2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
(a) With reference to Table 4, compare the changes in GDP between
Germany and the UK from 2015 to 2017. [2]
Similarity:
GDP of both Germany and the UK increased from 2015 to 2017.
Difference:
However, Germany’s GDP was increasing at an increasing rate, while the UK’s GDP
was increasing at a decreasing rate.
(b) (i) Using a diagram, explain why the pound sterling fell in value
after UK had voted to break out of the European Union. [2]
As mentioned in Extract 4, breaking out of the European Union was a “lurch into the
unknown”, which could give rise to loss in investors’ confidence in the economy.
Explain impact on SS of pound sterling in
forex market:
This would cause capital outflow from the UK,
leading to an increase in supply of pounds in
the foreign exchange market, hence reducing
the external value of the pound sterling.
OR
Explain impact on DD for pound sterling in
forex market:
This would cause a fall in capital inflow into the
UK, leading to a decrease in demand for pounds
in the foreign exchange market, hence reducing
the external value of the pound sterling.
(b) (ii) Explain whether the depreciated pound sterling would lead to
a higher cost of living and standard of living in the UK. [6]
Depreciated pound sterling fall in price of exports in F.C but increase in price of
imports in D.C
Impact on cost of living
If consumers consume a large quantity of imports, the increased price of final
imported goods and services will mean that cost of living will increase.
OR
If UK firms import significant amount of raw materials from overseas, this will cause
imported inflation and hence, increase their unit cost of producing domestic final
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
goods, hence, causing SRAS to fall, leading to increases in GPL. Hence, cost of
living increases.
Impact on material SOL
Assuming marshall-lerner condition holds (PEDx + PEDm>1), net exports will
increase as seen from “boosted exports orders for manufacturing”(Ext 6)
assuming there is spare capacity in the economy increase AD will result in
increase in real output national income increases by a multiplied amount
increase in quantity of goods and services consumed increase material standard
of living
Explain “whether”: Comment on the extent of change
Material SOL may have worsened instead if the rise in general price level is faster
than the increase in national income.
(c) Explain a likely advantage to the foreign firms for locating their
businesses in Ireland. [2]
Cost advantages
Locating businesses in Ireland will enable foreign firms to tap into the large EU
market and sell to a larger market as inferred from “jumping off point for their
European ambitions” (Ext 5). Such increase in market size in turn enable it to
produce larger quantity, reaping economies of scale, hence enjoying lower average
cost and higher profit, ceteris paribus.
Or
Access to good “technological infrastructure” and “leading services” (ext 5) can
enable foreign firms to gain greater productivity if these translate to greater output
produced per hour with lesser disruptions to internet connection etc, hence enjoying
lower average cost and higher profit, ceteris paribus.
Revenue advantages
Being able to sell to a larger market means that foreign firms will be able to gain
larger increases in demand for their goods and services, resulting in increases in
total revenue and hence profits, ceteris paribus.
(d) In light of the issues faced by the UK, as mentioned in Extract 3,
evaluate the Bank of England’s decision to cut interest rate. [8]
Issues faced by UK: Extract 3: “Inflation is surging, consumer spending is slowing,
productivity remains mired in pre-crisis growth levels, and uncertainty reigns
supreme”
Explain how decrease in interest rate works
Decreases in interest rate decrease cost of borrowing more firms will be willing
to invest Investment level increases
The fall in the cost of borrowing would also result in an increase in consumption
expenditure on big ticket items as consumers would have the ability to purchase
items on credit.
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
Decrease i/r: Ability to address the various issues faced by UK
(Students should address at least 2 problems mentioned below.)
1. “Slowing consumer spending”
The lowered cost of borrowing will therefore help to address the ‘slowing consumer
spending’ and hence help to contribute to economic growth.
The increase in both consumption and investment expenditure would result in an
increase in UK’s aggregate demand as AD= Cd + I + G + X shortage created
firms run down inventories upward pressure on GPL incentive for firms to
↑output to meet demandreal output in economy has increased, leading to actual
growth.
2. “Inflation is surging”
The decrease in interest rate may cause hot money outflows, hence, causing pound
to depreciate further. This would worsen inflation rates as explained in part bii.
However, this maybe a temporary impact as pound may strengthen after the
situation on Brexit has stabilised.
3. “Uncertainty reigns supreme”
However, given that ‘uncertainty reigns’ the extent of increase in Cd and I will be
smaller as consumers are more likely to withhold consumption given uncertainty in
their employment and firms are also likely to withhold investment levels given the
uncertainty in UK’s economic outlook after Brexit policy will be ineffective in
raising economic growth, if this is the intent of the UK govt.
4. “Productivity remains mired in pre-crisis levels”
Also, whether the decrease in interest rates will help to increase productivity in UK
depends on the type of investment that the firms will undertake given the cheaper
cost of borrowing. Given that it is rather incidental; the effectiveness of the policy is
likely to be very low.
Conclusion
[evaluate UK’s decision] UK’s decision to cut interest rate is ineffective given that it
is less likely to address any of the above problems. With uncertainty as the biggest
problem, therefore, increases in AD is likely to be low.
More importantly, weak productivity is likely to be a main concern and area for the
UK govt to focus on as UK leaves the EU. It needs to increase its competitiveness
in order to prevent greater loss of FDIs out of UK as a result of foreign firms that
used to locate in UK to have access to the larger EU market.
[suggest alternative policies] This can also help to reduce the uncertainty on UK’s
future economic outlook. Therefore, the UK govt should start looking at
implementing ss-side policies instead.
Level Knowledge, Application, Understanding and Analysis Marks
L2 For a well-explained answer on decreasing interest rate to 4-6
address at least 2 macroeconomic problems faced by UK.
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
L1 For a limited explanation (lacking in economic linkages 1-3
and analysis) on decreasing interest rate to address the
macroeconomic problems faced by UK.
Evaluation
E1 For an evaluation based on economic analysis and case 1-2
materials arriving at a judgement on UK’s decision to cut
interest rate.
(e) With reference to the data where appropriate, assess whether on
balance, the benefits of Brexit outweigh the costs for UK and the
remaining EU member countries. [10]
Introduction:
The decision to leave the EU will give rise to both benefits and costs to the UK as
well as the remaining EU member countries. However, whether the benefits
outweigh the costs for the UK and the remaining EU member countries depends on
a few factors.
(Note: Students should at least discuss 1 cost and 1 benefit for UK and EU
respectively.)
Development 1: Explain the impacts of Brexit on UK
Benefits of Brexit to UK
1. Impact on export revenue of the economies
One major and immediate impact on the UK after the Brexit vote was a depreciation
of the pound sterling against the dollar (Extract 4), which was explained in (b)(i).
This will lead to an increase in price of exports for the UK in foreign currency, as well
as a decrease in price of imports in pound sterling. Assuming the Marshall-Lerner
condition holds, where (PEDx+PEDm)>1, this leads to an increase in (X-M) and
hence AD. There is an increase in real output and hence actual growth in the UK.
As mentioned in (b)(ii), this may lead to an increase in material SOL.
2. Impact on govt’s contribution to the EU budget
Given that the UK is a net contributor to the EU budget, contributing up to £11.3
billion in 2013 (Extract 4), Brexit would mean that the UK government doesn’t need
to contribute to the EU budget in future and could use the funds to stimulate their
own economy. For example, the government could now use the funds to build
infrastructure in the UK, giving rise to an injection via increased G in the UK
economy. This will lead to an increase in AD, and hence actual growth in the UK
economy and improvement in material SOL due to rising incomes and greater
purchasing power and access to goods and services. Depending on which area the
government spends on, for e.g. if they spend on education and healthcare, there
could also be improvement in non-material SOL.
Costs of Brexit to UK
1. Impact on migration and the labour force
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
One of the main arguments for those in favour of Brexit was with regard to the
migration of labour from other EU countries. Moving forward, if the UK were to cap
immigration (Extract 7), there could be some consequences on their economy.
Firstly, with these migrants now returning to their own countries, the UK’s labour
force shrinks and this could give rise to a fall in productive capacity, illustrated by a
fall in the AS curve. This results in a fall in future material SOL as inflationary
pressures may persist with any increases in AD given a lower AS curve.
EV: However, this cap on immigration could also bring about some benefits to the
UK. With lesser migrants in their country, the quality of life of the remaining citizens
(and hence non-material SOL) may improve since issues like congestion will be
reduced given the smaller population size.
2. Impact on level of FDI
Given that the EU single market was a major factor in attracting FDI into the UK
(Extract 7), now that the UK is preparing to leave the EU, they would no longer have
access to the single market as before. As mentioned in Extract 7, FDI may be
diverted to other EU countries now, instead of the UK. The UK faces a fall in FDI
and this leads to a fall in AD and hence negative growth. The fall in FDI could also
lead to a fall in the UK’s AS curve as well, if the rate of increase in FDI does not
outweigh the rate of depreciation of capital. This causes a fall in the UK’s productive
capacity in the LR.
Development 2: Impacts of Brexit to EU members
Benefits of Brexit to EU members
1. Impact on level of FDI
Given that the UK is no longer seen as a viable destination for FDI (Extract 7), there
could be diversion of FDI to the remaining EU member countries. This will cause an
increase in AD in the SR and AS in the LR for these countries, causing actual and
potential growth.
Costs of Brexit to EU members
1. Impact on export revenue of the economies
As it is predicted that there could be a possible reintroduction of tariffs (Extract 7),
where the UK imposes tariffs on goods from the remaining EU countries, the UK will
import less from the other EU member countries as compared to before when the
UK was still part of the EU and they enjoyed free trade. Given a fall in import
expenditure by the UK for these countries goods, they will then experience a fall in
export revenue and hence a fall in AD. This causes negative economic growth and
rising unemployment fall in material SOL.
EV: However, the extent of fall in X and AD for the remaining EU members depends
on how close they were to the UK as trading partners. For instance, Extract 7
suggests that Ireland could be more severely affected compared to Germany,
especially because Germany has diversified its trading partners and has “many
other markets” for its auto and manufacturing sector. Hence, even with the lack of
free trade with the UK, Germany can still generate export revenue through the sale
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
of exports to other countries. That said, Ireland has actually been able to enjoy
higher growth rates than the UK and the EU as a whole from 2015 to 2017 (Table
4), so it could mean that they have been able to generate growth through other
means apart from export revenue to the UK.
2. Impact on govt’s contribution to the EU budget
Since the EU’s biggest contributor to its budget (i.e. the UK) has voted to leave the
EU, the remaining EU member countries would now have to “fill in some of the
shortfall from a lack of its contributions” (Extract 7). This is estimated to be up to
19.4 billion euros in total, with a large amount contributed by Germany of about 2.5
billion euros. This would mean that the governments of those countries would incur
an opportunity cost in terms of the loss in benefits from not spending that sum of
money on areas such as healthcare or education in their own economies. The larger
their contribution is to the EU budget (e.g. for countries like Germany), the larger the
opportunity cost incurred.
3. Impact on migration and the labour force
If the UK were to cap migration, migrants from other EU countries who used to be
in the UK will now have to return back to their countries. As mentioned in Extract 7,
countries in eastern Europe (e.g. Poland, Romania) will suffer the most as they have
the most number of citizens in the UK. With the large numbers of migrants returning
home, assuming if they are low-skilled workers, this will cause the supply of low-
skilled labour in those countries will increase, driving down wages in their labour
market. There could also be large scale unemployment which could bring about
increased social problems and increased burden on government budget should
these governments have to provide unemployment benefits for these returned
unemployed migrants.
EV: However, migrant workers maybe also be of higher skillsets. If so, they can
contribute to a more productive workforce and hence increase productive capacity
(rightward shift of AS) potential growth.
Conclusion:
[Answer the question] Evaluate whether benefits outweigh the costs:
For the UK, whether or not the benefits outweigh the costs would depend on whether
the government is able to put in place appropriate policies to deal with the potential
loss in FDI as well as the fall in productive capacity. For instance, if the UK is able
to develop the right infrastructure to attract FDI (e.g. like Ireland, in Extract 5), the
fall in FDI may not be so significant despite them not being a part of a large EU
single market. In addition, should the government be able to adopt appropriate
supply-side policies to increase productivity in the economy, in spite of the cap on
immigration which would lead to a fall in the quantity of labour, the quality of both
labour and capital can more than make up for it and hence still allow for an increase
in the productive capacity of the UK’s economy in the LR. This is especially possible
since the UK govt’s contribution to the EU budget can now be reallocated for such
a purpose.
2018 JC2 H2 Economics Prelim_CSQ2_Suggested answers
For the remaining EU members, whether or not the benefits outweigh the costs
depend on the closeness they are to the UK as trading partners and whether they
are able to diversify their trade to depend on other economies now that free trade
with the UK is no longer possible after their departure. Also, while the UK has now
left the EU, making the remaining member countries more attractive to FDI since
they are still part of the single market offered by the EU, the extent to which they
can benefit from increased FDI also depends very much on their own attractiveness
as a destination for FDI. For e.g., Ireland is an attractive destination for FDI and
would probably be able to attract much of the existing FDI in the UK over given their
“natural advantages” (Extract 5).
Level Knowledge, Application, Understanding and Analysis Marks
L2 Explanation of the benefits and costs of Brexit on the UK 5-7
as well as on the remaining EU member countries with
thorough economic analysis, making explicit links to
macroeconomic goals as well as SOL
L1 Explanation of the benefits and/or costs of Brexit on the 1-4
UK and/or the remaining EU member countries, which
may or may not include clear reference to the
macroeconomic goals or SOL
Up to 3 additional marks for evaluation
E2 Application of relevant economic concepts to make a 2-3
judgment on whether the benefits of Brexit outweigh the
costs for both the UK as well as the remaining EU member
countries
E1 Unexplained judgment on whether the benefits outweigh 1
the costs for the UK and/or the remaining EU member
countries
