HCI H1 Economics BT2 2018 Q2 Suggested Answers (a) (i) Question Extract 6 mentions that The latest official figures showed exports continued to rise in August but imports grew at a faster pace, meaning the UK s trade deficit with the rest of the world widened, despite hopes of a boost from pound s fall. State what can be inferred and what cannot be inferred from Table 1 with regards to UK s trade balance. [2] What can be inferred from Table 1 [1m] Possible answers Both exports revenue and import expenditure are rising. Increase in import expenditure is faster than increase in export revenue, except for year 2011. What cannot be inferred from Table [1m] Possible answers it cannot be inferred whether the balance of trade is in a surplus or deficit position. The exact values of balance of trade cannot be inferred It cannot be inferred whether UK s export revenue or import expenditure is higher since the data only reflects % change in the exports and imports. We can infer that BOT has worsen as we do not have the absolute figures of X and M to calculate how it could have changed. /Note Note: We cannot accept that we can infer that BOT has worsen as we do not have the absolute figures of X and M to calculate how it could have changed. Using an extreme hypothetical numerical eg in 2016 X in 2015 = $1000 M in 2015 = $100 BOT = $900 Markers comments:.however, the value of export revenue and import expenditure changes cannot be inferred It cannot be inferred if the trade balance is positive or negative. Decreasing/ reducing BOT BOT deproved. Question requires inference on TRADE BALANCE. Only show mathematical description. It is only meaning if you explain it cannot be inferred if there is a trade surplus or trade deficit. Please use the correct economic terms. We cannot infer this based on just %change of X and %change of imports. There is no such term - deproved. The correct term is deteroriate or worsen. But in this case, this is not an appropriate answer. Since %change in X in 2016 is 1.08% and % change in M is 4.26$, X in 2016 = $1010.8 M in 2016 = $104.26 BOT = $906.54 (ii) Explain how depreciation of a currency can improve an economy s trade balance. [3] A fall in the value of the domestic currency will cause the prices of exports to be cheaper in foreign currencies. Assuming PEDx>1, price of exports is relatively cheaper in foreign currencies, quantity demanded of exports increase more than proportionately à X revenue in foreign currencies increases optional. Given that the prices of exports in domestic currency remain unchanged, there is an increase in demand for exports will lead to an increase in exports revenue (in domestic currency). [1] Note that trade balance ultimately should be calculated in domestic currency. A fall in the value of a currency will cause the prices of imports to be more expensive in domestic currency and quantity demanded of imports to fall more than proportionately assuming PEDm>1, leading to a fall in import expenditure. [1]
Overall, increase in export revenue (X) and fall in import expenditure (M) à the trade balance, (X- M) or net exports will increase/improve [1m for recognition of what is meant by trade balance]. Note to markers: if answers are value first 2 para is worth like 0.5 and 0.5 with last part correct. We can give 2m. Markers comments: Some of the students gave incoherent analysis, mixing up the sequence of explanation. You need to UNDERSTAND why the analysis is written in this way. Depreciation of currency means that prices of goods and services would be cheaper. This will boost UK s exports. AD increases when balance of trade improves. Given that the prices of exports in domestic currency remain unchanged, there is an increase in demand for exports. A fall in the value of a currency will cause the prices of imports to be more expensive in domestic currency. Therefore, balance of trade improves. Lack precision. Accurate answer would be Given that the prices of exports in domestic currency remain unchanged, there is an increase in demand for exports will lead to an increase in exports revenue (in domestic currency). Explanation on AD is not a requirement of the question Conceptually accurate but it is incomplete. There is no implication of the change in export revenue and change in import expenditure before concluding that BOT improves. (a) (iii) Using Extract 6, explain two reasons why the depreciation of pound has worsened UK s trade deficit instead of improving it as explained in a(ii). [4] Up to 2m for each reason. Extract 6 also mentions that the UK economy is highly geared towards services, like financial and banking services and high-value products like pharmaceuticals where buyers are insensitive to price changes. That could mean that demand for most of the UK s exports is price-inelastic [1m]. As such, as pound depreciates, demand for exports increase less significantly (price of exports in pounds remains unchanged). [1m] Extract 6 mentioned that consumer spending has been strong, probably because most consumers voted for Brexit and they are happy with the results. [1m - reason] Hence, demand for imports has increased significantly, leading to an overall increase in import expenditure despite the fall in import expenditure due to the value of the pound falling. [1m for analysis] OR Demand for imports is price inelastic as Extract 6 mentioned that consumer spending has been strong which may be inferred that consumers are not sensitive to price change. Thus a fall in the value of the pound though causes the prices of imports to be more expensive in pound, the quantity demanded of imports will only fall less than proportionately, increasing import expenditure. [2m] Depreciation of currency means that prices of goods and services would be cheaper. This will boost UK s exports. Demand for imports is highly price inelastic as UK economy is highly geared towards services like financial, banking and higher value products. Lack precision. Need to bring out the increase in demand for UK exports and increase in export revenue. Financial, banking and higher value products refer to UK exports, not imports For scope, one reason should account for change in export revenue, another for the change in import expenditure. This question tests understanding on exports always being priced in foreign currency and imports are priced in domestic currency, so answer needs to follow that, for example, export revenue in local cannot fall even with a price inelastic demand for exports with a currency depreciates.
(b) With reference to Extract 2, explain whether the poorer households or the richer households will suffer more from Brexit. [4] Brexit has resulted in depreciation of pound OR imported price push inflation (1m) This makes spending imported goods more expensive in domestic currency. Poorer households spend a greater proportion of their income on imported goods like food, while Richer households spend a greater proportion of their income on local services, which are not affected by the depreciation of the pound since they are not traded internationally. [2] Conclusion: Hence, the poorer households will suffer more from Brexit. [1] The poorer households will suffer more as headline inflation increases. The poorer households will suffer more as they spend 18% of their income on food, which is double the proportion spent by the rich. No link to Brexit and the resultant depreciation that increased the price of imports. The key reason for the poor being more affected by the rich is the extent of imported goods vs domestic goods/ services consumed by the 2 groups. (c) (i) Define real GDP and explain how you would derive real GDP growth rate from the statistics given in Table 1. [2] Define real GDP [1] Real GDP is the value of all final goods and services newly produced within the geographical boundaries of an economy in a given period of time, usually one year with effects of inflation removed Real GDP growth rate = (Nominal) GDP growth rate inflation rate [1] Note to marker: No need to deduct marks if there is no newly produced but pls alert the students. In John Sloman text the definition is just value of output produced within the country over a 12 month period. Since table shows GDP growth only, we can accept it as nominal GDP growth rate. (ii) Explain how the data provided could have shown an improvement in standard of living in UK overtime and comment on whether it is necessarily true. [7] Introduction: Define standard of living It measures the level of well-being or welfare enjoyed by the average person or resident of a country. It involves both material and non-material aspects. State approach: I will consider whether the data provided has shown that there is an improvement in standard of living in UK overtime. Part 1: Explain that data has shown that material SOL could have improved overtime Calculated From Table 1 2011 2012 2013 2014 2015 2016 Real GDP Growth -3.03-0.12-0.5 1.59 2.3 1.15 Real GDP growth changed from negative to positive à Real GDP is increasing Unemployment rate has fallen à larger proportion of the labour force is employed à those who were previously unemployed are earning income
à Households generally has greater purchasing power to buy goods and services à improve material SOL It is also supported by household final consumption growth data (positive and rising) Some students may argue that increase M% growth à signs that households are consuming more as well. But actually this is not very critical as C = Cd + Cm. Optional point: Falling unemployment à less social problems à possibly better nonmaterial SOL Part 2: Comment that improvement in standard of living is not necessarily true There are limitations to the use of above data to show the material SOL has improved Need to consider changes in population à use real GDP per capita Consider changes in distribution of income à use Gini coefficient Considerations of non-material of SOL such as changes in disamenities and negative externalities Reasoned conclusion Mark scheme (4 + 3) L2 (3-4) A well-developed answer that explains change in material standard of living based on statistics in the table, with exemplifications and evaluation L1 (1-2) A vague, descriptive explanation on the material and/or non-material standard of living. Up to 3m for valid and relevant comments. One might gain up to 3m for one very well discussed reason with reasoned conclusion. Markers comments: Most students understood the question requirement. However, most students did not score full credit as they did not choose the best indicators to explain why (material) SOL could have improved and/or there is insufficient depth in analysis. On the comment segment, most students were able to recognise the limitations of the indicators used to determine change in SOL overtime. But many did not provide a conclusion. Choice of unemployment rate as an indicator to justify that material SOL has improved as more people are now employed. In extract 6, it mentions that consumer spending has been strong, so material SOL improves Lower unemployment rate means higher PROPORTION OF THE LABOUR FORCE is employed. But we can only infer that those who were previously unemployed are now better off since they can earn income now. There is no comparison over time. This is static. (d) (i) (ii) Describe the trend of UK s general price level from 2011 to 2016. [2] General price level is increasing (1m) at decreasing rate (1m) Discuss whether the UK government should be concerned about the latest inflation and economic growth rates. [9] Introduction (KIA) Note that question asked for trend of general price level, not inflation rate.
Thesis: Government could be concerned about slowing economic growth Slow economic growth Table 1: GDP growth in 2016 was slower than 2015 at 1.79% (can accept real or nominal data change accordingly) Extract 1: economic growth between July and September 2016 is expected to halve to 0.3% from 0.7% in the second quarter Consequences of slow economic growth: Pessimistic outlook might hinder growth even more, leading to a possible recession which will have adverse effects on material standard of living and job creation/ employment opportunities Evaluation: However, the Bank of England s decision to cut interest rates to a new alltime low of 0.25% might encourage consumption and investment due to lower cost of borrowing (Ext 1: support confidence in the housing market). However, given that interest rates is already very low, it s unlikely to increase C and I much especially when there is so much uncertainty regarding Brexit. Anti-thesis: Government may not be concerned, especially with inflation Table 1: Inflation rate increases from 0.05% in 2015 to 0.64% in 2016 Extract 1: Headline inflation jumped to 1% in September from 0.6% in August Inflation is considered low in 2016 and government should not be too concerned EV: HOWEVER, it is expected to reach 3% next year, beyond the target rate of 2% hence the government should be concerned about the rising rate of inflation. Consequences of rising inflation: Erodes purchasing power of money, hurting the low income households May result in wage price spiral given wages growth is around 2.3-2.4%, i.e. real wage might start falling Hinders economic growth as investment might fall due to greater uncertainty (Table 1: Gross capital formation growth has already fallen quite significantly in 2016) Evaluation: If pound continues to fall, cost-push inflation will worsen. However, this might be mitigated by the easing of demand-pull inflation given the uncertain business environment and rising trade deficit. Conclusion Overall, the UK government should be concerned about the latest economic indicators, especially when they are projected to worsen after Brexit. However, given that the indicators were only 4 months post-brexit, it is difficult to foresee how things might change in future. As mentioned in Extract 6, the growth rate of 0.3% in the third quarter was better than the 0.1% predicted by the Bank of England. But moving forward, given that the prime minister had hinted of a hard Brexit, things are likely to worsen. Extract 7: The prospects of a hard Brexit has knocked confidence in the UK s longer term economic prospects. Mark descriptor L3 7-9: Candidates awarded a mark at this level will provide a balanced view (Thesis and Anti-thesis), the UK government should or should not be concerned, for both goals. The answer should include an explanation of consequences for the goals that UK should be concerned with. There should be usage of economic concepts AND usage of case evidence. For maximum marks, there should be a thoughtful consideration of all the issues that are relevant before reaching a considered judgement. L2 4-6: Candidates awarded a mark at this level will have a lopsided answer, either the UK government should OR should not be concerned, but not BOTH. Can award up to 4m if there is no consequences explained but have a stand whether it is a concern to the government.
L1 1-3: merely identifies the data with not much explanation Markers comments The data of economic growth and inflation from 2010-2016 shows Deflation spiral may result as inflation was falling over the years Focus on 2015-2016 figures given the question as for latest inflation and economic growth rates The focus of the question was on post Brexit. Quite a number of students ignored information from Extract 6 (e) Using case evidence and/or your own relevant knowledge, discuss the effectiveness of the policies implemented by UK to tackle the economic problems. [12] Introduction (KIA) Post Brexit UK has faced with several problems which include depreciating pound, widening trade deficit, slow economic growth (fears are building that firms will put hiring decisions on hold and limit wage rises uncertain business environment, worsening income inequality (as pound depreciates), possible inflation. I shall discuss the effectiveness of the policies implemented which are expansionary monetary policy and quantitative easing/ fiscal policy to tackle the above problems. Part 1: Explain how the policies implemented can help to resolve/reduce some of the problems (e.g. slow economic growth, import price push inflation, trade deficit) (1) Expansionary MP loosen monetary policy to counter an expected downturn; cut interest rates by a quarter point to 0.25 per cent (explain how it works) An expansionary monetary policy aims at reducing the interest rate, thus reducing the cost of borrowing (credit). This would increase the uptake of loans/credit and spur growth and employment through increased consumption and investment. Such a policy of increasing credit to raise aggregate demand (AD) Moreover, a lower interest rate (assuming it is relatively lower than other major economies) is likely to result in short term capital outflows from the economy as investors pull out the funds to save with other banks to earn a higher interest. This would increase the supply of local currency in the foreign exchange market. Besides, there will concurrently be reduced capital inflow which would mean a decrease in demand for local currency in the foreign exchange market à reduce trade deficit à increase real national income from Y0 to Y1 via multiplier effect à boost actual growth àincrease in I, X à may negate depreciating pound à could possibly ease import price push inflation
Limitation; The government may face the problem of the inability to further reduce interest rates when they are already kept at or close to zero (liquidity trap); banks not lending, HH and firms may not borrow Ultimately, it depends on whether the business outlook improves to encourage household and firms to spend more. (2) QE UK aims to restart quantitative easing, pumping an additional 70bn into the economy, and to provide additional support for banks so they could offer cheap credit to households and businesses. This aims to inject more cash to boost liquidity in the financial system. Limitation: inflationary (there s room for inflation); but fear of capital outflow to other countries and hence not boosting growth in UK (3) Expansionary FP Explain how it works to boost growth. EV: insignificant increase in G (especially a decade long of austerity measures) Conclusion UK s government faced with various constraints such that there is no one single policy by itself that can effective to resolve all the economic problems. Although there are limitations to the above policies, they are still necessary to instil positivity to the economy. As mentioned in Extract 7, the Central Bank s actions had helped to lower the impact of uncertainty on activity. It is also a good restart by increasing government spending to stimulate AD at least in the short run. But spending needs to be carefully considered, given that budget deficit problem has not been fully resolved. Marking descriptors L3: 6-9 Scope and depth of at least 2 policies in explaining how they can help to solve some of the economic problems. There should be usage of economic concepts AND usage of case evidence. L2:3-5 Scope or depth of just 1 policy OR 2 policies without consistent link to solving of UK s economic problems. Or only focusing on 1 problem. L1:1-2 vague, descriptive or list-like answer, EV:1-3 for valid evaluative comment on the effectiveness of policies. For maximum marks, there should be a thoughtful consideration of most of the issues that are relevant before reaching a considered judgement. This essay will discuss the policies implemented by the UK. Essays with such a starting line mostly did not focus sufficiently on the economic problems that the UK faces. These essays end up explaining policies pretty well but fail to explain how the policies address or not address the VARIOUS economic problems UK are facing.