro, Yen, Pounds, and Yuan. [1] Students are expected to analyse how the factors lead to fall in C, I or X (at least 2) 1. Bleak business climate caused by fall in property prices in US and loss of consumer confidence durable-goods orders both fell more sharply than expected. Fall in investment & consumption 2. Fall in net exports The above will lead to probably net fall in the demand of US$ (due to fall in I and C (given large US domestic economy) and rise in SS of US$ depreciation of US$. (2 x 2m) NB: To gain full marks, students need to analyse how the factors affect the demand and supply of US dollar, leading to its depreciation.

(c) In the light of current problems in United States, do you consider that a reduction in interest rate to be an effective way to achieve her macroeconomic goals? [6] Problems in United States: 1. Trade deficit (current account deficit) 2. Slowing US economy 3. Depreciating US$ Thesis Explain how fall in interest rate help to boost US economy -- (Expansionary Monetary Policy) Will a fall in interest rate help to ease trade deficit? Explain how fall in interest rate leads to reduction in trade deficit: Capital outflow depreciation exports becomes relatively more competitive rise in export revenue, fall in import expenditure reduce trade deficit Anti-thesis However, it may depreciates US$ further due to speculation and capital outflow (rise in supply of US$) conflict of goals (stable exchange rate and high economic growth/improvement in current account) Fall in interest rate do not necessarily boost economic growth in view of bleak business climate – insufficient rise in C and I Level Description Marks L3 A developed 2-sided answer with sound analysis, adequately substantiated with reference from the context Evident evaluation & link to potential conflict between goals. 5-6 L2 An undeveloped answer with some analysis with reference to extract. 3-4 L1 Smattering of valid poin