Tariffs and How Do They Affect Us?

Pareto efficiency vs. Pareto improvement

What is Pareto efficiency?

It is also known as Pareto optimality or otherwise, social efficiency or economic efficiency. It is a state where the welfare of the people is said to have been maximised. There is no way that the society can be further better-off. The economy is already operating on the boundary of its frontier. The only way for a person or entity to become better-off is by having another person or entity becoming worse-off

What is Pareto improvement?

It is a process in which an economy is trying to further improve the overall well-being of its people. More technically, it is when an economic action leads to a further increase in overall utility whilst at the same time, no one is being made worse-off

 

Source: economicshelp

Point D illustrates the idea of economic inefficiency/ Pareto inefficiency. This is because the welfare of the people/ society can actually be further increased when point D moves to point A or B. Members of the society are able to consume a greater combination of both goods and services. There is no opportunity cost between the two. The higher is the level consumption, the greater is the utility or satisfaction or well-being of the community in this case

Some practical examples of Pareto improvement:

a. Charitable activities can be considered as one. When Bill Gates gave away, say, $5 billion of his wealth to a charity fund or a very poor Sub-Saharan African (SSA) nation, he may get a joy and pride of doing so. At the same time, the recipient(s) may also get to benefit in the form of new roads, new houses, new schools, new hospitals and others

b. Instructing prisoners to carry out community service e.g. graffiti art and picking up litters is another good example. In the process, inmates may gain some self-esteem by being able to express their thoughts or show their soft-side. Members of the society gain in the form of cleaner environment and more beautiful sights. Taxpayers' money can also be utilised more meaningfully in this case

However, it is also worth noting that not all movements to the boundary of PPC can be treated as Pareto improvement. For instance:

a. The construction of new roads, railroads, schools and hospitals have tremendous economic benefits to the society e.g. higher actual and potential growth, more job opportunities, more tax revenue for the government and many more. However, this is not a Pareto improvement because in that process, some people will be inevitably made worse-off e.g. families and firms that have to be evacuated, loss of biodiversity, vocal environmentalists and others

b. The establishment of a free trade area/ trading bloc may lead to long-term efficiency gain. Regional growth and income will increase, people will have more choice, there will be more jobs with better pay, government finances improve, firms exposed to competition will become more competitive in future, free movements of labour will improve allocation of resources and many more. All these are the net economic benefits that no one can deny. However, this still cannot be classified as Pareto improvement. There are plenty of costs to be considered too e.g. demise of local firms/ industries that are unable to compete, more cases of structural unemployment, problems associated with migrants like lowering wages and 'stealing' jobs,  worsening deficit and many more

Economist Dilemma Between Efficiency and Equity

What is economic efficiency?

Resources are finite or scarce. In fact, many of them are irreplaceable or non-renewable. Once they deplete, they will be gone for good. Therefore, there is an urge by policymakers and economists to utilise these resources in the best possible way to ensure that wastages can be avoided or at least minimised

To achieve efficiency (although this may be very difficult), we must ensure that the highest level of output is being produced from a given amount of input, and eventually, the final output must be in the best interest of society or individuals. The first condition is known as productive efficiency. If it is achieved, costs of production would be at its lowest. The second part of the definition refers to allocative efficiency. In order for efficiency to take place, both conditions must be present. Resources are still wasted if only either one condition is attained. For instance, a car company may brag about its ability to lower the costs of production over the years. However, if it finds great difficulty in selling them off each time, then it would be equivalent to resources wasted. Factors of production like land, labour and capital that went into making those cars could have been utilised elsewhere more meaningfully

It is also worth noting that once efficiency is fully attained, an economy would be operating along the boundary of its PPC. Society's welfare is said to have been maximised (hence the condition of MSB = MSC, which is also known as social efficiency). It is impossible to further increase social welfare. No one can be made better-off without making another person worse-off, and hence the condition of Pareto efficiency

What is equity?

Equity is concerned with the final outcome and it can only happen when the result is the same or fair for everyone

In practice, it can be quite difficult to achieve both simultaneously:

a. An increase in income tax rates will reduce the incentive to work hard. In other words, it causes inefficiency. However, equity may increase because of the benefits pay out

b. A poll tax (a levy that a voter has to pay in order to be able to cast a vote) can be considered as efficient as it doesn't reduce the incentive to work. However, it can be considered as inequitable as the rich pay the same amount as the poor

c. An indirect tax onto cigarettes obviously improves the allocation of resources. Production and consumption of a demerit good are reduced to a socially optimal/ desirable/ efficient level. However, the outcome may not be entirely fair to low-income smokers who happen to be the group that finds it hardest to quit the habit. There will be a regressive effect as they now have to spend a bigger portion of their disposable income to purchase cigarettes

d. Bailing out troubled banks is morally wrong. However, that seems to be the most sensible action to take especially when there is a major financial crisis. If major banks collapse, so is the entire economy. There are costs in doing so e.g. higher taxes, poorer credit rating, rise in budget deficit and national debt and many more. However, the economic benefits are perceived to be far greater e.g. preventing other firms from going bankrupt, save tens of millions of jobs, avoiding capital flight, preventing value of currency from nose-diving, lowering the number of poverty cases and many more. Having said so, some will not be happy. Their marginal tax rates may be adjusted upward, fewer low income/ jobless people qualify for benefits and spending onto healthcare and education per capita will decrease. This is inequitable

e. Construction of new roads may improve overall economic efficiency/ well-being. However, not everyone will be equally pleased e.g. affected families, evacuated firms and environmental activists

Economist Dilemma Between Equality and Equity

What is equality?

In economics, equality may imply:

a. evenness

b. fair division

c. equal access to resources 

d. same number of identical tools to work with

e. everyone is being given a similar opportunity

What is equity then?

In economics, equity is whether the final outcome is the same or fair for everyone. Equality does not automatically result in fairness. Everyone may be given the same access but the final result may be unfavourable for some. One can happen without the other. To illustrate, consider the following scenarios:

a. A family dinner of four, consisting of parents and two young kids. Equality means everyone is being served with the same portion of, say, chicken. However, this is inequitable. Adults have bigger appetite and therefore should be given a bigger portion. On the other hand, children have smaller appetite and therefore should be served with a smaller portion

b. An economics class with 20 students. Equality is when everyone gets the same teacher. However, different students have different needs, different academic capabilities and also different learning styles. The teaching technique employed by the teacher may not necessarily work for everyone in the class. This explains why some students may score better than their friends although being in the same class

c. An economics exam with 2 hours. Equality is when every candidate is being given the same amount of time to sit for a particular paper. However, the outcome may be unfair for certain students. Some may suffer from problems like minor dyslexic, hand injury and vision problem. To compensate or ensure equity, students with such problems must be given some leniency in the form of extra time, say, 30 minutes

d. 

Hurdle race. Equality is when everyone begins from the same starting line. However, we know that it is going inequitable. Runners in the inside lanes have distinct advantage over those runners in the outer lanes because the distance that they have to cover is shorter. To create an equitable outcome and to ensure that the result is fair, those who are running in the outside lanes must be positioned ahead of those who are in the inside lanes

e. Scouts with backpack. Equality happens when every scout member carries the same amount of weight. However, this could be very unfair/ inequitable as the scout leader does not consider the ability of each member. To achieve fairness, bigger and taller/ adult scout members must carry more weights while the rest shoulder lighter weights

Key Concepts That Are Frequently Being Tested in Paper 3 of Economics 9708/32 (CIE) (CAIE)

Popular economic concepts tested in Paper 3:

1. Outcomes due to unanticipated/ unexpected increase in money supply (according to Monetarist)

a. Unemployment will fall in the short-run. In the long-run, it will return to its initial level. Expansionary demand-side policies will not be effective in addressing supply-side unemployment

b. Price level will continue to increase, both short-run and long-run

c. SRPCs (short-run Phillips curves) will continue to shift upwards and to the right due to expectation of higher inflation rates by workers

2. Allocative efficiency/ overall economic welfare can be improved if one person can be made better-off without making another person worse-off (Pareto efficiency criterion). This will involve a horizontal or vertical movement between two points

3. Under monopsony labour market:

a. The dominant employer will use MCL = MRPL to determine the profit-maximising number of workers to be hired. The pay will be based on the ACL which is also the supply curve of labour

b. The pay that these workers get is even lower than what they would have otherwise received under competitive equilibrium of MRPL = ACL or DL = SL

c. An intervention by trade union will increase their current pay close to the competitive equilibrium. There will also be an increase in the number of workers hired

4. An increase in savings is crucial as banks will have more funds to generate lending. This will boost an increase in AD as well as LRAS, especially in the context of developing countries

5. When revenue is maximised:

a. MR = 0 (gradient at the peak of TR curve would be zero)

b. PED = -1

c. Profit would be lower than the one under MC = MR

6. Economies of scale corresponds with INCREASING returns to scale (% of change in output > % of change in input). As output increases faster than input, costs can be spread over a large number of output, thereby reducing unit costs. By contrast, diseconomies of scale corresponds with DECREASING returns to scale (% of change in input > % of change in output). As input increases faster than output, costs will be spread over a smaller number of output and this results in rising costs per unit. Please take note that you may be asked to CALCULATE % of change of both. It is PERCENTAGE of CHANGE NOT DIFFERENCE

7. Government incurring a budget/ fiscal deficit:

a. Is also equivalent to expansionary/ reflationary fiscal policy

b. Money supply will increase if the borrowing is from central bank or overseas

c. Money supply may not increase/ stays unchanged if the borrowing is from domestic banks/ non-banks private sector/ members of the public. This is believed to be related to crowding-out effect e.g. banks have less money to lend, firms have less money to invest and households have less to spend. It also implies more competition for money which causes interest rates to increase. Since cost of financing increases, both firms and households cut down their spending. This results in 'neutralising' effect of aggregate demand

8. Expansionary monetary policy:

a. The most common ones are cut in interest rates and an increase in money supply

b. It also includes relaxation of lending policies as well reduction in cash ratio/ reserve requirement so that more loans/ credit can be created

c. May also include currency devaluations 

d. Happens when the central bank buys bonds/ securities/ treasury bills from banks. This will result in an increase in money supply. Also known as OMO (open market operation)

9. Labour mobility can be increased if national minimum wage is abolished. Reason is, there is no point moving from impoverished areas with high unemployment into prosperous areas with job opportunities. After all, the wage is the same and yet costs of living are higher. Unemployed people are better-off staying at where they are now despite vacancies are hard to come about

10. Kuznet curve:

a. Initially, as income rises, quality of environment degrades. However, beyond certain level, as income continues to increase, quality of environment will improve. This is commonly seen everywhere in developed nations and even emerging economies like China and Malaysia. When people have lower income, they care less about the environment. Once people have reached certain level of income they would want to care for the environment they live in

b. Another Kuznet curve shows how income inequality changes over time as income rises. Initially as income rises, income inequality will worsen. However, after reaching certain level of income, income distribution will improve. This model is true considering the circumstance that one sees in developed nations. Reason being, income tax rates will become more progressive while benefits more generous

Common Errors/ Misperceptions in Paper 1 of 9708/12 Economics (CIE) (CAIE)

1. Money is NOT one of the factors of production. Resources/ inputs are strictly four only and they are none other than land, labour, capital and enterprise. To be considered as a factor of production, it must possess the feature of ready-to-be-use. Consider airline industry as an example. Pilots can be instructed to fly the airplane. Airplane itself enables the airline company to be able to provide flight services to its customers. However, money e.g. bank notes and coins cannot be instantly used to produce goods and services. They have to be converted into land, labour, capital and enterprise before any production process can commence

2. Enterprise must be a business-starter or owner. This is not true. Enterprise is someone who is willing to undertake business risks. It must also manage the other three factors of production. In this case, key/ management people like CEOs, CFOs, COOs and even division managers are completely fit to be known as enterprise as they fulfill the definition. It is worth noting that they are not business founders

3. Public transport is a public good. Just because the term 'public' is being used, that does not automatically imply that public transport is a public good. Do not classify a good/ service based on its name, instead, group it according to the features that it has. In this case, public transport is a merit good. It has economic benefits not just to the users but also to people around them e.g. reducing congestion and air pollution

4. Change in demand and change in quantity demanded are similar. No, they are not. Economists attempt to segregate the most important determinant (price) away from other 'not-so-important' determinants (advertisements, taste/ fashion, income, price of substitutes and price of complements). For the most important determinant, we give it a special name which is 'change in quantity demanded'. It involves movements along the same demand curve. It either contracts or expands

5. Change in supply and change in quantity supplied are similar. Again, they are not. Change in quantity supplied is due to the most influential determinant and that is 'price'. change in supply is due to 'less important' determinants such as indirect tax, subsidy, technology and wage costs. For a change in price, we say quantity supplied rises or falls. It will be a movement along the same supply curve. It either expands or contracts. There will be no shift, contrary to what some may think

6. Total revenue (TR) is different from total expenditure (TE) by households (P x Q). No, they are the same. What you pay is what the firms will get. If you pay more, the firms will receive more and likewise is true. If PED < 1, an increase in price will lead to an increase in TR and TE. Likewise, if PED > 1, a rise in price will lead to a fall in TR and TE

7. Elasticity is gradient. No, it is not and will never be. Gradient is the same along the same demand/ supply curve. However, elasticity varies from one pair of price and quantity to another

8. Flipping the formula of PED and PES. Instead of (% of change in QD/ % of change in price) and (% of change in QS/ % of change in price), they become (% of change in price/ % of change in QD) and (% of change in price/ % of change in QS). Do take note that, according to the definition, it is how sensitive is QD/ QS to a change in price. Whatever that is being 'to' will always be at the bottom. If you still think that they are difficult, then think of 'having Dinner on Plate' and 'having Supper on Plate'

9. Underestimating the importance of unity/ unitary PED. This concept is EXTREMELY important in our syllabus of Economics. Every time if you are given a hyperbola demand curve, you must be pre-informed that the total revenue/ expenditure will be unchanged regardless of whether the price increases or falls. It is also the case where total revenue/ expenditure is maximised when PED = 1

10. Ignoring the term 'effective' for both maximum and minimum price. For maximum price to be effective, the new price has to be set below the equilibrium. If, due to information failure, the price is accidentally set above equilibrium, then everything will be back to normal e.g. follow existing equilibrium price and quantity. There will be no effects at all. The same for effective minimum price where the line must be above the equilibrium price. After all, the aim is to protect producers from lower prices. If it were to be accidentally set below the equilibrium, then obviously producers will be disappointed as that will not be helpful to them. The market will revert back to the original equilibrium price and quantity

11. Only tax can be progressive. This is not true. Benefits can be progressive too. For income tax, the richer is an individual, the bigger will be the proportion of their income being paid out as tax. The concept works the same for benefits too. The poorer is the person, the greater is the amount of benefits that he/ she will receive. This would eventually cause the amount of benefits received to increase expressed as a percentage of income

12. Confuse between marginal tax rates and average tax rates. This results in being unable to perform calculations/ interpretations involving these two. Bear in mind that marginal tax rate is the additional rate of tax that will be applicable when income increases from one range to another. In the UK, there are three marginal tax rates, 20%, 40% and 45%. Average tax rate = amount of tax paid/ income

13. Free trade area means that there will be no trade barriers at all. In case if you think that member countries are free to export to one another, then you may be misinformed. Yes, according to TEXTBOOK definition, but NO in the real world. In ASEAN alone (which is a free trade area), there are about 6000 goods that are being subjected to various trade barriers. Check the link below:

(https://www.thestar.com.my/news/nation/2017/04/28/najib-remove-trade-barriers-within-asean/)

14. Government spending, direct taxes and investment can only affect AD. This is true in the short-run. However, in the long run, they can have impact onto LRAS too. For instance, government spending onto healthcare will improve public health and as a result, there will be fewer absenteeism from workplace. This will reduce wage costs for firms. Lower direct tax e.g. income tax may increase one's incentive to work knowing that he/ she may get to keep a larger proportionate of disposable income. Investment will keep operational costs low as new technology tends to be more efficient. LRAS/ PPC will shift rightward

15. Depreciation affects only exports. This is untrue. It also affects imports. When the value of a currency falls, imports will become pricier. Ceteris paribus, less imports will be purchased

16. Unaware that an exchange rate may affect both demand-pull and cost-push inflation. My observation tells me that most candidates will only mention about cost-push inflation e.g. increasing/ reducing costs of import. What majority aren't aware of is, it can also increase or decrease (X - M) and hence AD

17. A country does not have to be paid in its own currency. In answering, we say that if we trade with another country, we must honour the transactions by paying that country their respective currency. However, the country that we trade with may request to be paid in another valuable currency e.g. dollar, pound, euro etc. Do watch out as this element/ idea has been tested several times in MCQ (sorry I can't remember which question but I have seen it before)

18. Unaware that trading possibility curve (TPC) is part of syllabus. It is the a frontier that both countries can achieve shall they choose to specialise and trade goods in which they have comparative advantge

19. Flipping between expenditure-dampening and expenditure - switching policies (This is usually due to rote-learning). How to remember then? The key lies in these two terms itself. To dampen/ reduce expenditure, income must be reduced and that is only possible through contractionary fiscal (cut government spending and raise taxes) and monetary policie (reduce money supply and increase interest rates). With lower income, less imports that can be purchased. Expenditure switching means measures to switch spending away from imports through methods like currency devaluations, subsidies, tariffs and quotas. All of them will increase price of imports relative to home-made goods 

20. Thinking that monetary policy involves only money supply and interest rates. In reality, it also involves currency devaluation/ revaluation, reducing/ increasing reserve requirements (amount of money that commercial banks must keep with them and cannot be lent out) and loose/ tight bank lending policies

Mistakes are always found on these areas:

1. Unable to perform calculations involving elasticity e.g. either flipping the formula, using the wrong formula or unable to interpret the information given

2. Unfortunately, elementary mistakes still seen in questions involving shifts of demand or/ and supply curves. Another one includes movements along the same demand/ supply curves

3. Unaware that total revenue/ expenditure will be unchanged if PED = -1

4. Unable to perform calculations involving consumer or/ and producer surplus e.g. problems with interpreting the areas

5.Unable to determine areas of tax revenue, tax incidence for consumers and firms and total subsidy payout by government. Therefore candidates have problems in calculations too

6. Lack of understanding especially with the terms of trade e.g. 1 apple < 1 banana < 4 apples involving the theory of comparative advantage

7. Difficulty to match the options given (A to D) to the diagram involving shifts in demand and supply of an exchange rate

8. Lack of understanding in terms of macroeconomic logic e.g. which macroeconomic parameters that can affect AD or/ and SRAS/ LRAS

9. Unable to satisfactorily interpret/ perform calculations involving CPI. Rate of inflation = (CPI2 - CPI1) / CPI1

10. Thought that deflation and disinflation are the same. The former means falling CPI and therefore negative rate of inflation. Disinflation is where prices are still increasing albeit at a slower pace. CPI is still rising

All da best to all of you 

'Confusing' Economic Terms That Are Often Being Used in Paper 3 (9708/32) (CIE) (CAIE)

Economic terms that have the same meaning:

1. Capital formation/ capital stock/ investment - rise in capital goods such as buildings, equipment and machines

2. Budget deficit/ fiscal deficit/ public sector borrowing requirement (PSBR, used in the UK in the past)/ public sector net cash requirement (PSNCR, currently being used in the UK) - where government spending exceeds tax revenue and hence there is a need to borrow

3. Reflationary policy/ expansionary policy - measures to increase the aggregate demand

4. Law of diminishing marginal return/ law of variable proportions - a situation in which output will begin to increase at a slower/ diminishing rate as more workers are being added to a fixed capital 

5. Withdrawals/ leakages - outflows of money from the circular flow of income such as savings (S), taxation (T) and imports (M) 

6. Managed float/ dirty float - an exchange rate system in which the value of a particular currency is allowed to fluctuate against another but within a predetermined range

7. GST (Goods and services tax)/ VAT (Value added tax) - a charge which is levied by the government on each stage of production process

8. NRU (Natural rate of unemployment)/ supply-side unemployment - refers to structural, real-wage, seasonal and frictional unemployment

9. price control/ maximum price - the highest legal price for a particular good or service above which it cannot increase

10. MFC (marginal factor cost)/ MCL (marginal cost of labour) - wage costs incurred when one extra worker is hired

11. AFC (average factor cost)/ ACL (average cost of labour) - total wage costs per worker

12. GDP at market value/ GDP at current price/ nominal GDP - value of all final output within an economy which is calculated using prices of that reporting year

13. MV/ PT/ GDP - M is money supply while V is velocity of circulation of money, the number of times in which the money exchanges hand from one person to another. Multiply both and you will get total expenditure. P is price level and T is number of transactions. Multiply both together and you will get total value of output. Since total expenditure = total value of output, they must also equal to total income and hence GDP

Economic terms that are often thought to be the same but they aren't:

1. natural monopoly vs. monopoly - Natural monopoly is when the ideal number of firm in an industry is one. Usually, such industries have very high fixed costs and therefore cannot possibly tolerate competition. Otherwise, costs per unit will increase as it cannot sufficiently enjoy economies of scale. Monopoly has two possible definitions. It is the sole producer for a good or service. As such it owns 100% of the market share (traditional definition). Another definition is that, when a firm controls at least 25% of the market share (legal definition that is widely used)

2. budget deficit vs. national debt - One is when government spending exceeds tax revenue. National debt on the other hand implies accumulated deficit over the years. While budget deficit is probably a couple of percent of GDP, national debt could be as large as 200% (probably more) of GDP

3. means-tested benefits vs. universal benefits - Benefits that are available for those whose income falls below certain level e.g. cash aid. Universal benefits refer to benefits that are available for everyone, regardless of age, gender and socioeconomic status

4. mpc (marginal propensity to consume) vs. apc (average propensity to consume) - Former means, how much of an increase in a dollar of income that will be spent away. For example, mpc = 0.64 means, of every $1 dollar increase in disposable income, 64 cents will be consumed. Latter refers to the percentage of income that is being spent. So, if apc = 0.64, it means 64% of disposable income is being spent

5. mps (marginal propensity to save) vs. aps (average propensity to save) - In the same fashion, mps means, how much of a dollar increase in disposable income which will be saved. So, if mps = 0.36, that means, of every $1 increase in disposable income, 36 cents will set aside as savings. On the other hand, aps is defined as, percentage of income which will be saved. So, if aps = 0.36, it simply means, 36 percent of disposable income will be saved

6. NRU (natural rate of unemployment) vs. NAIRU (Non-accelerated inflation rate of unemployment). Both are not quite the same although they are related. If NRU = 4%, then this is the rate of unemployment in which the inflation rate will not accelerate. Any efforts e.g. expansionary fiscal or monetary policy to reduce NRU will eventually cause inflation rate to accelerate (and hence the name)

7. Law of diminishing marginal return vs. returns to scale - One refers to production in the short-run and the other into the long-run. In the short-run, capital is fixed, The only way to increase output is by hiring more workers. So, as more workers are being added to a fixed capital, we can observe how the output changes. It initially increases with a faster rate. Eventually the rate in which it increases will diminish, and hence the name. Returns to scale is the observation on how the output changes as both capital and labour are increased proportionately. If output increases faster than inputs, we get increasing returns to scale for instance

8. multiplier vs. credit/ money multiplier - Multiplier means, the number of times that the national income will increase from an initial amount of injection. Credit multiplier is, how an initial deposit can lead to a bigger final increase in money supply

9. GDP vs. GNP - value of all final goods and services that are being produced within the borders of an economy over a period of time. GNP is the value of all final goods and services that are being produced by factors of production which belong to an economy over a period of time. GDP may include output/ earnings by foreign workers but GNP does not

10. Government failure vs. market failure - One is when government interventions lead to misallocation of resources. The other is, when operations of market forces lead to misallocation of resources

11. terms of trade vs. balance of trade - Former is, average export prices/ average import prices x 100. Latter refers to the value of exports of goods and services minus the value of imports of goods and services

12. trade deficit vs. budget deficit - One is a withdrawal (W) because M > X. The other is an injection (J) because G > T

 All da best peeps!!!

MCQ Review for Winter 2016 (9708/32) (CIE) (CAIE)

 

F to G represents substitution effect and G to H represents income effect. Answer is C

Vertical integration refers to the merger between two firms from the same industry but at different stage of production process. Backward vertical is a cooperation/ merger between a manufacturer and a firm which is close to the source of inputs. Forward vertical is a cooperation/ merger between a manufacturer and a firm which is close to the customers. A is incorrect as it is equally applicable to horizontal integration. B may or may not be true unless stated as forward vertical. D may or may not happen. Larger firms/ firms with bigger market share may or may not be productively and allocatively efficient. Answer is B. Through backward vertical integration, a manufacturer is able to secure a steady supply of raw materials. Through forward vertical integration, a firm will be able to expand its market share easily without the need to incur high spending on advertisements and R&Ds 

A contestable market is one where the barriers to entry and exit are low. Perfectly contestable implies that there are no barriers to entry and exit. Answer is therefore D. One common mistake is to always assume that a contestable/ perfectly contestable market is necessarily perfect market. That is not true. In fact, even a monopoly or an oligopoly can be contestable. Otherwise, we won't have so many options of banks, airlines, cars, smartphones and others to choose from. A big firm can even become contestable if the government were to intervene into their operations. Answer is D B is the answer. Income inequality is NOT A MARKET FAILURE. It cannot be considered as one, as wage/ pay differentials may be due to factors like academic qualification, experience and skills which correctly justify as to why one person earns more than the other.  A, C and D are market failures. Asymmetric information causes transactions not to settle at the socially efficient/ optimal e.g. consumers buying when they shouldn't and consumers aren't buying when they should. Monopoly will cause market output to settle below socially desirable level. Non-excludability is related to public goods. They are goods that are high in demand and therefore should be made available. Unfortunately, in free market, none of them that will be provided Poverty trap is a situation in which a person has no incentive to take up a better paying job. The reason is, that particular individual may realise that he/ she is not really well-off after being promoted. He/ she will start to pay higher rates of income tax, benefits will be significantly reduced or withdrawn altogether and there are also more job commitments. A is therefore the answer Net leakages imply that there are greater outflows of money than inflows from the circular flow of income. Trade surplus is where X > M and this is a net injection. Budget deficit is when G > T and this is another net injection. Private sector surplus means S > I. Answer is D. The first two are net injections. Only the last one is a net leakage  Most candidates thought that there is only one type of time lag. In fact there are four e.g. recognition lag, decision lag, implementation lag and finally effect lag, all in their own sequence. The question asks for the first stage and therefore the answer is C  Contractionary monetary policy involves measures like reduction in money supply, higher interest rates, higher cash reserve ratio/ reserve requirement and stricter bank lending. A will allow commercial banks to pass on the cheaper cost of funding in the form of lower interest rates. B will allow commercial banks to be able to generate more lending. Purchase of foreign currency using local currency will cause foreign currency to appreciate while local currency to depreciate. This will cause X to increase while M to fall. The economy will expand. Answer is D. Sale of government bonds in an open market a.k.a. open market operations (OMO) will cause commercial banks to have lesser money to lend out. So it is a contractionary policy