(2017) 9757 H2 Econs CSQ 2 Suggested Answers by Mr Eugene Toh (A Level Economics Tutor)
(2017) A Level H2 Econs Paper 1 CSQ Q2
Question 2
a. When interest rates fall, the cost of borrowing decreases and the opportunity cost of spending decreases as well, consumers find it cheaper to borrow to buy large ticket items, therefore Consumption will increase
OR
When interest rates fall, as per MEI curve, more investments become profitable when interest rates fall, thus Investments will increase.
b. Rate of inflation has slowed (or decreased), while prices are now increasing at a decreasing rate.
c. As the U.S. economy strengthens, we would expect an increase in household incomes, which would prompt an increase in demand for goods & services, which will include imports from China. China would thus see an increase in (X-M) à increase in China’s AD à increase in real national income à higher economic growth.
As the positive sentiments grows in U.S., this may encourage firms to increase investments (in order to step up production), which may further encourage an inflow of FDI to China. Investments in China may thus increase à increase in China’s AD à increase in real national income à higher economic growth.
An increased spending on capital goods may thus also increase China’s productive capacity, shifting AS to the right.
Illustrate rightward shift of both AD & AS curve
d. Factor 1: Dependence on trade for GDP growth
1. An economy is more likely to be significantly affected if trade (X-M) takes up a large % of the GDP, and therefore contributes significantly to economic growth.
2. An example of a country dependent on trade for growth is Singapore
Factor 2: Dependence on China for trade
1. Another factor would be the importance of China as a trading partner.
2. If China is one of the country’s largest export markets (e.g. top 5), then a fall in export sales would hurt trade tremendously, therefore affecting growth
e. How China might attempt to transform the economy to one that is driven by consumer spending
1. Moving the focus of monetary policy from one that is focused on driving exports growth to one that is focused on driving consumption growth
2. This can be done by shifting the focus from exchange rates to interest rates
o Explain that China was focused on keeping its exchange rates weak via fixed/ managed float ER system in the last decade in order to keep its exports competitive
o This however in turned brought about significant inflation (imported/cost-push and demand pull) à which could reduce households’ ability to spend
o Moving to interest rates policy could encourage households to spend rather than to save since interest rates would now be lower (explain EMP briefly)
Assess whether they are likely to be successful
1. The slow-down in growth would suggest that the initial efforts to switch from export-led growth to consumption-led growth hasn’t been extremely effective, at least in the short-run. This is evident by the “disappointing figures” cited in the extract.
2. Social/cultural factors are likely to play a part in the low consumer spending in China – even with lower interest rates, consumers in China may rather find other avenues of parking their excess funds (e.g. in housing) as opposed to an outright increase in consumption. Thus, there would likely be an increase in investments but not so much of consumption
3. In the longer term, when incomes increase significantly, the consumption spending may pick up. There is a likely higher chance of success in the longer term
f. Explain how EMP would work
1. Increase MS à fall in interest rates à C&I would increase à AD will increase à real national income will increase à higher economic growth & lower unemployment
Limitations & tradeoffs of EMP
1. C&I might be interest rates inelastic (possibly, especially for consumption)
2. Possibility of higher inflation (unlikely, given inflation only at 1.4%)
3. Impacts on trading partners (beneficial or not?)
4. If incomes in China were to increase as a result of EMP, consumption will increase, which will include imported goods. This will result in an increase in demand for trading partners’ exports. Trading partners will thus see an increase in (X-M) à increase in AD à increase in real national income à higher economic growth and lower unemployment
5. However, given that the extract suggests that interest rates cuts hasn’t been very successful in driving consumption, the impact on trading partners’ exports may not be very significant.
6. We need to also take into the consideration the net impact on China’s AD considering that China’s net exports aren’t doing particularly well – which could dampen consumers’ willingness to spend due to the overall state of the economy (slow growth)
Additional Note: a fall in i/r should in usual circumstances also lead to hot $ outflow à depreciation of the Yuan. This may however likely not to be the case because China controls both interest rates & exchange rates (concept of monetary policy trillema understanding comes in here.)
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