SRJC H2 ECONS P1 CSQ2 Suggested Answers

1 ©SRJC 9757/01/Prelims/2018 SRJC H2 CSQ 2 Suggested Answers (a) With reference to Figure 2, compare the UK’s trade in goods with trade in services over the period. [2] • trade in goods is in deficit whereas trade in services is in surplus • both shows an increasing trend i.e, deficit is getting bigger whereas the surplus for trade in services is getting larger (b) Explain one possible cost and benefit to the UK economy of its exit from the EU. Assess whether they are likely to occur. [8] Possible cost: 1) Fall in economic growth due to fall in AD • As a member of a custom union, UK exports to the EU are not subjected to tariffs • But now that it exited the custom union, this privilege is withdrawn. UK goods are taxed or subjected to other protectionist measures when sold in the EU as well as in other countries that EU has signed FTAs. Analysis • A tariff increases the price of UK exports to the EU and other non-EU countries  reduces UK export competitiveness  demand for UK goods likely to be price elastic as there are many substitutes in the EU market  qty demanded falls by more than proportionately  export revenue falls • UK will be a less attractive destination for inflow of FDI. Many foreign firms locate production in UK to take advantage of the large EU market but now their exports will be affected by tariffs making their investments less profitable. In addition, cost of production would increase as UK too will impose tariffs on imports raw materials from the EU. This further makes UK exports less competitive. • Due to the uncertainties with regard to the profitably of firms and the ability to continue to work in the EU, households may cut back on consumption as there is fear of loss of jobs. • So with fall in C, I and X, AD falls and this will cause economic growth to fall. Other costs 2) Higher unemployment • There could possibly be a rise in demand-deficient unemployment. So when AD falls, firms will retrench workers to cut costs since firms are faced with increase unsold stocks. There is no need to hire additional workers since the demand for workers is a derived demand and the demand for goods has fallen. Over 3 million jobs are linked to exports to the EU and some of these workers will be unemployed. • In addition, there may be increase in capital outflow due to the uncertainties linked to Brexit. As firms relocate to other countries, more workers will be unemployed. OR 3) higher inflation rates Possible Benefits 1) Higher economic growth due to increase in exports and increase in Govt spending • After exiting the EU, UK need not contribute to the EU  money saved can be used for domestic spending  increase in G  increase AD

2 ©SRJC 9757/01/Prelims/2018 • Being in the EU, UK cannot sign FTA with other non-EU member countries on its own which restricts her ability to increase trade further • But after Brexit, UK can choose to sign FTA with those economies which are of benefit to her such as emerging economies like BRICS. China, for eg, is growing more strongly than the EU. Due to the rising middle income class, their ability to spend may be greater than the EU which has been suffering from slow economic growth. UK’s trade with the EU has been declining anyway which shows that even though there is free trade, UK is not benefitting from it. Breaking out of EU in search for high growth economies to trade is more beneficial for its exports  increase in exports  increase in AD • UK may not have benefitted from free trade with EU but may benefit more from free trade with non-EU members. A possible reason could be that the opportunity cost difference for the goods traded between EU and UK may not be that big since they may have similar factor endowments or that UK may be losing comparative advantage in manufactured goods to countries like Germany. But this may not be the case between UK and other countries where the difference in factor endowments may be greater and therefore having FTA with them will give UK exports an edge. • Overall, with exports and government spending increase, AD increases  higher economic growth Other benefits 2) There may be increased economic efficiency as UK may not need to abide by rules and regulations imposed by the EU. Stringent environment standards such as high tax rates set by the EU may increase UK cost of production making her goods uncompetitive in the world market. But now after exiting EU, UK can set its on environmental standards which may be more in line with its own pollution standards and thereby benefitting domestic firms. OR 3) Brexit will reduce trade diversion for UK. How likely will the UK experience the above cost and benefit. In the short run, Brexit is more likely to be negative for the UK economy. (i) Regardless, the EU is a huge market which is not easily replaced in the short run. (ii) (UK would have to negotiate FTA with the EU as well with other non-EU countries which may be a very long and complicated process. The uncertainties with regard to the ability of the UK in signing favourable free trade agreements and the extent EU will impose barriers on UK may weigh heavily against firms’ decision to invest in the near future. (c) With reference to Figure 3, state and account for the relationship between US economic growth and trade deficit. [3] When growth rate is high, the trade deficit is large but when growth rate is low, trade deficit becomes smaller. ( or increase in growth rate , increase in trade deficit and when growth rate falls, trade deficit falls) • Trade deficit is where imports are greater than exports • High ec growth  bigger trade deficit because rise in imports > rise in exports High US econ growth rate  large increase in income  increase in purchasing power  YED > 1 (or high YED) or MPC is very high  increase demand for goods and services including imports  import expenditure increases

3 ©SRJC 9757/01/Prelims/2018 Export revenue did not increase by as much probably due to foreign YED not as high as US demand for goods or protectionist measures or slower economic growth (d) Extract 6 mentions that ‘Mr Trump has long argued that the trade deficit hinders economic growth, and that reducing it will accelerate American job creation.’ How does Figure 4 show that President Trump’s concern about the US trade deficit and unemployment is unfounded? Explain why this is so. [4] President Trump thinks that the rising trade deficit will cause rising unemployment. As US increase its imports, domestic firms will not be able to compete and so domestic production falls causing the demand for labour to fall as it is a derived demand and firms need to cut costs when revenue falls. However, Figure 4 shows that trade deficit increases, unemployment rate falls. Possible reasons • There may be a rise in unemployment in those industries that are producing goods that are close substitutes of imports but there may be rise in production of goods from other industries where cheap imports cannot compete with the US. For example, high tech goods as well as services. • (X-M) is just one component of AD. There could be rise in both domestic and foreign investments as well as government spending. • There could be increased capital inflow from those countries that have a trade surplus with the US. If this is long term capital flow in the form of direct investments such as the setting up of plants and offices, more jobs could be created in the US (e) With the aid of a diagram, explain how a tariff on steel imports will reduce the comparative advantage that a steel exporting country has over the domestic country. [3] Steel exporting country has a comparative advantage in producing steel means that its opportunity cost of producing steel is lower compared to th