Tut 16-18 - Case Study (PJC & VJC) - Revised by David

HWA CHONG INSTITUTION
Year One H1 & H2 Economics 2013

Tutorials #13-18: Macroeconomics II Internal Macroeconomic Problems & Policies
TUTORIAL #16-18: MACROECONOMIC POLICIES

SECTION A: Case Study Practice PJC Prelim 2009
Economic Performances of Germany and France
(a)
(i)
Describe the trend in the government budget balance as a percentage of GDP in

Germany between 2003 and 2007. [2]
Table 3: Germanys Macroeconomic Indicators
Germany
Government Budget (% of GDP)
2003
-4
2004
-3.8
2005
-3.3
2006
-1.5
2007
0.1
With reference to Table 3:

The government budget balance as a percentage of GDP in Germany has improved [1]
from deficit to a surplus [1].
Note: Those candidates who described budget as negative/positive will not be
given credit. Students are expected to present answers in an economic context, not a
mathematical one.
(ii)
Compare
this trend with the change in the Frances governments budget

balance as a percentage of GDP in the same period. [2]
Germany
2003
-4
2004
-3.8
2005
-3.3
2006
-1.5
2007
0.1
2006
-2.4
2007
-2.7
Table 4: Frances Macroeconomic Indicators

France
2003
-4.1
2004
-3.6
2005
-3
With reference to Tables 3 & 4:

BOTH countries budget balances have improved over time [1].
HOWEVER, Frances budget balance remains in deficit whilst Germanys budget
balance has improved to a surplus position, at the end of the period [1].
Alternative answers are accepted as refinement for difference:
Germanys budget improved faster than Frances.
Hwa Chong Institution. All Rights Reserved. Tutors Copy

(b)
Extract 4 indicates that wages in Germany are kept low. Explain

reason for Germanys unemployment rates shown in Table 3. [2]
a possible
Note for tutors: Wage rates and employment

While wages are low (Extract 4), the unemployment rates (Table 3) seem fairly high.
However, according to market forces (for labour), low wage rate would induce higher
qty demanded for workers (by firms), ceteris paribus. Hence the data may not be
explained by simple DD/SS theory.
Germany
Unemployment rate (%)
2003
9.3
2004
9.8
2005
10.6
2006
9.8
2007
8.4
With reference to Table 3:

Germanys unemployment rate was between 8.4 to 10.6%. The figures seem
incompatible with the fact that wage rates were kept low (i.e. real wage
unemployment was not an issue).
Suggested answers:
1m identify a possible reason
1m elaborate the reason using information from the extracts or otherwise.
(1) Technological unemployment:
According to the data, the use of capital or capital-intensive method of production results in
the low demand for labour (capital as a substitute for labour), thus unemployment will still be
high (i.e. as firms prefer to use capital than labour for production) although wage is low. This
is a form of structural unemployment, i.e. machines displacing workers.
(2) Frictional unemployment due to unemployment benefits/Welfare:
If unemployment benefits are high in Germany, this could encourage more to remain
unemployed and make claims for unemployment benefits. This is a form of search
unemployment or frictional unemployment.
Note: The 1st answer can be inferred from Extract 4 but not the 2 nd. But the question
asks for a possible reason. So answers need not be found in the data.

(c)
With reference to the data, account for the difference in the current account
balance between France and Germany. [6]
Note: Refer to Case Study Skills Package. Since the command word is account, this
question is still considered a type of Lower Order Skills Question. But the weighting is high,
therefore the answers have to be detailed and yet concise.
General Mark Scheme for 6m LOS Questions:
L3
L2
L1
Elaborate (Extend to include analysis)

Analyse use relevant theory to aid explanation
Apply place explanation in context of evidences from the data
Consolidate (Add some details application)
Explain the economic concepts more in depth.
Clarify give examples from data with more elaboration
Knowledge/Recognise (Description)
Identify the key theory without explanation or/and key evidence without explanation
Outline: give a list of relevant factors
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Tips: Use SEED

State
Elaborate with economic analysis
Exemplify with evidence from
Data
Germany
Current A/C balance (% of GDP)
Current A/C balance (Billion Euro)
2003
2
47.3
2004
4.7
77.9
2005
5.2
95.8
2006
6.1
116.1
2007
7.5
181.9
2006
-0.7
-32.6
2007
-1.2
-28.5
Table 4: Frances Macroeconomic Indicators

France
Current A/C balance (% of GDP)
Current A/C balance (Billion Euro)
Mark Scheme:
L3
L2
L1
2003
0.8
10.3
2004
0.6
-4.4
2005
-0.6
-30.9
Provides a balance analysis and reaches a reasoned conclusion on the basis of the
tables and the extracts.
Uses the tables and extracts to elaborate with economic analysis on the difference in
the current A/C balance in Germany and France.
Makes some relevant points without/with little elaboration
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Suggested Answers:
State
With reference to Tables 3 and 4:
Germany: current account balance surplus improved over the years.

Identify
the France: current account balance deteriorated from surplus to a deficit
difference
Current A/C balance = net trade in visibles (goods) + net invisibles (services)
+ net balance on income and transfers
Elaborate with Why Germany BOT improved:
economic
According to Extract 4, Germanys improving current account surplus may be
analysis
explained by her export competitiveness (rise in export revenue leads to

Exemplify with improvement in current balance). This is achieved by maintaining low wages and
hence lowering production costs. Thus Germanys exports can be priced
evidence from competitively in the international markets. Assuming demand for exports is price
Data
elastic in the overseas market due to availability of other substitutes, export revenue
will rise since quantity demanded will increase more than proportionately with lower
Germanys
price.
and Frances
Moreover, her comparative advantage in producing capital goods (machine tools in
current
Extract 4) is helping her to export significantly to developing countries (such as
account
China, India and Russia mentioned in the extract). With growing demand from
position
developing countries and competitively-priced exports, Germany is able to enjoy
improving current account surplus.
Why France BOT deteriorated:
France is losing her export competitiveness as high wages drives up production
cost. With more imports and deteriorating exports (or export competitiveness),
Frances current account position worsened, ceteris paribus.
In addition, based on Extract 5, Frances worsening current account could be
explained by the robust consumer spending which may encourage consumers to
import more.
Conclusion
The main reason for the difference in the current account for Germany and France
is that the former has improved in terms of its export competitiveness while the latter
is still lagging behind.
Missing information:
Lastly, the data only suggest trade or visible accounts as possible reasons for the
countries current account positions. No information about the invisible trade
accounts is available to provide more evidence for the current account positions of
Germany and France in Tables 3 and 4.
Note: It is not needed to include the missing info in the answers for an
account question. Nonetheless, it is always good to notice the insufficiency
of the data.
(d)
Discuss whether the data are sufficient to assess changes in the standard of living
in these economies over the period. [8]

Note: Refer to Case Study Skills Package This is a typical Higher Order Skills question. So it
should be written in a form of mini-essay.
The style and approach would be similar to writing an AWEsome essay using thesis, antithesis and synthesis for structure. Nonetheless, it does not mean they are the same.
In terms of emphasis given to synthesis and conclusion, it is less demanding than an essay.
General Mark Scheme for 8m HOS Questions:
L3
L2
L1

Balanced view
Justified conclusion
Consider both sides but lopsided
No justified conclusion.
Consider 1 side no evidence of discussion.
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Tips: Use SE3DS
State
Elaborate with economic analysis
Evaluate
Exemplify with evidence from
Data
Stand

TIPS:
For such a high weighting discursive question in the case study, the following steps are
highly recommended:
1. While planning for the answers, approach it from an essay perspective to form a
structure.
SOL over time:
Introduction: Define SOL + approach
Material:
Nominal GDP
Real GDP
Real GDP per capita
Composition
Distribution
Non-material: Suggest other supplementary indicators.
2. Next, based on the case material, select the relevant points and organize the points in
order of importance according to the amount of evidence from the data.
3. Throughout the analysis, always remember to insert evidence from the case material.
Key words: With reference to/According to (Extract 1, para 2, Table 4, Chart 2..)
1. For this particular question, nominal GDP will not be selected since real GDP is given.
2. Real GDP is rising and thus shows an improvement in terms of material well-being. Do the
extracts agree to or support that?
3. It is obvious that population figures are absent.
4. There are some forms of ideas on composition since the extracts mentioned that Germanys
growth is more export-driven and France has robust consumer spending.
5. The case study material also provides ideas on distribution: Germany those who work in
industries producing machines for exports, France those who work in the IT and services
industry are most likely to fare better. But a better indicator is always the Gini-coefficient.
6. Non-material: Information on longer life expectancy and high expenditure on healthcare is
useful. But more info such as stress level, working hours, environment, etc should be
provided. Others indicator such as HDI / NEW / PQLI is needed.

Discuss
whether the data are sufficient to assess changes in the standard of living in
these economies over the period. [8]
1. This question requires the students to assess whether the data is sufficient to reach a
conclusion whether SOL in Germany and France has improved.
2. To answer this question, the approach is there is data but there are gaps and more
information is needed.
Suggested Answers
Introduction
Standard of living reflects the material and non-material well-being of the residents in a country.
I shall be discussing whether and to what extent information from the data, namely tables 3 & 4 and
extracts 4 & 5 are sufficient to assess changes in the standard of living in Germany and France over
the period.
Body
Material wellGermany
France
being
Real GDP
According to the Real GDP growth (%) figures from Tables 3 & 4, both Germany
and France are enjoying economic growth from 2004 to 2007. This would mean that
there are more quantity of goods and services available for consumption. It also
means that Germans and French are experiencing higher income and purchasing
power which can be used to improve their material well-being.
Extract 4 states that real wages did not
increase significantly when firms try to
stay competitive by keeping wages low.
Hence the extent of SOL improvement
may be limited.
But the high unemployment rates in Tables 3 & 4 may signal structural
unemployment. As a result, a significant number of Germans and French may suffer
from lower material well-being,
Real GDP per Simply looking at real GDP statistics may end up overstating the improvement in
capita
standard of living. One should take population growth into consideration. Thus, a
better indicator will be real GDP per capita. This piece of information is absent
from the data.
Distribution
Composition
If a large proportion of the national income is earned by the minority, then we

cannot conclude that the average Germans or Frenchs SOL has improved.
The data does suggest that those who If the bulk of the income is earned by
work in the export markets benefit more those in the IT and service sectors, then
from the growth.
it may not be accurate to conclude that
an average resident in France is
enjoying higher SOL.
Nonetheless, to have a better picture of income distribution, Gini coefficient
should be available.
From Extract 4, it suggests that the Extract 5 mentions robust consumer

economy was doing well due to an
improvement in export sector. The
increase in goods and services is not for
local consumption and thus current
standard of living may not have
improved.
Non-material
spending and that it may suggest better

material well-being of the French and
thus higher SOL. This is especially so if
consumers in France indulge in betterquality imports or enjoys a wider range
of consumer goods that enhance their
material and non-material well-being.
Quality of life indicators

The significant expenditure on healthcare (more than 10% of GDP) and the longer
life expectancy are evidence to support that Germanys and Frances SOL has
improved over the period (2004-2007).
Germans workers may be under more
stress out of fear of losing their jobs
since managers can threaten to move
work to central Europe i.e. go offshore
and capital seems to be replacing labour
(Ext 4).
Extract 5 seems to suggest that with the

help of strong unions, French workers
may not be subjected to a competitive
work environment (e.g. less stressful
work or shorter working hours), and their
fringe benefits may be secured to
improve their quality of life.
Conclusion (evaluative judgment)

The data provided is clearly insufficient to assess accurately/conclusively changes in SOL for both
countries over the given period of time. This is because the most basic indicator of material wellbeing which is REAL GDP per capita is not available. Furthermore even if this available there are
other issues which must be considered such as whether income disparity has worsened.
Moreover the information provided which pertain to the quality of life is far too inadequate. There are
other issues besides health care and life expectancy that impact on quality of life e.g. stress; quality
of the environment. At best, the information provided is only indicative of changes in the SOL. Other
indicators such as PQLI are needed.
Mark Scheme:
L3
L2
L1
Assesses both sides for both countries and come to a justified conclusion.
Considers both sides/countries and with some form of economic analysis & evidences
from the data.
Considers only sufficient or insufficient data without/with little elaboration OR
considers only 1 country.
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(e)
With reference to the data, evaluate the measures that France can adopt to achieve its
macroeconomic aims. [10]
Note: This is another typical Higher Order Skills question. So it should be written in a form
of mini-essay.
The style and approach would be similar to writing an AWEsome essay using thesis, antithesis and synthesis for structure.
General Mark Scheme for 10m HOS Questions:
L3
L2
L1
E2
E1

Balanced view
Consider both sides but lopsided
No justified conclusion.
Consider 1 side no evidence of discussion.
Judgment based on analysis
Mainly unexplained judgments
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2
1

TIPS:
For such high weighting discursive question in the case study, the following steps are highly
recommended:
1. While planning for the answers, approach it from an essay perspective to form a
structure.
Measures to achieve macro goals:
Introduction: State the goals + approach
Body: Measures:
Short-run policies and their limitations: Fiscal, monetary, exchange

rate
Long-run policies and their limitations: Trade and supply-side

policies
Conclusion: Synthesis + Judgment
2. Next, based on the case material, select the relevant points and organize the points in
terms of importance according to the amount of evidence in the data.
3. Throughout the analysis, always remember to insert evidence from the case material.
Key words: With reference to/According to (Extract 1, para 2, Table 4, Chart 2..)
For this particular question:
a. Identify the goals/problems slow growth rates, high unemployment rates and
current a/c deficit
b. Identify the policies to be used:
Table 4 has evidence of expansionary fiscal policy based on budget deficit, Thus for shortrun policy, FP will be chosen. Limitations?
Extract 5 mentions low interest rate, so may consider expansionary monetary policy.
Limitations?
Note: The question is measures France can adopt. So any logical policy can do.
In reality cutting i/r cannot be carried out unilaterally or independently by France. This
is because as a member of the Eurozone (i.e. EU countries using a common currency
the euro), France is bound by treaty to adopt a common interest rate or monetary
policy in order to uphold the value or exchange rate of the euro. If France were to say
cut i/r independently of the rest of the Eurozone, then funds will flow out of France,
thus de-stabilising the value of the euro.
Similarly, as a member of the Eurozone (i.e. common currency area), France cannot
independently devalue the euro to improve its trade deficit. This is the price it has to
pay for being a member of the EU.
So if these policies are chosen, it must be brought to the attention of the examiners, it
is not done by France unilaterally.
As short-run policies do not solve the root cause of the problem, it is necessary to introduce
appropriate long-run policies.
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(e)
With reference to the data, evaluate the measures that France can adopt to achieve its
macroeconomic aims. [10]
Introduction
To be a successful economy is to achieve the four macroeconomic.goals one that is characterised
by sustained growth, stable price level, full-employment and favourable BOP.
However, with reference to Table 4, it appears that the French economy is facing:
Slow Growth rates (1.1-2.2%) and High Unemployment rates (8-9%)
Unfavourable or deficit in the current account
Note: inflation is least of the concerns here. But the use of expansionary policies, if not
accompanied with SSP, can lead to demand-pull inflation.
This part of the case study shall discuss on the measures that France can adopt to achieve its
macroeconomic aims.
Body: Possible policies that can be used to spur economic growth and reduce unemployment
and reduce trade deficits (any 3, but should include long-run policies)
(A) Expansionary Fiscal Policy (fiscal stimulus)
Explain how expansionary FP can stimulate AD, hence lead to actual growth and lower cyclical
unemployment (refer to notes): In theory through a budget deficit, the government can inject more
expenditure into the circular flow to create K effects. Given the relatively low inflation rate (less than
2%), an increase in AD is likely to expand output and hence create more jobs for the economy.
Limitations:
According to Extract 5 and Table 4, the French government already has been running persistent
deficits between 2003-2007.
This policy might result in the government having to finance its deficit by further borrowing
which leads to crowding-out effects. Crowding out effects: Increased government borrowing
in the financial markets pushes up interest rates leading to higher cost of borrowing for the
private sector. This in turn may discourage private consumption and investment expenditure.
In short, private spending is displaced by more G spending and borrowing, resulting in only
marginal increase, if any in overall aggregate expenditure for the economy. Hence growth
may be limited.
From Ext 5 para 2, budget deficit is also well-above the eurozone average of 1.6% and its
accumulated debt levels amounted to 64% of GDP. There is thus little room for more fiscal
deficits, as further borrowing may lead to a debt crisis.
Possible demand-pull inflation may ensue, conflict macro goal of price stability. In the worse
case scenario, may worsen the export price uncompeitiveness that France is currently facing
and worsen the current account deficit.
11

EXTRA
Other possible adverse effects on the economy of mounting public debts:
Cut spending or Austerity Measures: Government may adopt austerity or belt-tightening

measures such as cutting G spending on welfare benefits; healthcare and education. Such
cutbacks on G spending may adversely impact on quality of life and standard of living for the
average resident of the country.
Print Money: Government may have to resort to printing money i.e. monetizing the debt to
finance the deficit. This would lead to hyperinflation if economy is flushed/flooded with excessive
liquidity.
Increased T: Raising taxes to finance the deficit. Hefty tax increases may lead to a sapping of
productivity due to its disincentive effects on individuals and firms willingness to work, save and
invest. This in turn may hinder future growth as productivity and innovation shrinks.
(Bi) Expansionary Monetary Policy
Explain how expansionary MP can stimulate AD, hence lead to actual growth and lower cyclical
unemployment (refer to notes): Cut interest rates to stimulate more borrowing to spend on C and I.
Could be effective if the demand for loans is interest elastic. That implies borrowers are optimistic
and upbeat about the economic outlook. Extract 5: economy propped up by low interest rate and
robust consumer spending seems to suggest monetary policy is effective in France.
Limitations
Since the interest rate is already low, there is thus limited scope for further cut/reductions in
nominal interest rate.
In reality cutting i/r cannot be carried out unilaterally or independently by France. This is
because as a member of the Eurozone (i.e. EU countries using a common currency the euro),
France is bound by treaty to adopt a common interest rate or monetary policy in order to
maintain the value or exchange rate of the euro. If France were to say cut i/r independently of
the rest of the Eurozone, then funds will flow out of France, thus de-stabilising the value of the
euro.
Possible demand-pull inflation may ensue, conflicting with the macro goal of price
stability. In the worse case scenario, may worsen the export price uncompeitiveness that France
is currently facing and worsen the current account deficit.
(C) Exchange rate policy (not mentioned in the data)
In theory, a country can devalue its currency to improve its BOP. Devaluation lowers the price of
exports in terms of foreign currency and raise the price of imports in terms of dmextic currency.
According to the Marshall-Lerner Condition, if the sum of the price elasticities of demand for X and M
>1, the BOT would improve. Ceteris paribus, BOP would improve. With BOT improving, AD will rise
and shift right since (X-M) increases, leading to actual growth.
Limitations
However, as a member of the Eurozone (i.e. common currency area), France

cannot independently devalue the euro to improve its trade deficit. This is the price it has to pay
for being a member of the EU.
The J-curve effect suggests that BOT may worsen in the short-run
Price of imports will be more expensive in terms of domestic currency, so this

will lead to import-price-push inflation. If Frances exports have a high import content, then it will
lose its export price compeitiveness and worsen the current account deficit.
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(D) Supply-side Policies

The root of the problems may be due to the fact that France has lost its comparative advantage and
the skills of the workers are obsolete.
Use SSP
To gain export competitiveness to correct for the unfavourable current account position.
To upgrade the skills of workers to fit them in the new jobs
Possible ways to carry out such policy would be to reduce to reduce/cut business costs and/or
expand productive capacity
Examples:
Governments investment in infrastructure.
Tax incentives: Introduce tax incentives to those firms in the export sector and those which can
develop new comparative advantage through R&D. According to Extract 5, Frances comparative
advantages seem to be IT and services and they are attracting substantial investment.
Subsidies: Subsidises education/training e.g. IT industry
Positive spin-offs:
With more firms engaging in production, more tax revenue can be collected although with lower
corporate tax rate, the tax collected from each firm is lower, the increase no. of firms would
compensate for the lower tax rate imposed, to end up with higher tax revenue at the end of the day.
This could also help to address the high debt burden and the persistent budget deficit.
Limitations
Time-lags long-gestation period to bear fruit e.g. R&D.
Governments investment in infrastructure may be limited since the budget deficit is a concern at
present (based on Extract 5).
Tax and subsidies/benefits to exporters might be construed by trade partners as a form of
protection or unfair competitive advantage given by the government and thus might attract
retaliatory measures.
(E) Labour market reforms including wage policy
According to Extract 5, poor labour market performance appears to be a major source of Frances
poor economic performance in terms of exports and growth. Solution institute reforms in the labour
market to make wages and hiring more flexible to changes in economic conditions.
Examples:
Ban union militancy (e.g. ban strike; give employers the right to hire/fire)
Adopt flex-wage policy ( wages can rise/fall in tandem with economic conditions)
Adopt performance-based wage policy ( wage growth is tied to productivity growth)
Limitations
Strong political resistance -The French people are ardent supporters of socialist or pro-labour
policies. Difficult to break this culture. As mentioned in Extract 5, it may be difficult to garner support
to implement wage or labour market reforms to make the labour force more flexible and nimble.
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Conclusion (justified judgment)

Given the special circumstances, it would appear that the French government has indeed very
limited policy options to address the macroeconomic problems on hand i.e. unemployment, slow
growth and unfavourable BOP.
As a member of the Eurozone it does not have the option of using monetary policy and exchange
rate policy. Its ability to use fiscal stimulus is also curtailed by its mounting public debt. Moreover, its
strong unions and socialist culture pose formidable challenges to implementing labour market
reforms.
Perhaps, the silver lining seems to come from French comparative advantages in IT and services.
Thus effective policies targeted at making the Paris region Europes Silicon Valley and a service hub
may be a promising proposition in dealing with the current economic problems.
Note: Under exam conditions, you need not have all the points. Just ensure there are at least
3 policies with a balance of short and long run measures.
Mark Scheme:
L3
L2
Evaluates the measures with strong reference to the data.

Explains the measures more in depth and with some reference to the data. Limitations
are mentioned.
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L1
Identifies the key measures without explanation or/and key evidence without
explanation
No mentioning of the limitations of the policies
Judgment based on analysis (justified conclusion)
Mainly unexplained judgments
13
E2
E1
2
1
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SECTION A: Case Study Practice VJC Prelim 2010

The Chinese Economy
(a) (i) Compare the trend in Chinese headline-exports-to-GDP ratio and the true export ratio
between 1980 and 2006.
[2]
Similarity: Both exports to GDP ratio and true export ratio rose.
Difference:
But exports as a ratio of GDP is higher than true export ratio.
Note: Tutors may wish to highlight that it is incorrect to say that the headline-exports-to-GDP ratio
rose faster than the true export ratio, as the latter started off with a much lower value in 1980.
(ii) Explain possible reasons for the above trend in a(i).
[4]
Reasons for export rising:

Exports surge due to entry into WTO in 2002 and therefore explaining the substantial rise in
headline exports to GDP ratio.
Reason why Export-to-GDP always higher
True exports ratio measures the value added of manufactured exports which excludes imported
inputs whilst headline exports to GDP ratio measures the total export revenue inclusive of
imported inputs, so the latter is always higher.
(b)
With reference to Extract 4 and Chart 3, to what extent was the Chinese economy
affected by the downturn in the American economy in 2008?
[6]
With the downturn in the American economy, we can expect US citizens to face a falling income and
demand for lesser imports, including from China, assuming that the imports are mainly normal
goods. China would thus face a fall in net exports. Moreover, FDI from US to China may fall as US
investors face difficulty financing their investments given the ailing US banking system. These would
lead to a fall in AD and in turn a fall in real GDP for China via the multiplier effect. Moreover, Chinas
relative share of exports to GDP has increased substantially and accounted for 40% of GDP in 2007.
These seem to suggest that the Chinese economy would be severely affected by the downturn in the
US economy in 2008, and thus explain the significant fall in both US and Chinas GDP growth in
2008 as shown in Chart 3.
However, Extract 4 noted that North America accounts for less than 10% of Chinas exports, and
Chinas exports to other emerging economies, where demand is more robust, are bigger than those
to America. This suggests that Chinas net exports were unlikely to fall significantly due to the US
economic downturn.
Moreover, even if the contribution from net exports fell to zero, strong domestic demand in China
would help to buffer the external impact of the US economic downturn on its net exports.
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Conclusion
Overall, the downturn in the American economy has a negative impact on the China economy, but
the effect is partly cushioned by its other export markets and strong domestic demand.
L1
L2
L3
Attempts to state reasons as to how US economy downturn can affect Chinas economy
One-sided explanation as to how Chinas economy is affected by US economic downturn
OR
A poorly explained but two sided answers
A well-explained and balanced answer as to whether US economic downturn does affect
Chinas economy to a certain extent + reasoned conclusion
(c) Discuss the impact of the huge stimulus package on the Chinese economy.
[10]
Chinas 4 trillion Yuan fiscal stimulus package was to be spent on public works, social welfare and
tax reform over 2 years (Extract 5). We can expect the expansionary fiscal package to also have a
supply-side impact, as its spending includes areas such as infrastructure projects and education,
which would help to improve the productive capacity of the economy in the long run. I shall examine
the impact of the stimulus package on the Chinese economy in terms of the four macroeconomic
goals, namely economic growth, unemployment, inflation, and Balance of Payments.
An autonomous increase in Chinas government expenditure will lead to an increase in AD from AD 0
to AD1, and a multiplied increase in real Y from Y 0 to Y1. Given the poor consumer and business
confidence (Extract 5, Para 1), the huge stimulus may also be intended to be a signal of the
governments support for the economy to boost confidence and revive C and I. Hence, GDP growth
and employment is expected to improve with possible inflationary pressures in the short run, as
indicated by the rise in general price level from P 0 to P1. The increase in inflation would however be
a concern as China had earlier implemented the deliberate tightening of monetary policy to curb
inflation.
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However, as the supply side effects of the spending manifest over time, the productive capacity of
the economy would also increase, leading to potential growth and a shift in AS from AS 0 to AS1. This
is likely to reduce inflation from P1 to P2 as well as increase GDP growth from Y1 to Y2 in the long run.
AS0
AS1
General
Price
Level
P1
P0
P2
AD0
Y
AD1
Real National Income
An increase in actual growth would lead to an increase in income and in turn consumer spending on
imports. This may add on to Chinas problem of weaker exports as the world economy sags and
the fall in net exports would weaken the current account balance. Nevertheless, if the strong support
from the government helps to increase business confidence, it is possible that FDI and short term
capital inflows will continue to be high, boosting the capital account. The eventual impact on BOP is
likely to depend on the extent to which the business confidence of foreign investors would be
restored.
Evaluation on the effectiveness of the policy
It is uncertain whether the fiscal stimulus would be sufficient to boost the confidence of the
consumers and investors.
Given that saving rate is high (i.e. MPC is low) and confidence is failing, the multiplier effect
may not be so pronounced and consumers may be reluctant to spend due to pessimism. In
this regard, infrastructure investment is much better at boosting growth.
The boost of the income of rural farmers is likely to be effective given their relatively higher
MPC, hence leading to a much greater proportionate increase in C and economic growth.
However, as the bulk of the stimulus is on infrastructural spending, boost on GDP arising from
farmers may be limited.
Other possible evaluations (tutors may however wish to highlight that students should prioritise
the evaluative points that were provided in the extracts):
Timing, lag effect
Possible crowding out effect
(Note: given that the question focuses on the impact on the Chinese economy, students answer
should focus on the impact on the 4 macroeconomic goals, although there are other evaluative
points on the policys impact on income indistribution and SOL:
The scheme targeted at the rural farmers also helps to achieve equity by helping the poor to
boost their purchasing power.
17

As suggested in Extract 5 (last para) investment in China is already high as a share of

GDP, it may be better to spur consumption through income-tax cuts to achieve a higher
current material standard of living. )
Conclusion
Despite the small multiplier that China may have, the fiscal stimulus is quite substantial and domestic
demand is still considered strong, hence we can expect the package to boost China GDP
significantly. Inflation may however increase in the short run. The eventual impact on BOP would
depend on the extent to which the business confidence of foreign investors would be restored.
L1
L2
L3
E1
E2
Recognise the workings of fiscal stimulus and how G can boost AD and/or LRAS but without
much conceptual explanation
Able to explain how G can increase actual growth through multiplier effect as well as to attain
potential growth
and/or
Provide some factors that affect its effectiveness but poorly explained
Above + taking into account the case evidence to provide arguments for its effectiveness
Unjustified conclusion
Justified conclusion with substantiation.
(d) Comment on the effectiveness of the various economic measures mentioned in the
extracts that can be used by the Chinese government to prevent the economy from
overheating. [8]
Possible economic measures mentioned in the Extract: MP, ER policy and policy targeted at property
regulation. Need only to discuss 2 policies. However, students should include discussion on the
property regulations given that it was already implemented.)
Overheating economy attributable to DD-pull (rise in G, bank lending, DD for property) and cost-push
(rising food and rent costs) inflationary pressures. Evidence: inflation rose 2.8%, rising consumer
prices and property prices.
Economic measures adopted by the govt. (Extract 6) were related to property regulations. Other
measures include raising of interest rate and allowing appreciation of currency.
Property regulations
Tightening restrictions on advance sales of new property developments, the introduction of

new curbs on loans for third home purchases and the raising of minimum down-payments for
second homes.
With rising GDP and affluence, there may be increase in affordability. Whilst these measures
may help to reduce the DD for properties, effectiveness depends on ability to curb speculative
DD and whether DD is fuelled by foreign buyers. It will also reduce the rentals.
Raise interest rate
Raise the opportunity costs of borrowings and hence C & I. This will cause AD to fall and
through the downward multiplier reduce the DD-pull inflation. However, effectiveness likely to be
limited as there is substantial liquidity in the market and will depend on the extent of the increase
in the interest rate. Moreover, in a booming economy, consumer and business optimism are high,
so unless the rise in interest rate is substantial, there may not be substantial contraction in C & I.
18

The higher borrowing costs may deter people from buying properties and speculation, thus
dampening the rising property and rental prices.
ER policy revaluation of the Yuan (teach students to use proper term: revaluation / devaluation /
undervaluation for the Yuan)
With revaluation of the Yuan, it will reduce the relatively export competitiveness of China
goods & services, and make imports relatively cheaper. Net exports will fall, reducing AD and
thus cooling the DD-pull inflation. It will also reduce the imported inflation, especially food.
However, effect is likely to be marginal as China is unlikely to allow its Yuan to revalue
significantly considering that the global economy has not recovered
The measures may help to slowdown DD-pull inflation, however, cost-push inflation caused by rising
food prices and rent costs may not be resolved. The rising rent may be due to lack of public housing
whilst higher food prices may require the govt. to provide help in boosting food supply through better
methods of agriculture, e.g. higher yield crops that use better technology.
Conclusion
Whilst property restrictions and raising the interest rate/Yuan appreciation may help to slowdown the
demand for loans and properties and external demand, thus helping to reduce the DD-pull inflation, it
may not be effective in addressing the cost-push inflation which requires policies such as increasing
the supply of food and housing.
L1
L2
L3
E1
E2
Identifies various policies but limited elaboration on its workings

Explains how the economic measure works to reduce inflation; recognizing that these
measures helps to reduce demand pull inflation in particular
Able to explain 2 economic measures well + attempt to address the effectiveness with the
good use of evidence
Makes a stand on the overall effectiveness of Chinas economic measure with little or no
justification.
Makes a stand with strong justification.
19

Tut 16-18 - Case Study (PJC & VJC) - Revised by David

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HWA CHONG INSTITUTION

Year One H1 & H2 Economics 2013

TUTORIAL #16-18: MACROECONOMIC POLICIES

Describe the trend in the government budget balance as a percentage of GDP in

With reference to Table 3:

this trend with the change in the Frances governments budget

Table 4: Frances Macroeconomic Indicators

With reference to Tables 3 & 4:

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Extract 4 indicates that wages in Germany are kept low. Explain

Note for tutors: Wage rates and employment

With reference to Table 3:

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Elaborate (Extend to include analysis)

Tips: Use SEED

Table 4: Frances Macroeconomic Indicators

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explained by her export competitiveness (rise in export revenue leads to

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Elaborate (Extend to include analysis)

Tips: Use SE3DS

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Real GDP per capita

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If a large proportion of the national income is earned by the minority, then we

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spending and that it may suggest better

Quality of life indicators

Extract 5 seems to suggest that with the

Conclusion (evaluative judgment)

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Elaborate (Extend to include analysis)

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Short-run policies and their limitations: Fiscal, monetary, exchange

Long-run policies and their limitations: Trade and supply-side

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Cut spending or Austerity Measures: Government may adopt austerity or belt-tightening

However, as a member of the Eurozone (i.e. common currency area), France

Price of imports will be more expensive in terms of domestic currency, so this

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(D) Supply-side Policies

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Conclusion (justified judgment)

Evaluates the measures with strong reference to the data.

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SECTION A: Case Study Practice VJC Prelim 2010

Reasons for export rising: