EJC_H2_ECONS_Essay4_Suggested_ans_and_mark_scheme

1 JC2 Preliminary Examinations 2018 H2 Economics Paper 2 – Essay Part (a): Explain possible causes of rising price pressures of goods and services in an open economy. [10] Question Dissection Command Word Explain Question Type Explanation Concept(s) • Meaning of an open economy • Causes of inflation in an open economy o Cost-push inflation o Demand-pull inflation End Point To explain at least 2 causes of inflation specifically in the context of an open economy. Context Any country, though reference can be made to Singapore’s context Suggested Answers (I) Introduction An open economy refers to an economy that interacts freely with other economies around the world. Economic openness can be measured as openness and reliance of an economy to trade, foreign investment, labour and capital flows. Singapore is one such open economy where its external demand constitutes a large percentage (about 300%) of its GDP and FDI is about 70 % of its total investments. Due to the constraints of a small population size with a lack of natural resources, the Singapore economy has to be open which means that it is heavily reliant on exports and FDI to drive its economic growth. When an economy is faced with rising price pressures on good and services, it suggests that the economy is facing an Inflationary situation. Inflation is defined as a sustained rise in the general price level of a given basket of goods and services in an economy over time, usually a year. Hence rising price pressures (or inflation) can be caused by a persistent rise in aggregate demand (AD) or due to a persistent fall in aggregate supply (AS). Being open means that the main types of rising price pressures of goods and services is often that of import-price-push inflation and external demand-led demand pull inflation. 4 Many economists argue that managing rising price pressures is the single most important macroeconomic objective for governments. (a) Explain possible causes of rising price pressures of goods and services in an open economy. [10] (b) Discuss the extent to which a government’s policy decisions to manage rising price pressures are affected by the degree in which its economy is open. [15]

2 (II) Body (1) Cost-push Inflation Being open makes an economy most vulnerable to external supply shocks such as increase in the price of imported oil and other raw materials caused by strong demand from China and other emerging economies , higher prices of imported food due to bad weather, and higher foreign inflation. Singapore’s lack of natural resources implies a heavy reliance on imported raw materials and necessities for both the production of goods and services, as well as for consumption respectively. As such open ec onomies such as Singapore are extremely susceptible to rising prices pf imported good s and services. An example is how Singapore’s in