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2010 8819 H1 Case Study Q2 a)i) Compare the GDP of India and Japan in 2005 The GDP of Japan

is higher than that of Indias in 2005 ii) What can be inferred from Table 2 about the change in the world GDP rank order by 2050? [4m] The selected E7 countries experienced a higher growth in their GDP as compared to the selected G7 countries, with China overtaking USA and India and Brazil overtaking the rest of the G7 countries in terms of world GDP rank order. Worlds resource allocation This could mean that there is a shift in the world resource allocation with more resources land, labour, capital and entrepreneurship being utilized by the E7 countries. The quantity of investment increased more in these countries as compared to the G7 countries and this is evident as companies such as the motor industry companies are shifting their operation to China, Japan and Thailand. The quantity of labour could rise as well as population growth is significant in countries like China. The quality of these factors may have risen more significantly in the E7 countries due to better education or training. Standard of living/income This change could also mean that the people in the E7 countries are experiencing a more significant improvement in their living standards or conditions which could mean better housing, transportation as well as higher income (higher purchasing power as a result) than their G7 counterparts. b) Extracts 5 and 6 refer to the effects of government fuel subsidies. i) Using a supply and demand diagram, explain the effect on the market for fuel of the introduction of a fuel subsidy. [3m] S Price P0 P1 E E1 S1 [1m]

D 0 Q0 Q1 Quantity

A fuel subsidy would lead to a fall in the cost of production of the supplier/producer of fuel and this lead to a rise in the profit margin which acts as a incentive for supplier or producers to increase their supply. The increase in supply is illustrated by a rightward shift of the supply curve from S to S1. The equilibrium price will fall from P0 to P1 and quantity will increase from Q0 to Q1. ii) Explain what determines the impact of the fuel subsidy on government expenditure.

[4m]

The amount or percentage of the fuel subsidy will affect how much the government has to spend. In countries such as Indonesia and India, where fuel are heavily subsidized, the government expenditure on subsidies will be higher as compared to countries such as Singapore where little or no subsidy is given to the provision of fuel. The extent of the fuel price increase is another factor. Under a subsidy system, the government pays oil companies the difference between world price of the fuel and its price at the pump thus if the world fuel price increase significantly and yet countries want to maintain their price at the pump, they would have to spend more on the provision of subsidy. The price elasticity of demand also affects the amount of government expenditure. The PED for fuel is less than 1 and the amount of government subsidy given is less than if it has a price elastic demand (Quantity increase more than proportionately)

c) Comment on the view expressed in Extract 7 that subsidies hinder the effective working of the market mechanism. [6m] In a market system, every good or service has a price, which is the value of the good in terms of money. Prices are determined by market forces the demand for and the supply of the good. Demand shows the quantity of a good that consumers are willing and able to buy at a given price level and supply shows the quantity of a good that producers are willing and able to supply at a given price. When the preferences of consumers and producers meet (demand equals supply), a price is set and with no externalities, the society welfare is maximized. With the introduction of subsidies, this could distort what the consumers actually want to buy and this could lead to overconsumption of the good. However, subsidies could also help in the effective working of a market economy. In the case of merit good such as education, where positive externalities is present, the good is usually underproduced or consumed. Thus with the introduction of subsidies, it could lead to an optimal level of production or consumption.

Benefit / Cost

MSC=MPC

Ps
Subsidy per unit = MEB

Pp MSB MPB Qp Qs
Quantity of education

With the subsidy, the MSC will shift rightwards and the society will consume at the social optimal level Qs. In conclusion, whether the subsidy is hindering the market mechanism depends largely on the good consumed/produced. If the good does not display any externalities (as in the extract), then the subsidy would distort the optimal level of consumption/production. Governments objective of implementing or giving a subsidy is another factor to consider. d) Explain the case for the use of protectionism measures by governments such as those of the UK or the US to prevent the destruction of their motor industries. [4m] Protectionist measures are policies which distort market forces in order to give a competitive advantage to the domestic industry of an economy. In face of stiffer competition from the global market, the use of protectionism measures could be justified. Trade barriers can increase domestic production and employment which will encourage the growth or continuity of the motor industries. With the trade barriers, foreign cars that are imported are likely to cost more than the locally produced cars, thus they are less likely to be able to compete with the local firms. Without protectionism, local industries may be edged out by foreign producers resulting in a fall in employment and hence standard of living. As mentioned in extract 9, although there are benefits from trade, the immediate effect on the economy could detrimental is no trade barriers are being set up. Dumping occurs when an overseas firm sells its product in another country below its cost of production. This causes the domestic industry to face unfair competition that results in a reduction in domestic output and employment. Moreover, it is sometimes practice to force out domestic producers so as to gain a monopoly position so as to exploit it later by raising prices. As mentioned in extract 8 (UK) and extract 10 (US), the local companies are facing immerse competition from these up and coming economies and are likely to face fierce competition from the foreign companies. Hence the government may practice protectionism to protect local industries from such unfair competition.

e) Subsidies and protectionist measures are examples of government intervention. Discuss the view that the removal of government intervention can only be beneficial to the global economy. [8m] *We are taking the stand of Pro-removal of government intervention (Free trade) Thesis:

Government intervention can include protectionist measures, price controls as well as other forms of intervention such as law and legistration. With countries allowing to trade freely, they are able to enjoy a wider range of products which might not be produced in their own countries and smaller countries such as Singapore will be able to tap into a bigger global market to sell their products. Without protectionism measures, countries will not have an unfair advantage over their foreign competitiors and could improve trade balance between countries and therefore can enjoy the benefits of free trade which includes a increase in the world trading volume as well as an increase in the consumer welfare. For example, if the government chooses to adopt trade protectionism and restrict imports, it will affect the export revenue and economic growth of its trading partners. Alternatively, the country may subsidise its export industries, giving them an unfair advantage over foreign competitors. This would also adversely affect the trade balance of other countries. Trade protectionism could then lead to decline of the global economy. A government may decide to restrict capital and financial flows outside the country to stem capital outflow and encourage more domestic investments. This could create problems for countries which rely on capital inflow to finance their trade deficit or stimulate aggregate demand and employment. Eventually, the protectionistic policies will also harm the country imposing them as well. As the economies of trading partners and other countries decline due to their worsening trade balance and fall in capital inflow, it will cause a decrease in their demand for imports as well. This in turn will lead to a fall in the exports of the country imposing the protectionistic measures. Hence, protectionism damages all the countries eventually. Thus, without government intervention, global economy could benefit from fair trade. Anti-thesis However, without government measures, it would handicap the government when dealing with internal problems with in turn might affect the global market. In the short term, domestic problems may take priority. For example, if the country is facing massive unemployment, the government may need to implement protectionistic

policies to prevent decline of domestic industries and prevent further loss of jobs. This allows the country to manage their unemployment level in the country. Some countries may have lost their comparative advantage of producing their niche goods and protectionism may give a chance for the country to develop infant industries in which they have potential comparative advantage. Once the industries are sufficiently developed, the protection can be removed as they are able to compete in the world market. For a large economy, protectionism can help to increase the size of the domestic sector and reduce the countrys reliance on external demand. The country can become more stable as it is less vulnerable to external fluctuations and shocks. However, in the long run, there could be a loss of welfare to society due to the reduction in trade. There is therefore a trade-off between reducing external vulnerability and maximising economic welfare. Also, without governments intervention and collaboration, free trade agreements (FTA) could not have been reached and the countries involved would not be able to enjoy the benefits that FTAs bring such as tariff savings. Conclusion While there may benefits from the absence of government intervention, these are also cons that would tend to harm all countries. Using interventions can be justified as well as beneficial and useful in certain situations to promote global economy growth. The governments ability and judgment as well as the objective of the removal of the intervention are also points to be considered.