Question No. G.C.E. (A/L) Support Seminar - 2014 21 - Economics - I Guide for the Answer Answer No. Question No. Answer No. 1 5 26 2 2 3 27 5 3 4 28 2 4 1 29 5 5 3 30 2 6 3 31 2 7 3 32 4 8 3 33 3 9 5 34 1 10 4 35 2 11 1 36 5 12 4 37 4 13 5 38 1 14 3 39 4 15 2 40 5 16 3 41 2 17 3 42 4 18 5 43 5 19 2 44 4 20 4 45 1 21 1 46 1 22 3 47 2 23 3 48 4 24 4 49 3 25 3 50 5 Marks 2 50 } 100 [See page 2
- 2 - G.C.E. (A/L) Support Seminar - 2014 21 - Economics - II Guide for the Answer 01' (i) Criteria i. Decision making and decision coordinating mechanism Economic system Market economic system Command system Traditional system ii. The nature of property ownership Capitalist system Socialist system iii. The nature of incentives Traditional system Command system Market system (06 marks) (ii) In a traditional economic system, the output is distributed in accordance with the directions of the leader/s, together with traditions and cultures. In a command system, the output is distributed by the directions of the central planning authority to maximize the social welfare. A market economy the distribution of income in a factor market, rations and distributes the output. (03 marks) (iii) Agricultural goods 0 PPC 1 PPC 2 Industrial goods - Due to the decrease in the factor requirement, the productivity increases and as a result the production possibilities frontier pivots to the right only from the axis that shows the output of industrial goods. For the graph For the explanation (iv) Basic economic problems are solved by using both price mechanism and the central plan of the government. Both the private sector and government sector own factors. Both private enterprises and public enterprises exist. The private sector prioritizes the profit motive where as the public sector considers the social welfare, employment creations, political objectives etc. (03 marks) (v) It is true to say that most of the countries that previously followed socialist command system moved to capitalist market system. The following were the main reasons for the socialist system to fail. Bureaucratic control Limited economic freedom Environmental degradation Misplaced incentives (04 marks) [See page 3
- 3-02. (i) The inverse relationship that exists between the price of a certain product and quantity demanded of that product during a given period of time while all other determinants of demand are held constant. (02 marks (ii) Giffen goods When the quality is described by the price When people show their social status with the price (iii) a) Essentials b) Luxuries c) Substitutes d) Complements (04 marks) (iv) Qd=600-10P Qs=10P Price 60 -D 50-40 - 30-20- 10-0 100 ¹ 200 ¹ 300 ¹ 400 ¹ 500 ¹ 600 ¹ S Minimum price Quantity (for equilibrium; 02 marks, Graph is not compulsory) (02 maks) Qd = Qs 600-10P = 10P - 10P - 10P = - 600-20P = - 600-20 - 20 P = 30 Qd = 600-10P Qd = 600-10 30 Qd = 300 (02 maks) (ii) Consumer surplus Rs. 50 100 = Rs. 5000 Business revenue Rs. 50 500 = Rs. 25000 (02 maks) [See page 4
- 4 - (iii) Before the price floor } Rs. 30 300 } Rs. 9000 } Rs. 4500 2 2 After price floor } Rs. 10 100 } Rs. 1000 } Rs. 500 2 2 The change in consumer surplus } ^500-4500& } - 4000 iv. Before the price floor } Rs. 30 300 } Rs. 9000 } Rs. 4500 2 2 After price floor } Rs. 50 500 } Rs. 25000 } Rs. 12500 2 2 The change in producer surplus } ^12500-4500& } Rs. 8000 v. The cost incurred by the government } Rs. 50 400 } Rs. 20000 vi. Deadweight loss The change in economic surplus } ^Rs. 8000 - Rs. 4000& } Rs. 4000 The cost of the government } Rs. 20000 Deadweight loss } Rs. ^4000-20000& } Rs. 16000 ^Total marks 2 x 6 = 12& 03. (i) Short run production process When the employment of the variable factors is increased with a given amount of fixed factors, after a certain point, both the average and marginal productivity diminish. We call this the law of diminishing marginal returns. (ii) Long run production process When a firm changes all of its factors, the scale of the business will change and it would cause the returns to scale. Short run average variable cost Initially the SRAVC decreases and after reaching a certain minimum point, it increases. This is caused by the law of diminishing returns to the variable factor. As the average and marginal returns increase, the AVC decreases and vice versa. Long run average variable cost In the long run initially, the LRAC gradually decreases and then it will increase. During the decreasing part of the LRAC, the returns will increase and vice versa. (iii) Monopoly firm Downward sloping demand curve Imperfect information is the main reason Price discrimination Perfectly competitive firm Perfectly elastic demand curve Perfect information, homogenous products, unlimited number of firms Price taking behaviour [See page 5
- 5 - (iv) Price MC ATC AVC P AR=MR 0 Q Quantity (02 marks for the graph) Here at P price, the total revenue can cover the total variable cost. There the total fixed cost is the maximum loss. Although the firm is shut down the firm experiences the total fixed cost and it is the total fixed cost. If the price falls below the P price, the firm will shut down. (v) Monopolistic competition A large number of suppliers Free exit and free entry Differentiated product Advertising exists. Monopoly Only one supplier Barriers for entry Special and unique product Advertising don t exist (04 marks) 04' ^i& The value of government services is valued at the cost of production. For that in national income accounting the following items are considered. Expenses on goods and services Wages and salaries to employees Provisions for capital depreciation (03 marks) ^ii& 1. Net exports = Gross domestic product Gross domestic expenditure = 1200 1800 = -600 (01 mark) 2. Disposable gross national income = GDP + Net foreign factor income + net foreign current transfers = 1200 800 + 900 = 1300 (01 mark) 3. Gross domestic savings = GDP Total consumption = 1200 600 = 600 (02 mark) 4. National savings = DNI Total consumption = 1300 600 = 700 (01 mark) [See page 6
- 6-5. Current account balance = NX + NFFI + NFCT = 600 800 + 900 = - 500 (01 mark) 6. Real gross domestic product = 1200 120 Economic growth rate 100 } 1000 = (Real GDP of the current year Real GDP of theprevious year) Real GDP of the previous year = (1000-900) 900 100 = 11'1] (iii) Ú Second hand sales Ú Intermediate products Ú Transfer payments Ú Purely financial transactions (03 marks) (iv) Value added is calculated by deducting the values of intermediate products purchased from other producers from the selling price. This value addition comprises of the factor incomes (rent, salary, interest, profit) The income approach also considers the factor incomes mentioned above. Therefore both of these methods consider the factor incomes. (03 marks) (v) Real Gross National product is the GNP calculated at constant price where only real effects of the change in output is produced without considering the inflationary effect. Real National Income is the GNP adjusted to the impact of terms of trade. Therefore the difference between the Real GNP and Real National Income is the impact of terms of trade. RNI = Real GNP + Export purchasing power Export value at constant price (03 marks) 05. (i) The relationship between the change in personal consumption to the change in disposable income. MPC = ΔC ΔYd (01 mark) The relationship between the change in savings to the change in disposable income MPS = ΔS ΔYd In a simple economy, the sum of both MPC and MPS equals 1. (01 mark) 100 C + S = Yd ΔC + ΔS = ΔYd ΔYd MPC + MPS = 1 ΔYd ΔYd (ii) The equilibrium level of national income is the situation where the level of output doesn t have any tendency either to increase or decrease. There are two conditions 1) Actual output = Planned aggregate expenditure Y = E Y = C + I + G (01 marks) [See page 7
- 7 - (iii) 2) Withdrawals = injections W = J S + T = I + G (01 marks) Aggregate expenditure A B E C D Y=E E O Income Y 1 Y 2 Y 3 At Y1 level of output, Y < E, There is a shortage of stocks, and as a result the level of output will expand. At Y3 level of output, Y > E, There is a surplus of stocks, and as a result the level of output will contract. At Y2 level of output, Y = E, There isn t any unplanned stocks, and as a result the level of output will remain constant. (04 marks) (iv) a) Y = E Y = C + I + G Y = 180 + 0.8 yd + 120 + 160 Y = 180 + 0.8 (Y - 100) + 120 + 160 Y = 460 + 0.8 y - 80 Y = 380 + 0.8 y Y - 0.8 y = 380 0.2 y = 380 y = 380 0.2 y = 1900 Or W = J S + T = I + G - 180 + 0.2 yd + 100 = 120 + 160-180 + 0.2 (y - t) + 100 = 280-180 + 0.2 (y - 100) + 100 = 280-100 + 0.2 y = 280 0.2 y = 380 y = 1900 b) Tax multiplier Government spending multiplier K T = - b 1 - b - 0.8 (1-0.8) - 0.8 0.2-4 K T = 1 1 - b 1 1-0.8 1 0.2 5 [See page 8
- 8 - (v) Aggregate expenditure (E) Y=E A B E 2 E f E 1 O Y 1 Y F (Y) Income mqr K fiajd kshqla;s iu;=,s; ksuejqï uügu Inflationary gap is shown by A-B gap. (01 marks) Unemployment gap is shown by Y1-Yf gap. (01 mark) 06. (i) Medium of exchange Standard of measuring value Store of value Method of making deferred payments (04 marks) (ii) (a) Excess reserves of the bank = 200 - (1800 x 10/100) = 200-180 = 20 (b) The balance sheet of the bank Liabilities Assets Deposits 1820 Reserves 200 Loans 1620 1820 1820 (For the correct value of deposits; 01 mark) (For the correct value of loans; (01 mark) (c) The adjusted balance sheet of the bank Liabilities Assets Deposits 1800 Reserves 180 Loans 1620 1800 1800 (For the correct value of deposits; 01 mark) (For the correct value of loans; (01 mark) (iii) (a) - Currency held by the general public - Currency held by commercial bank - Demand deposits held by commercial banks with the central bank - Deposits held by government institutions with the central bank b) Usually the value of the money multiplier must at least be 1. It is because the money supply must contain at least the monetary base. When money is created, the money supply would exceed the monetary base and as a result, the money multiplier must be greater than 1. [See page 9
- 9 - (iv) Decreasing the interest rate Decreasing the statutory reserve ration Purchasing securities from the reverse repo market (03 marks) (v) When the input prices increase the aggregate supply curve shifts to the right and we call this cost push inflation. The following reasons will affect it. Increase in the wage rate due to the pressures of the trade unions Expansion of profit margins by businesses Increase in the cost due to supply shocks (03 marks) 07' (i) The method that is used by the government to obtain the assistance and contribution of the private sector to successfully provide infrastructure facilities and other public services is termed as PPP (Public Private Partnership). This can be seen in BOT, BOO, BOOT etc. The advantages of PPP 1. Can limit government borrowings 2. Improvement in efficiency 3. Improvement in quality and productivity of projects and services 4. Ability to obtain improved technology (ii) 1. Reducing the disparities in income and wealth 2. Managing resources efficiently 3. Decreasing the consumption of the products that have a higher social consumption 4. Managing aggregate demand 5. Influencing aggregate supply 6. Minimizing BOP problems (04 marks) (iii) Current expenditure 1. Expenditure on goods and services 2. Interest payments 3. Current transfer payments Capital expenditure 1. Acquisition of real assets 2. Capital transfers 3. Net lending (04 marks) (iv) a) Current account balance = -3500 b) Overall balance = -9000 c) Balance of the primary account = -8500 d) Government consumption = 15000 a) Current account balance = total revenue recurrent expenses b) Overall balance = total revenue grants total expenditure c) Primary account balance = total revenue grants total expenditure excluding government interest payments d) Public consumption = current expenses (interest payments + current transfers) (04 marks) (v) Ú The ability to honour current and future debt obligations of the government without having any need of changing the conditions and adjustments. [See page 10
- 10 - Ú To evaluate this the index that is used is government debt servicing index. Debt servicing index = debt repayments and interest Ÿ 100 Gross Domestic Product Ú Recent trends 2010 } 14'6] 2011 } 13'7] 2012 } 13'4] 08. (i) a) The absolute advantage is concerned with the product that is produced with the least relative cost of resources. In that wither the product with the lower cost or higher efficiency will be specialized. In contrast, comparative advantage is concerned with the product with the least opportunity cost of production. Here the product that has the least opportunity cost is selected to specialize. (03 marks) b) (1) Perfect factor mobility (2) Constant return to scale (3) No externalities of production or consumption (4) Cost of transport is not considered (ii) a) Protecting infant industries Diversifying the products to gain stability Preventing dumping practices Promoting employment National defences Minimizing BOP crises (02 marks b) Imposing quotas Providing incentives or subsidies for domestic production Controlling foreign exchange Limits for exports and imports Trade barriers Setting administrative and technical barriers (iii) Portfolio investment means the foreign investments in shares, bonds, debentures, money market debt securities and financial derivatives. (01 marks) Foreign Direct investments mean the foreign investments made in domestic businesses for lasting interests. (01 marks) With FDI, a country gets human capital, technology and management from foreign sector. This would further promote domestic employment, forward and backward linkages in industries by promoting economic growth. [See page 11
- 11 - (iii) 1. Promoting traditional exports 2. Establishing export promotion zones 3. Export diversification 4. Trade agreements with other countries 5. Promoting import substitution industries 6. Devaluating the domestic currency 7. Controlling domestic inflation and improving domestic competitiveness in the foreign markets 8. Discouraging non-essential imports (03 marks) (v) As Sri Lanka is considered as a lower middle income earning country, the ability to take soft loans will move away to hard/commercial loans Commercial loans will increase due to the concessionary loans provided by bilateral trade agreements and EURO union Obtaining long term debt financing such as with year maturity period through the international financial market Increase in interest expenses due to the higher orientation of short term debt financing (04 marks) 09. (i) a) Sacrificing the current consumption Environmental degradation Inflation Disparities in income distribution (03 marks) (ii) - b) - Economic development is an evolutionary process. The changes in quantitative, qualitative and structural changes can be collectively considered as economic development. - The following changes must occur when a country develops. - Promoting industrialization - Decrease in the relative contribution of the agricultural sector - Change in international trade pattern - Improvement in resource productivity - Modernization Human poverty refers to the situation of deprivation of opportunities to obtain and sustain a happy and healthy standard of living due to the loss of self freedom, self esteem and respect. - Human development is the process that promotes opportunities and approach for a successful standard of living with longevity and other healthy and civilized human life. (01 marks) According to the above description it can be noted that the movement from poor standard of living to higher standard of living can be considered as human development. The following are the main criteria. Items that are needed for a good life Health Security Freedom to choose Social contacts (01 marks) [See page 12
- 12 - (iii) (a) - Longevity (health) - Knowledge (education) - Higher standard of living (03 marks) (b) - Health - Education - Standard of living (03 marks) (iv) (a) - Developing rural roads - Rural electricity development - Improving irrigation - Promoting IT facilities in rural sector - Road network, ports and aviation services promotion - Divi Neguma programme - Regional development projects (Uthuru Wasanthaya, pubudamu wellassa, nagenahira navodaya) (03 marks) 10. (i) Prosperity index (01 marks) Year Prosperity Index 2011 62'5 2012 66'8 (ii) - Increasing GDP to US $ 185 - Decreasing the employment rate to 3% - Decreasing the poverty level to 2% (03 marks) (iii)- Making the global attitudes on the image of Sri Lanka - Making diversified extensive markets to cover the fields that would attract foreign tourists - Constructing hotels to fulfil the increased demand of tourists - Improving the informal sector related to tourism industry - Developing and maintaining the locations of tourist attraction - Promoting railway, highway and airway transport - Training labour force to treat customers (04 marks) (iv) Higher performance has been attained. - The Millennium Development Goals (MDG) that were set in the year 2000, must be attained in year 2015. Eradication of extreme poverty was one of the goals. - Sri Lanka has attained that goal by the year 2013. Year Poverty headcount index 2002 22'7 2006$7 15'2 2009$10 8'9 (04 marks) (v) There are four objectives of Divi Neguma programme. (i) Improving family nutrition (ii) Decreasing the daily cost of living of family (iii) Ensuring food safety of family (iv) Generating additional income sources for families [See page 13
- 13 - The method of implementation Stage 1 Stage 2 Stage 3 Stage 4 : Isurumath Nivahanak Asirimath Mawubimak Making one million economic household units : Making benefits to 2.1 economic household units by providing vegetable, fruits and other commercial seeds : Making 200 divi neguma entrepreneurial centres by giving benefits to 2.5 household units by giving livestock, storing and small scale rice manufacturing centres : Providing seeds, fruits, flowers, herbal plantspeople who have ¼ and 2 ½ acres lands were promoted to start commercial plantation There were 5 million beneficiaries and the total cost was Rs.5.9 billion. In year 2013, the Divi Neguma Act was approved and a national level regulatory framework was set. Forming the Divi Neguma department by combining Samurdhi authority, Southern development authority and etc (04 marks)