Thursday, October 11, 2018

Highly Likely Essay Questions for Section B of Paper 2 Economics CIE (CAIE)

Highly anticipated essay questions for 9708/22 this coming Wednesday (17th October):

1. How a production possibility curve can be used to illustrate economic ideas like opportunity cost, rising opportunity cost (these two are different and the latter is becoming more popular in the recent), unemployment, economic growth and unattainable position
2. Whether market economy or planned economy is more desirable/ likely to improve consumer well-being/ better in making decisions/ better in allocating resources
3.  Functions of money and whether money is able to perform all the four functions in an economy that is experiencing high rate of inflation
4. What is meant by equilibrium price and quantity and how a change in demand/ supply would alter both equilibrium

5. The right type of elasticity to determine whether two goods are substitutes or complements/ normal goods or inferior goods

6. Whether PED/ XED/ YED would be useful for firms and governments (I won't do these essays if I were you!)

7. Whether the problem of demerit goods can be dealt with an indirect tax and banning/ better information/ minimum price

8. Whether the problem of merit goods can be dealt with subsidies and maximum price

9. Whether the imposition of maximum price would be able to help low income families 

10. Using AD/ AS diagrams, explain how a fall in exchange rate/ depreciation can cause both demand-pull and cost-push inflation

11. Inter-relationships between the inflation rate, exchange rate and balance of payments

12. Whether floating or fixed exchange rate system is more desirable

13. Terms of trade and whether a fall/ increase in terms of trade is beneficial to an economy

14. Comparative advantage and how an economy can consume outside its own PPC. Illustrate with trading possibility curve

15. Fiscal/ monetary/ supply-side policies to achieve macroeconomic objectives like higher growth, lower unemployment and lower inflation

16. Expenditure-dampening vs. expenditure-switching policies in reducing current account deficit

Several important observations:
a) There is somewhat an observable trend in Paper 2. When the examination board found a new method/ technique or even question to ask, they will 'toy around' with the new concept for several exams/ years before moving on to other new techniques or questions. For instance 'increasing opportunity cost' makes its first appearance in W16 (V3). Then it was asked again in W17 (V3) and now in Feb/ March 2018 (V2)

(b) There is also an indicator that questions may no longer be asked according to chapter/ cluster. This may pose some challenges for candidates that tend to specialise in micro/ macro (which I strongly forbid!!) In W17 (V3), part (a) was about PPC (Chapter 1). However its part (b) was about supply-side policies (Chapter 5). Another one is the recent Feb/ March 2018 paper. Part (a) was about price elasticity of supply (Chapter 2) but its part (b) was regarding supply-side policies (Chapter 5)

(c) Effectiveness of fiscal/ monetary/ supply-side policies to achieve price stability is extremely popular in recent years (let's hope that the trend stays until your exam)

Popular Questions in Section A of Paper 2 Economics CIE (CAIE)

Important updates:
1. Do not evaluate/ provide conclusion just because the question is an 8-marker (Section B, part (a) of each essay). High marks do not automatically indicate that the question is evaluative in nature. By contrast, low marks also do not necessarily imply that there won't be any evaluation. In A2, there were instances where a question is a 5-marker and yet evaluation and conclusion are expected from students. Instead, interpret/ watch out the keywords that they use such as:
(i) Discuss (most common one) ....
(ii) Explain whether ....
(iii) How far ....
(iv) To what extent ....
(v) Do you agree ....
(vi) Is this the most important feature ....

2. Evaluations and conclusion come in a package. You can only have something to conclude or weigh upon after considering both advantages and disadvantages/ pros and cons. It is somewhat illogical to provide conclusion where no arguments/ discussions prior take place (to conclude against what?)
After a 'chronic' two hours, this is what I found:

Microeconomic questions
a) Calculating percentage of change. You may be asked to find the new price or the original price

b) Identify one demand reason and one supply reason which may explain for the rise/ fall in the price of a particular commodity

c) Using demand and supply diagram to show how equilibrium price and quantity will be affected when an indirect tax/ subsidy is being introduced. It can also be applied to show how an exchange rate has risen or fallen in value. Please take note of the keyword 'show'. It means that you do not have to provide analysis/ explanation. The diagram on its own is suffice to earn you a full 2 marks. Only provide analysis when the instruction is 'explain'. Alternatively, watch out for the marks allocated. If it is a 4-marker, then you have to explain

d) Maximum/ minimum price. Normally, you will be asked to draw a diagram. Then you need to include analysis e.g. expansion in demand but contraction in supply which leads to shortage. Likely to be a 4-marker

e) Production possibility curve e.g. whether it will shift inward or outward based on the information provided e.g. recession, peace talk with rebels, economic recovery and others. There will be analysis marks for this. Usually, it would be a 4-marker

Macroeconomic questions
a) Current account balance. Compare between two given years of whether it has improved or worsened. Likely to have minor calculations here

b) What other information would be needed to determine the current account balance e.g. you may be given 'balance of trade in goods' and so, you have to state the others like 'net trade in services', ' net investment income' and 'net transfers'

c) How a depreciation may cause demand-pull and cost-push inflation

d) Conditions necessary for a depreciation to turn a current account deficit into surplus e.g. PEDx > 1 or/ and PEDm > 1, there is no parallel devaluation, inflation rates must not increase by the full extent as depreciation, trading partners do not impose protectionist measures and others (very, very, very popular!)

e) Whether protectionism is justified. To some extent e.g. protect sunrise industries, safeguard sunset industries, ensuring survival of strategic industries and prevent dumping. No since it will promote complacency, lead to trade war and cause cost-push inflation

f) How components of the aggregate demand are affected when there is a rise/ fall in the price of a particular commodity. Consider the case of falling oil prices. Oil typically has low PED. So, when the price of oil falls, total revenue from oil exports will also decline. Ceteris paribus, (X-M) will fall and so there will be a decline in AD. Second, oil firms will reduce their investment e.g. oil exploration activities. That will also reduce the AD. Then, government revenue from oil exports will also be adversely affected. Spending into the economy e.g. schools, hospitals, roads and bridges is likely to be cut. Again this is a fall in AD. What about C? In an oil-dependent economy, it is safe to assume that many people are employed in the oil and gas sector. In this case, employment will be axed and so C will fall. Alternatively, the government may raise taxes or introduce new ones to cover up shortfall in revenue. This will again reduce C into the economy. All these reflect a fall/ leftward shift of AD

g) Whether currency appreciation/ depreciation is more desirable

h) Whether fixed exchange rate system is reliable. Yes as this may promote international trade, encourage investment and avoid speculation which may destabilise local financial market. No, as it requires huge amount of foreign reserves, speculations will always be there and interest rates can no longer be altered to achieve certain macroeconomic aims  

i) Which category of spending that has the greatest impact onto price index. Here you need to watch out for largest price change or/ and component with biggest weighting assigned

Easy-to-follow tips which may increase your ability to score:
a) If you cannot finish the 'discuss' question in Section A, list out all the points and evaluations. You may still gain 2 marks for listing. Obviously, this is better than nothing

b) Before you hand up your paper, please check all the diagrams and ensure that they are in satisfactory condition e.g. label of axes, label of curves, whether you accidentally put price and quantity instead of price level and real output (most common mistake). Ignoring this may cause you to lose up to 4 marks, depending on how many diagram questions are there in the paper

c) Write concisely. Do not provide evaluations or/ and conclusion for an 8-marker. It is a pure waste of time as the instruction is 'EXPLAIN'. There is no provision of marks for these two, no matter how well you have written them. While it is not wrong to do so, do bear in mind that they will certainly take away some precious time from other sections/ parts. Inability to finish the paper = lower marks

d) Use lots of paragraph to distinguish your ideas/ evaluations, one from another (especially for candidates whose writing skills are still in the development/ formation stage). It also gives the examiner a pleasant marking experience which may translate into higher marks (how significant I wouldn't know, but it does bear some weight. More so in A2 essays)

e) Use diagrams wherever possible in case if you do not know how to explain a particular concept. Perhaps, the diagram may do some 'talking' on behalf of you

Saturday, October 6, 2018

Basic Techniques To Elevate Your Marks For Paper 2 CIE (CAIE) Economics

1) Regarding diagrams. This is one of the most overlooked areas. Most candidates would just proceed into explanations without having a second look/ thought about the diagram they drew. When I go through my students' work, I often find that the diagrams are either wrongly labelled or unlabelled. For instance, there is a tendency to label 'Price' vs. 'Quantity' instead of 'Price level' vs. 'Real output' for an aggregate demand-aggregate supply analysis. Another problem is the tendency to label 'Price' vs. 'Quantity' instead of 'Price of USD1 (in MYR)' vs. 'Quantity of USD' for an exchange rate diagram. Such mistakes can cost candidates up to 2 marks

2) Regarding the 'Discuss' question under data response. I personally find that this is the most poorly-answered question in Section A. The most obvious reason is poor time management. Candidates may feel that they have spent too much time in the first couple of questions and as a result, this particular question has to be rushed through to make way for Section B. Sometimes, they are even being left out. My suggestion is, in the worst case scenario, list out the answers (in a proper sentence). You would still qualify up to 2 marks provided if the points and arguments are sound and relevant. In case if you do not know how to argue/ evaluate, you could still earn up to 4 marks for one-sided answer

3) Always remember to ask yourself a question. 'Am I answering the question?'. According to the examiner reports (it's not the first time), very frequently, candidates tend to write very generally about a particular economic theory without even considering whether it answers the question or not. For instance, if a question asks candidates to discuss whether the knowledge of PED would be useful for the government, then by all means, PED must be written with the theme 'government' in mind. Unfortunately, in a large account, many would write 'everything-they-know-about-PED' e.g. when a firm should increase or decrease prices (not even relevant in the first place), factors that influence the value of PED etc. Marks could be significantly increased if one keeps this simple rule in mind

If these three are strictly adhered to, it is possible to easily raise your overall Paper 2 marks to as much as 8 (consider 22/40 to 30/40). That could be a three-grades jump!! (assuming your Paper 1 is doing fairly well) 

Monday, October 1, 2018

Interrelationships Between Inflation Rate, Exchange Rate, Interest Rate and Current Account Balance (AS Economics)

Question from a student of mine: Can you please explain the interrelationships between inflation rate, exchange rate, interest rate and current account balance?

a) Inflation rate and exchange rate
A country has relatively higher rates of inflation --> home-made goods become less price competitive in both domestic and international markets --> rise in imports and fall in exports --> increase in the supply of local currency & fall in the demand for local currency to facilitate transactions --> excess supply --> currency depreciation

b)  Exchange rate and inflation rate
Currency depreciation --> imported raw materials, semi-finished goods and finished goods become artificially more expensive --> increase in the costs of production --> leftward shift of SRAS --> an increase in general price level --> rise in cost-push inflation

Currency depreciation --> local goods become artificially cheaper in international market and foreign goods become artificially more expensive for domestic market --> assuming PEDx > 1 and PEDm > 1, export value would increase while import value fall --> rise in net exports --> rightward shift of AD --> increase in general price level --> higher demand-pull inflation

c) Inflation rate and interest rate
An increase in the rates of inflation --> exceeded the targeted level --> monetary authority would have to intervene pre-emptively --> raise interest rates to slow down economic activities

d) Interest rate and inflation rate
Higher interest rates --> cost of borrowing will increase --> households and firms will reduce spending into the economy --> fall in AD --> decline in price level --> reduce demand-pull inflation

e) inflation rate and current account balance
Relatively higher inflation rates --> home-made goods become less price competitive in both domestic and international markets --> assuming that PEDx > 1 and PEDm > 1, value of exports would fall while value of imports rise --> worsening of current account balance

f) Current account balance and inflation rate 
Say, if a country has current account deficit --> value of imports is greater than the value of exports --> a decline in net exports --> lower AD --> fall in average prices --> lower demand-pull inflation

g) Exchange rate and interest rate
Currency depreciation --> imported raw materials, semi-finished goods and finished goods would become artificially more expensive --> an increase in costs of production --> fall in SRAS --> rise in general price level --> triggers cost-push inflation --> if this exceeds the targeted inflation rate, then monetary authority may have to intervene by raising interest rates

Currency depreciation --> local goods would become artificially cheaper in international markets while foreign goods would become artificially more expensive in domestic market --> assuming PEDx > 1 and PEDm > 1, value of exports would increase while imports fall --> higher net exports --> rise in AD --> higher price level --> triggers demand-pull inflation --> if this exceeds targeted rate of inflation, then the central bank may have to raise interest rates

h) Interest rate and exchange rate
An increase in interest rates --> commercial banks and financial institutions offer higher rates of return on savings --> attract very wealthy foreigners and pension funds to deposit/ save money in this said country while at the same time there will be lesser outflows of hot money --> demand for local currency would increase while supply of local currency in money market would fall --> excess demand causes appreciation

i) Exchange rate and current account balance
Currency depreciation --> foreign goods become artificially pricier in domestic market while local goods cheaper in international markets --> assuming that the both exports and imports are price elastic in demand --> value of exports would increase while imports fall --> net inflows of money --> improvement in current account balance

j) Current account balance and exchange rate
Say, a country has current account deficit --> imports are greater than exports --> supply of local currency would increase while demand for local currency to facilitate transactions would fall --> excess supply causes depreciation

k) Interest rate and current account balance (has two possibilities where one can become the evaluation of the other)
Rise in interest rates --> higher cost of borrowing --> spending by households and firms into the economy would fall including buying imports --> lesser outflows of money --> improvement in current account balance

Rise in interest rates --> rise in inflows of hot money while a fall in outflows of hot money --> demand for local currency increases while its supply falls --> excess demand leads to appreciation --> foreign goods eventually become more price competitive --> buy more imports --> worsening of current account balance (assuming imports are price elastic in demand)

l) Current account balance and interest rate
Say, a country has large and persistent current account deficit --> value of imports is greater than value of exports --> fall in net exports --> leftward shift of AD --> fall in general price level --> lower demand-pull inflation --> may fall below targeted rate of inflation --> monetary authority may be forced to cut interest rates pre-emptively

This should be a comprehensive guide. Do use it wisely and please refrain yourself from memorising them at all costs! Think logically :)

Wednesday, June 27, 2018

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

Sunday, June 24, 2018

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


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

Monday, June 11, 2018

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

Sunday, June 10, 2018

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:

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 

Sunday, June 3, 2018

'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!!!