HCI H2 ECONS Essays ans

HWA CHONG INSTITUTION C2 Preliminary Examination 2016 Higher 2 Economics Paper 2 Essays Suggested Answers Question 1 (a) Explain how free trade helps to alleviate the problem of scarcity. [10] (b) In the recent decades, technological advan cement has helped to promote the spread of information and economic integration has facilitated labour migration. Discuss the extent to which the above events could help to reduce resource misallocation arising from imperfect information and immobility of factors of production. [15] Part (a) Introduction: Using the theory of Comparative Advantage, we will be illustrating how a country’s problem of scarcity may be reduced. Body: 1) Theory of CA  The Law of Comparative Advantage states that trade 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.  The illustration of the Law of Comparative Ad vantage is based on the following assumptions: ‐ Only 2 countries are involved in the pr oduction and exchange of 2 commodities. ‐ Each country has 10 units of re sources and devotes half of her resources among the production of the 2 goods. ‐ There is constant opportunity co sts of production of the goods. ‐ There are no transport costs, which might out weigh the benefits of specialisation and trade. ‐ There are no restrictions to trade (protectionism). ‐ There is perfect factor mobility within each countr y and factor immobility between countries (otherwise no need for trade). ‐ There are no emergencies or political or strat egic reasons for a country to produce a good with the higher comparative cost. Production of textiles and cars before specialization and trade Opportunity Cost of producing 1 unit of Production with: DC: Partial Specialise with 75% resources in cars and 25% in textile LDC: Full specialization in textile Consumption after trade by exchanging 12T for 12C TOT: 1T:1C Countries Textiles Cars Textiles Cars Textiles Cars Textiles Cars Developed Country (DC) 20 30 3/2 C 2/3 T 10 45 22 33 Less Developed Country (LDC) 15 10 2/3 C 3/2 T 30 0 18 12 World 35 40 40 45 40 45  Although DC is able to produce more of both goods than LDC.  Both countries can still gain from trade if they specia lize according to their comparative advantage which is determined by their opportunity cost in production or relative efficiency in producing the good.  Before specialization, DC 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, LDC 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 DC and LDC have a lower opportunity cost or comparative advantage in producing cars and textiles respectively.

 Assuming DC will have partial specialization in cars us ing 75% of resources and 25% of resources in textiles while DC goes into full specialization in textiles.  DC will produce 10 units of textiles and 45 units of cars and LDC 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, DC gain 2 and 3 units of textiles and cars respectively and LDC 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 DC and LDC gain from trade and consume beyond their PPC 2) Free trade also allowed even more movement of capita l goods and even resources. As a result, the country will have increase in the quantity of resources. That will means that the PPC can actually shift outwards to encompass more points outside the original PPC. This means that people can now access the point in ABCD and thus the problem of scarcity has been alleviated. Conclusion:   Consumption beyond PPC  able to alleviate the problem of scarcity  Extent of pt beyond PPC will depend on the difference in opp cost and the type of goods that has been traded. Marking Scheme LEVELS DESCRIPTION MARKS 3  Shows good explanation of the CA theory using appropriate examples.  Ability to explain how the theory allows co untry is able to consume beyond the PPC and thus it is a alleviation of scarcity with the a PPC diagram  Well-illustrated and explained table. Or Brief explanation of Theory of CA but shows understanding that free trade can alleviate scarcity through trade of FOPs. 7-10 2  Ability to explain how the law of CA lead to increased world output but inadequately explained.  CA table contains minor errors and inadequately explained  Scarcity unexplained with PPC. 5-6 1  Major conceptual errors with little coherent explanations.  Not linking theory of CA to scarcity  CA table unexplained 1-4

Part (b) Introduction: ‐ Given the age of technological advancement, there has been information explosion and unseen amount of movement of labour. ‐ Will be examining if such an age had led to better resource allocation and thus less welfare loss for the society. Body: Thesis : Allocation of resources has been improved Anti- Thesis: Allocation of resources might not have improved Imperfection of information  Will better access to information, consumers are better informed and thus make better decision and able to attain optimal social efficient pt.  Using an example and diagram for framework Possible Context: Healthcare – Colorectal cancer screening Consumers may underestimate their true private marginal benefits from colorectal cancer screening due to imperfect information. For example, if consumers knew that colorectal cancer is now the most common cancer in Singapore affecting both males and females, they would realise that the benefit of such screenings is that it has a good chance of detecting the cancer early. Furthermore, the early stage of colorectal cancer is often localised to the bowel and hence early diagnosis can often lead to a complete cure.  Assume that there are no positive or negative externalities.  As seen in Figure 9 above, with imperfect information, consumer demand for colorectal cancer screenings is lower at PMB perceived as they underestimate the actual benefit of such screenings.  As such, the market equilibrium quantity would be at Q m where PMB perceived = PMC.  However, the true private marginal benefit should be at PMB actual.  Hence, with perfect information, the market equilibrium quantity would be higher at Qm’ where PMB actual = PMC.  Hence the ignorance of the full benefits of colorectal cancer screenings causes an underconsumption Qm’ – Qm of such screenings.  Area Qm’QmCB is the actual total private benefit foregone for the underconsumption Qm’ – Qm.  Area Qm’QmAB is the total private cost not incurred for the underconsumption Qm’ – Qm.  Since the actual total private benefits foregone exceeds the total private costs not incurred for underconsumption Qm’ – Qm, area ABC represents the deadweight welfare loss due to underconsumption of Qm’ – Qm.  There might over compensation and result in too much increase demand, resulting in overconsumption and DWL t