NYJC H2 ECONS CSQ2 QP with answers

Question 2: UK and EU: A Tale of Two Economies Extract 4: The Evolution of the Eurozone The common currency was an outgrowth of efforts that began in the mid-20th century, as Europe reeled from the carnage and disruption of two world wars. In 1957, this vision came closer to being a reality with the signing of the Rome treaty, which established the European Economic Communi ty (EEC), comprising of Belgium, France, Italy, Luxembourg, the Netherland s and West Germany. Step by step, restrictions were eased on work, travel and trade between the ex panding list of EEC countries. The European Union (EU) was established in 1993 and created much of its economic structure and institutions – including setting in motion the process of adopting a common currency, the Euro. Advocates of the Eurozone rightly argue that it was not just an economic project that sought to improve standards of living by increasing the efficiency of resource allocation, pursuing the principles of comparative advantage, enhancin g competition, taking advantage of economies of scale and st rengthening economic stability. More importantly, it was a political project; it was supposed to enhance the political integration of Europe, bringing the people and countries closer together and ensuring peaceful coexistence. Source: The Problem with Europe is the Euro, The Guardian, August 2016 Extract 5: Brexit Countries band together to promote trade, defend human rights, protect the environment and repel threats. They sign treat ies and join international groups, and each time they do, they give up a bi t of independence. That happened in a big way with the creation of the Eur opean Union (EU), a free-tr ade zone and global political force forged from different European countries. Freedom of movement for labour is one of the key principles of the EU. However, this ease of movement has been attacked in the UK, which had an unexpectedly high level of migration from several old Soviet bloc states after they joined the EU. Findings from the British Social Attitudes (BSA) survey revealed that Brexit was the result of widespread concern over the numbers of people coming to the UK that strained public services– millions of whom have done so under the EU’s freedom of movement rules in recent years. As a result, the people of the UK, in a June 2016 referendum, shocked the world by voting to leave the bloc they'd joined in 1973. The way many Britons saw it, the EU was expensive, out of touch and a source of uncontrolled immigration. They chose what's become known as Brexit. Adapted from: Bloomberg, December 2017

Extract 6: The Pros and Cons of Leaving the EU The Eurozone economy is growing twice as fast as the UK’s. The Eurozone economy’s gross domestic product grew 0.6 percent in r eal terms in the second quarter of the year — versus 0.3 percent for the UK Contrary to appearances, this is good news for Britain. But it also illustrates what the British economy stands to lose from Brexit. Some see the contrasting performances of the economies on either side of the Channel — highlighted by the Bank of E ngland cutting its UK growth forecast— as a sign that worries about Brex it are beginning to weigh on British consumers and businesses. The impact of Brexit is manifold. The pound slumped to the lowest level in 30 years on Friday, tumbling as much as 13 per cent, as investors took flight at Britain’s shock decision to leave the EU. The weakness of t he pound is fuelling do mestic inflation, constraining household spending and hurting European exports to the country. Furthermore, uncertainty about the terms of a Brexit deal between London and the EU is putting a brake on investment, as “businesses are delaying crucial decisions,” said Bert Colijn, senior economist at ING Bank in Amsterdam. Outside the EU, the UK would lose trade with its neighbours (17 percent of EU exports go to the UK, whereas the EU absorbs 44 percent of UK exports) and reduce its negotiating power with the rest of the world. It seems the UK can’t look anywhere else for hope. The Bank of England cut its growth forecast for this year from 1.9 percent to 1.7 percent, after a similar move by the International Monetary Fund last week. And there are few other available means to boost growth in the short term. Monetary policy has run its course after a massive easing last year in the wake of the Brexit referendum. “It’s easy to forget that the UK economy has relied massively on monetary stimulus in the last year, but that is coming to an end,” Moëc noted. Nonetheless, Brexiters said UK’s departure from the EU could more than compensate for those disadvantages because it wo uld be free to establish its own trade agreements. Furthermore, the UK will no longer be bound by the Maastricht Treaty 1 and is now able to use fiscal policy tools with greater flexibility. Currently, the UK’s budget deficit is forecast at 3 percent of GDP, unchanged from last year. Adapted from: Politico, August 2017 1 Article 126 of the Maastricht Treaty defines tw o criteria which Member States’ governments should comply. These are: a deficit to Gross Domestic Product (GDP) ratio of 3% and a debt to GDP ratio of 60%.

Figure 3: USD per unit of Great British Pound (GBP) Source: Macrobond, The Independent Figure 4: Import sources of the UK in 2016, by import value (in million GBP) Source: Office for National Statistics

Figure 5: Export destinations of the UK in 2015, by export value (in million GBP) Source: Pink Book, Office for National Statistics Questions (a) (i) How does the value of Great British Pound (GBP) in April 2016 compare to its value in May 2017? [1] (ii) With the aid of a diagram, ex plain one possible reason for the trend above. [3] (b) With reference to extract 4, use PPC analysis to illustrate how the following will lead to an improvement in material standard of living: (i) Pursuing the principle of comparative advantage [3] (ii) Enhancing competition [3] (c) Explain why the weakness of Gr eat British Pound (GBP) will hurt European exports to the UK. [2] (d) With reference to the data, discu ss how Brexit is likely to impact the UK economy. [8] (e) In the light of the issues ment ioned in Extract 6, discuss the policy options available to the UK government to achieve its macroeconomic goals. [10] [Total: 30]

Suggested Answers (a)(i) How does the value of Great British Pound (GBP) in April 2016 compare to its value in May 2017? [1] - The Great British Pound has depreciated against USD. - Falling [0] (a)(ii) With the aid of a diagram, explain one possible reason for the trend above. [3] Ext 6: “investors took flight at Britain’s sh ock decision to leave the EU.” Supply for pound increases due to capital flight from economy due to uncertainty. As such, people lose confidence in the currency and started selling GBP. Hence, this increases the supply of GBP in the foreign exchange market as shown in the diagram from SS1 to SS2 and this caused the value of GBP to fall from $F 1 to $F2. [2] Diagram [1] - Alternatively, students can also explain that demand for GBP falls due to low confidence in the economy. (b) With reference to extract 4, use PPC analysis to illustrate how the following will lead to an improvement in material standard of living: (i) Pursuing the principle of comparative advantage [3] Definition [1] The Principle of Comparative Advantage states that trade can benefit all countries, if each country specialises in the production of goods in which they have a comparative advantage in. A country enjoys Comparative Advantage over another when it can produce a good with a lower opportunity cost in terms of other goods forgone. Price of £ in foreign currency Quanti