2011 H2 Economics Paper 2 Essays

Question 1
Consumers and producers are generally assumed by economists to be motivated by self-interest.
(a) Explain how, according to economists, the pursuit of self-interest can help to address the
problem of limited resources and unlimited wants. [10]
(b) Assess whether the price mechanism will always allocate scarce resources in the most
efficient manner for all goods and services in a market economy. [15]

Introduction
Clarify key terms
o Clarify the problem of limited resources and unlimited wants scarcity
o Clarify the concept of self-interest from the perspective of consumers and producers
Consumers seek to max satisfaction given a maximum budget
Producers seek to max profits by minimising cost/wastage of resources seek
to be productively efficient or X-efficient

Body:
Use the PPC framework to illustrate the problem of scarcity
o Illustrate concepts like choices, opportunity cost
o Productive efficiency and allocative efficiency

Use the demand-supply framework to show the pursuit of self-interest can help to address the
problem of scarcity
o In the pursuit of self-interest
Consumers will increase quantity demanded when price of a good falls, ceteris
paribus. Explain why
Demand curve is downward sloping
Producers will reduce quantity supplied when price of a good falls, ceteris
paribus. Explain why
Supply curve is upward sloping
o Assuming a perfectly competitive industry and the absence of sources of market failure,
the free market mechanism (which refers to the interaction between the market demand
curve and market supply curve) achieves allocative efficiency and hence helps to
address the problem of scarcity.
Using the demand-supply diagram, show how consumers and producers, in the
pursuit of self-interest, respond to surpluses and shortages
Automatic price adjustment process how shortages and surpluses are
removed
At the equilibrium price level, consumer surplus and producer surplus are
maximised

Part (b)
Assess whether the price mechanism will always allocate scarce resources in the most efficient manner
for all goods and services in a market economy. [15]

Introduction:
o Clarify what is meant by price mechanism can allocate scarce resources in the most efficient
manner
o Refers to free market forces achieving efficient allocation of resources allocative
efficiency and productive efficiency

Thesis:
o The price mechanism can allocate scarce resources efficiently provided these assumptions are
met
o Perfect competition
o No externalities
o No merit goods and no demerit goods
Personal well-being argument due to imperfect information
Externality argument due to pursuit of self-interest
o No public goods
o Perfect information
o No immobility of factors of production (not necessary given that focus is on goods and
services)
o Answer in part a already provides an explanation on how allocative efficiency can be achieved
using the demand-supply framework
o Part b can provide an explanation on how productive efficiency can be achieved by the PC firm.

Anti-thesis:
o However, the price mechanism fails to achieve allocative efficiency and productive efficiency in
the following cases. Using an economic framework (diagrams where possible), explain each
source of market failure in detail and compare the efficient output level to the free market output
level clearly.
o The market structure is imperfect
Monopolistically competition, oligopoly and monopoly
o Externalities are present
Due to the pursuit of self-interest
o Merit goods and demerit goods are being produced
Due to the consumers underestimating or overestimating their personal benefits
arising from the consumption of the goods as a result of imperfect information
o Public goods are not produced
Due to the two features non-excludable and non-rival.

Conclusion:

o In conclusion, the price mechanism will not always allocate scarce resources in the most efficient
manner for all goods and services in a market economy. It all depends on the nature of the good
and service and the type of market structure the firm is in.
o Possible evaluation:
o Hence, government intervention is justified and necessary when there is market failure.
Explain how and why government intervention can help to achieve efficient allocation of
resources in the above cases.
However, government failure may arise
Government intervention may allocate resources less efficiently than if
left to free market forces because of: E.g.
o Imperfect information
The public sector has poor mechanisms available in
deciding how to allocate resources. In the market, prices
are an automatic mechanism through which consumers
indicate the value they place on different goods and
services.
Difficult to put a monetary value on external benefits and
costs
o Lack of incentives
In the private sector, there is a strong incentive to
produce efficiently because lower costs mean higher
profits, and high costs mean losses and even business
failure. Bankruptcy weeds out inefficiency in the private
sector but the public sector does not have this
mechanism at its disposal to eliminate inefficiency.

Question 2
Singapore is facing an aging population issue. By 2030 senior citizens are expected to comprise
almost 20% of the population.
Using economic analysis, discuss the effects of this demographic change on product markets in
Singapore. [25]

Introduction:
o Clarify what is meant by the effects of this demographic change in Singapore
o Singapore is facing an aging population
More dependent on certain goods and services
Change in taste and preference for goods and services
Workforce is expected to shrink, hence
Economic growth is likely to slow down fall in national income
Fall in supply of labour rise in wage rates increase in cost of
producing goods and services



Body:
o Analyse the effects of this demographic change on product markets in Singapore
o Choose product markets that are positively affected and negatively affected by the
change
Analyse changes to eqm price, quantity and TR generated in each of these
product markets
Consider welfare issues? Changes to consumer and producer surplus?
o Choose product markets that illustrate shifts in demand curves and supply curves
o Choose product markets that enable the application of elasticity of demand concepts
PED, PES, YED

o Analyse the impact on the market for health care and medical products and services like walking
sticks, hearing aids, surgery, pharmaceutical products
o The market for basic health care services is likely to expand. Why?
Overall increase in demand for basic health care services
Increase in demand for basic health care services as the elderly will
need these services more than the young (necessity)
However, fall in demand for basic health care services as incomes fall
o Health care services is deemed to be a normal good
YED is positive
The demand for basic health care is likely to be income
inelastic as it is a necessity
YED is between 0 and 1
Hence the extent of fall in demand for health
care service is likely to less than proportionate to
the fall in income, ceteris paribus
Overall, the demand for basic health care services is likely to increase as
the increase in demand for it due to it being a necessity is likely to be
greater than the fall in demand for it due to falling incomes
o Eqm price and quantity and hence total revenue generated in the
market for basic health care services is likely to increase, ceteris
paribus
o Expanding market for basic health care services

Overall fall in supply of basic health care services
Aging population smaller workforce rise in wage rates increase
in the cost of providing basic health care services shift supply curve of
health care services to the left
Ceteris paribus, the eqm price of basic health care services will increase
but the eqm quantity of health care services will fall
Whether total revenue increases or falls depends on the PED for basic
health care services
o The demand for basic health care services is likely to be price
inelastic as it is a necessity
o Hence, for a given increase in the price of basic health care
services due to a fall in its supply, its quantity demanded will fall
less than proportionately
Hence total revenue will generated in the basic health
care service industry will increase

Combined shifts in demand and supply for the market for basic health care
services
Increase in demand and fall in supply
o Eqm price for basic health care services will increase
o Whether eqm quantity increases or falls depends on the relative
shifts in demand and supply curves
It is likely that the demand for basic health care services
will increase by a greater extent than the fall in supply of
health care services
Hence, eqm quantity is likely to increase
Hence, TR generated in the market for basic
health care services likely to increase.

o Analyse the impact on luxury health care services

o Analyse the impact on the market for healthy food vs unhealthy food
o Market for healthy food likely to expand. Why?
o Market for unhealthy food likely to shrink. Why?

o Assuming population size does not change (must have this assumption), an increase in the
proportion of elderly in the population implies a fall in the proportion of youth in the population
o Which markets that cater to the youth will be adversely affected?

Conclusion
o In conclusion, the demographic change in Singapore will affect some markets positively but other
markets negatively.
o However, the success and survival of product markets in Singapore are not just affected by
demographic changes. Other factors also play a role in their success and survival. What are
they?












Question 3
(a) Explain how the different features of monopolistic competition and oligopoly affect the
price and output determination in these market structures. [10]
(b) Recession will affect firms in different ways, depending on what they produce and the
market structure in which they operate. Discuss the likely effects of a recession on
different firms. [15]

Introduction:
Clarify the characteristics of monopolistic competition
Clarify the oligopoly
Clarify what is meant by price and output determination
o Ability and incentive/necessity to set price and output to maximise profits


Body
Use two different diagram to explain price and output determination in the two different market
structures
o One diagram for MPC firm
o Another diagram for oligopoly

Explain how the characteristics of MPC firm requires the MPC firm
o To be able to set price or output and to be able to practice independent pricing policy
Differentiated products ability to set its own price
Close substitutes ability to set price is limited
Low entry and exit barriers to entry Many small firms relative to market size
Downward sloping demand curve
MPCs demand curve is relatively more price elastic than oligopoly

o To always maximise profits in the long run because
It can only make normal profits in the long run due to low barriers to entry and
exit
Explain why.
Include AR, MR, LRAC and LRMC curves into the diagram to show profit-
maximising MPC firm making normal profits in the long run

Assume non-collusive or competitive oligopoly. Explain how the characteristics of oligopoly firm
requires the oligopoly firm
o To be able to set price or output but prices tend to be rigid in the oligopoly market
structure because of mutual interdependency between oligopoly firms
Usually differentiated products ability to set its own price
High entry and exit barriers to entry A few dominant firms in the market
Downward sloping demand curve and kinked demand curve
Oligopolys demand curve is relatively less price elastic than MPC firm

o Assuming a profit-maximising competitive oligopoly (kinked demand curve),
It can only make supernormal profits in the long run due to high barriers to entry
and exit
Explain why.
Include AR, MR, LRAC and LRMC curves into the diagram to show profit-
maximising oligopoly firm making supernormal profits in the long run

o Oligopoly firms tend to maximise profits in the long run but it does not necessarily have to
do so. It can pursue other objectives in the long run so long as it makes at least normal
profits (diagram and elaboration not necessary due to mark allocation and demands of
the question).

Part b:
Recession will affect firms in different ways, depending on what they produce and the market
structure in which they operate. Discuss the likely effects of a recession on different firms. [15]

Introduction:
Define recession falling national income for at least two consecutive quarters in a year

Body:
Impact of recession on firms producing normal goods
o YED for normal goods is positive
AR curve will shift to the left elaborate (profit-max price and output will fall)
Ceteris paribus, profits will fall

Some firms in MPC market structure will make subnormal profits and they will
have to leave the industry because in the long run, firms in MPC market structure
can only and must make normal profits due to low barriers to entry

Oligopoly firms are more likely to survive because they might initially already be
making substantial long run supernormal profits. Hence the fall in demand will
reduce their level of supernormal profits but they might still be able to make a
smaller level of LR supernormal profits or at least normal profits.

o Impact of recession on firms producing necessities
Normal good; YED is between 0 and 1

o Impact of recession on firms producing luxuries
Normal good; YED is greater than 1


Impact of recession on firms producing inferior goods

Conclusion:
During a recession, firms producing normal goods will suffer, with those producing luxuries
suffering to a greater extent than those producing necessities
o Oligopoly firms have more financial resources to survive a recession than MPC firms
During a recession, firms producing inferior goods will benefit
Evaluate why Apple, a firm producing normal/luxury goods has done so well in the face of a
recession
o Factors, other than income, also affect the demand for the good and in turn the profits of
the firm producing the good



Question 4
(a) Describe the process whereby an increase in government expenditure can lead to a bigger
change in national income. [10]
(b) Discuss the extent to which conflicts in government macroeconomic objectives limit the
scope for the use of fiscal policy in any economy. [15]

Refer to Interconnected slides






Question 5
In the study of macroeconomics, investment can take many forms including foreign direct
investment, fixed capital investment and investment in human capital.

(a) Explain what is meant by these different types of investment. [10]
(b) Discuss how far supply-side policies can be used to stimulate these different types of
investment. [15]

Question 5
(a) Almost all candidates had a good knowledge of human capital with the vast majority also showing
some understanding of foreign direct investment. Fixed capital investment was correctly defined
by the majority, but it was (surprisingly) less well understood than the other two concepts with a
significant minority of candidates thinking it was hot money flows or investment in stocks and
shares.

(b) This question produced some strong, relevant evaluation of the policies in terms of their
effectiveness, especially with regard to the human capital investment policies, and to the idea that
any supply-side policies are ineffective without sufficient demand. However, the explanations of
how policies affected investment tended to be stated rather than explained. It appeared that
candidates were adapting rote-learned answers for determinants of investment and/or
evaluation of supply-side policies. The most relevant responses came from those who thought
carefully about the question and recognised, for example, that investment in human capital and
fixed capital investment could themselves attract further investment in the form of FDI. There was
some misunderstanding about what counted as supply-side policies and what did not: for
example, some candidates wrote in detail about the effects of interest rates or exchange rates
without establishing whether these were supply-side policies or being presented as a better
alternative.

Question 6
The Singapore economy is open to the world, in trade and investment. This is both a matter of
policy and necessity because of our size and limited resources. In 2008, our trade to GDP ratio
was 360%, the highest in the world.
(Ministry of Trade and Industry, Singapore, 2009)

Discuss whether the openness of the economy is beneficial or harmful to the standard of living in
Singapore. [25]

Introduction:
Define key terms
o Globalization
o Openness
o SOL material and non-material

Body:
Singapore as an importing country:
The openness of the economy is beneficial to Singapores SOL:
o Absence of Tariff diagram for Singapore as an importing country
Increase consumer surplus without tariffs increase material SOL
No restrictions on imports greater variety of goods and services available
to Singaporeans increase material SOL
In line with the theory of comparative advantage, Singapore imposes no
restrictions on imports, hence she is able to import raw materials and
intermediate and final imports from foreign countries with a comparative
advantage in the production of the good or supply of raw materials.
Keep cost-push inflation low (because tariffs add on to cost of
production, hence the absence of tariffs keep cost push inflation low);
Singapore lacks natural resources, heavily dependent on imported raw
materials and food
o Lower prices increase consumer surplus increase material
SOL
Trade creation. No trade diversion

However, the absence of protectionist measures may affect the SOL of certain groups of
workers in Singapore adversely
o Structural unemployment increases in industries that Singapore has lost her CA
affect the SOL of unemployed adversely

Singapore as an exporting country
o Sign FTAs with other countries to reduce restrictions on our exports

Beneficial to Singapores SOL
o Able to more fully exploit available IEOS as she produces for not just the domestic
market but the international market
Fall in LRAC as scale of production increases cheaper products increase
consumer surplus increase material SOL

Not beneficial to Singapores SOL:
o Increased industrialization
More pollution lower non-material SOL
o More production devoted to exports and less for domestic consumption
Singapores current standard of living cannot be as high as it could potentially
have been?

Singapore as a recipient of FDI
o Remove restrictions on inward FDI

Beneficial to Singapores SOL:
o Helps Singapore to achieve both actual and potential growth
Increase current and future SOL

Not beneficial to Singapores SOL:
o

Singapore as a source country of FDI
o Sign FTAs with other countries to remove restrictions on Singapores outward FDI

Beneficial to Singapores SOL:

Not beneficial to Singapores SOL:

Singapore as a recipient of foreign labour and foreign talent (not necessary)
o Remove restrictions on foreign labour and foreign talent

Beneficial to Singapores SOL:

Not beneficial to Singapores SOL:

Singapore as a source country of foreign talent (not necessary)
Beneficial to Singapores SOL:

Not beneficial to Singapores SOL:
Conclusion