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H1 Economics 8816 Paper 1 Oct/Nov 2007 (a) (i) Summarize the two main features of the changes in international

visitor arrivals to ASEAN shown in the chart in Figure 1. [2] Overall there is an increase in international arrivals to ASEAN but there was a fall in 1998 and 2003 (ii) Explain possible reasons for these features. [4] Due to long term economic growth, household incomes have been increasing and as holiday abroad is a luxury good, demand increases by more than proportionately. However this upward trend is interrupted due to the Asian Financial Crisis and Sars which cause tourist arrivals to fall. During the Sars period, there was a greater deal of uncertainty and fear, as it was not known what cause the deadly infectious disease. The accompanying stringent screening measures also deter tourists from coming to ASEAN. (b) In the light of Extract 1, use supply and demand analysis to explain how you would expect the tsunami of December 2004 to have impacted upon world tourism. [6] price S2 S1

P1 P2 D2

D1

Right after the tsunami, the supply of world tourism fell as hotels, beaches and infrastructures all part of the tourist industry were destroyed. The demand fell too as there was less desire to visit the affected countries due to fear and uncertainty. The result was a fall in the volume of tourist activities. What happens to price depends on the extent of the fall in demand versus the fall in supply. In figure 1, the fall in demand is greater than the fall in supply, resulting in a fall in price as well as the volume of tourist activities.

However, based on extract 1, tourism normally bounced back after a crisis. In this case, supply increases after the affected countries took measures to rebuild the tourist industry and demand too increases as affected countries launched campaigns to lure tourists and also tourists regain confidence to travel to these countries again. (c) (i) Explain one negative externality which is claimed to result from tourism. [2] A negative externality refers to the cost borne by the third party who is not directly involved in the production or consumption of the good. Some examples of negative externalities are the destruction to the natural environment, loss of traditions and pollution. As land is cleared for building roads and hotels, large areas of forest may be destroyed and the loss of vegetation could result in more frequent flooding and landslides. The third parties are the residents in the vicinity who may lose property, livestock and even lives whenever there is a landslide or flood and these are people who may not be related to the tourist industry at all. (ii) Discuss the case for and against imposing eco-tourist taxes. [8] Revenue/ cost a b MSC MPC

Q2 Q1

quantity

Before the imposition of eco-taxes, the equilibrium quantity of tourist activities is at OQ1 and at this level of output, producers and consumers maximize their benefits as they equate MPB with MPC but from the societys perspective there is over-consumption as the market fails to take into account marginal external cost ab, which means to say that the price does not fully reflect the true cost of production. At OQ1, MSC is greater than MSB and this gives rise to a deadweight loss equal to the shaded area. By imposing the eco-taxes, the MPC shifts upwards to MSC and now tourists have to pay a higher price equivalent to the MEC and this will reduce consumption to OQ2. Thus, eco-taxes are necessary to reduce welfare loss associated with negative externalities generated by tourists. However, the above analysis assumes that it is possible to determine the monetary value of the negative externality but it may be difficult to do so because the monetary value of things like loss of cultural traditions or the extent of the damage cause by floods and landslides is not easy to

compute. This can result in over or under- taxing the tourists in which case there will still be a welfare loss. An argument against the imposition of eco-taxes is that the higher price of a holiday would drive away tourists especially where there are other tourist attractions available. This could lead to increase in unemployment in the tourist industry as well as those industries that are indirectly related to tourism through the multiplier effect. This is especially significant for poor countries where tourism is the major source of income and employment. However, if the tax revenue is used for preservation of heritage sites, the protection of land for national parks, providing assistance to those who were displaced because of tourism then the welfare loss may be smaller as new jobs will be created and the unemployed can be absorbed into these projects.

Eco-taxes should only be imposed if the main tourist attraction has a fragile natural environment which can be destroyed by hordes of tourists and where the tax system is very well established. Besides, there are alternatives to imposing eco-taxes such as firmer rules and regulations governing land use, controlling the type of transport in the area to reduce damage from pollution etc. In conclusion, there is a need to strike a balance between the micro economic objective of efficient resource allocation and the macro objective of employment and income. Moderating the growth of tourism is necessary but there can be better alternatives to taxes alternatives that are less damaging to the economy than eco-taxes.

(d)

How would you assess the macroeconomic impact on an economy of a change in tourism demand worldwide? [8] I can assess the macroeconomic impact of a change in tourism demand worldwide by observing the changes to the unemployment rate, inflation rate, economic growth rate and the state of its balance of payments. As most economies aim for full employment, stable prices, sustain economic growth and healthy balance of payments, changes in these economic variables will reflect whether the changes in tourism demand will have positive or negative impacts on the economy. I shall now look at how tourism demand affects the economy. Tourism demand affects a countrys net exports as expenditure by tourists is classified under export of goods and services. It will also have an impact on

domestic investment as the building of hotels and tourist attractions such as Singapores integrated resort is in response to greater tourist arrivals. I shall consider a fall in tourism demand. First of all, this fall in demand would mean that a countrys export of goods and services would fall. With fewer tourists, hotels and shops will experience a fall in demand for their goods and services. If the fall in exports is great, the country will have a current account deficit. This will be the first indicator that the macro economy is adversely affected. As net exports is a component of aggregate demand, its fall will lead to a multiple fall in income as not only is the tourist industry such as hotels, restaurants, transport companies, tourist attractions affected, other industries are also affected. Face with lower demand firms may lay off workers to cut costs. The rising unemployment would mean that there is less income to buy other goods and services. Other industries such as food, retailing, clothing, entertainment would be badly hit as well. This is called the multiplier effect. So the next indicators, the unemployment rate and the GDP will fall. This is illustrated in figure 1 below. The leftward shift of GPL AS

P1 P2

AD2 AD1

Y1 Y2

real NY

AD1 to AD2 causes income to fall from Y1 to Y2. Prices too will increase as the rise in AD will slowly exhaust the available unemployed resources and output cannot rise faster enough to satisfy the higher demand. This will be reflected by higher inflation rates. To what extent a fall in tourism demand worldwide would affect a country in the above manner would depend very much on how dependent a country is on the tourist industry. A small country like the Maldives is very much more affected than say Japan because revenue from tourism takes up a big proportion of net exports whereas for Japan, there are many items, both consumer and capital goods, that constitute her exports. So Japans current account would not go into a deficit even if tourism demand falls.

Even if net exports fall, whether AD will fall or not would depend on whether other components of demand such as C and G are increasing. If the government is embarking on an industrialization drive by spending more on infrastructure and education, AD may still increase. Again even if AD falls, the extent income falls will depend on the size of the multiplier. If both mps and mpt are high, the impact on the changes in income will be smaller. As for employment, tourism is highly labour intensive and so a downturn in this industry will cause unemployment to increase substantially. Overall whether the economys unemployment rate will rise will depend on how important is tourism to the economy. As for the rate of inflation, the analysis above assumes that AS is constant. But if a country has been adopting supply side policies to increase productive capacity, the adverse impact on price levels can be reduced. Or in the case of a small open economy, an appreciation of the domestic currency to government intervention may also dampen inflation. In conclusion, how a fall in tourism demand would affect an economy would depend on many other factors such as how important tourism is to the country, whether the other components of AD are changing and whether AS is changing as well. More information about the economy must be available before one is able to assess the impact of falling tourism demand on an economy.