Economics 9708/42 — October/November 2022
Cambridge A-Level · A Level Data Response and Essays · worked solutions for every part, with the mark scheme
Topics Exchange Rate Systems · Economic Development and Living Standards · Effectiveness of Macroeconomic Policies · Economic Growth and Sustainability · Employment and Unemployment · Externalities, Social Costs and Benefits · +9 more
An Opportunity for Guyana
The International Monetary Fund (IMF) believed that Guyana, one of South America’s geographically smallest countries, was likely to see a dramatic 86% rise in its economic output in 2020.
Content removed due to copyright restrictions.
- invest in coastal protection to guard against rising sea levels.
Source: The Economist, 29 February 2020 pg.35
Explain how the discovery and extraction of oil affects the productive capacity of Guyana.
Answer
The discovery and extraction of oil increases Guyana's stock of natural resources, thereby expanding its productive capacity (potential output). This is represented by an outward shift of the production possibility curve (PPC) or an increase in long-run aggregate supply (LRAS).
Oil extraction expands Guyana's productive capacity, shifting the PPC outward and increasing LRAS.
Background Concept
Productive capacity (or potential output) is the maximum output an economy can produce when all resources are fully employed. It is determined by the quantity and quality of factors of production: land, labour, capital, and enterprise. An increase in any factor shifts the production possibility curve (PPC) outward and increases long-run aggregate supply (LRAS). The discovery of oil adds to the country's natural resources (land), thereby expanding its productive capacity.
Understanding the Question
The question asks how the discovery and extraction of oil affects Guyana's productive capacity. This is a straightforward application of the concept of potential output. The article states that Guyana is likely to see an 86% rise in economic output in 2020 due to oil. The candidate must explain the link between oil extraction and the economy's ability to produce goods and services.
Approach
Define productive capacity. Explain that oil is a new natural resource, which increases the factor endowment. Conclude that the PPC shifts outward and LRAS increases, representing an expansion of potential output.
Step-by-Step Reasoning
- Productive capacity refers to the economy's potential output when all resources are used efficiently.
- The discovery of oil adds a valuable natural resource to Guyana's factor endowment.
- With more resources, the economy can produce more output, so its productive capacity expands.
- This can be illustrated by an outward shift of the production possibility curve (PPC) from PPC1 to PPC2, showing that more of both goods (e.g., oil and other goods) can be produced.
- Alternatively, in the AD-AS model, the long-run aggregate supply (LRAS) curve shifts to the right, indicating a higher potential output.
- The extraction of oil also requires capital investment and technology, which further enhance productivity.
Key Takeaways
- Productive capacity is determined by factor endowments.
- Discovery of natural resources expands the resource base, increasing potential output.
- The PPC and LRAS models are used to represent changes in productive capacity.
Common Mistakes
- Confusing productive capacity with actual output. The question is about potential, not actual.
- Failing to link oil extraction to an increase in resources.
- Not mentioning the PPC or LRAS shift, which is required for full marks.
Things to Be Careful About
- Use precise terminology: "productive capacity", "potential output", "PPC", "LRAS".
- Keep the explanation concise; 2 marks require only two clear points.
Using the information in the article:
Explain the type of unemployment arising from the closure of sugar plantations in Guyana.
Answer
The type of unemployment is structural unemployment. It arises because the sugar plantations cannot compete with foreign producers, leading to a permanent decline in demand for sugar workers. The workers' skills are specific to sugar production, so they are mismatched with available jobs.
Structural unemployment.
Background Concept
Structural unemployment occurs when there is a mismatch between the skills of workers and the requirements of available jobs, often due to changes in the structure of the economy, such as the decline of an industry or technological change. It is a form of disequilibrium unemployment because the labour market does not clear at the current wage rate.
Understanding the Question
The question refers to the closure of sugar plantations in Guyana. The article likely mentions that sugar production cannot compete with foreign producers, leading to job losses. The candidate must identify the type of unemployment and explain why it is that type.
Approach
Identify structural unemployment. Explain that the decline of the sugar industry is a permanent change in demand, and workers' skills are specific to sugar production, so they cannot easily find new jobs without retraining.
Step-by-Step Reasoning
- The sugar plantations close because they cannot compete with lower-cost foreign producers.
- This represents a permanent decline in a major industry, not a temporary fluctuation.
- Workers laid off from sugar plantations have skills specific to sugar cultivation (e.g., harvesting, processing).
- Other sectors of the economy (e.g., oil, services) require different skills, so there is a mismatch.
- Therefore, the unemployment is structural: it arises from the changing structure of the economy.
- This differs from cyclical unemployment (due to recession) or frictional unemployment (temporary between jobs).
Key Takeaways
- Structural unemployment results from sectoral decline or technological change.
- It requires supply-side policies to address the skills mismatch.
- Identifying the type of unemployment is a common exam question.
Common Mistakes
- Confusing structural with cyclical or frictional unemployment.
- Not explaining why it is structural (i.e., the mismatch of skills).
- Simply stating "structural" without explanation.
Things to Be Careful About
- Use the term "structural unemployment" explicitly.
- Provide a clear reason: the industry cannot compete, leading to permanent job loss and skills mismatch.
Explain how this type of unemployment might be reduced.
Answer
Structural unemployment can be reduced through supply-side policies:
- Retraining and skills development: Workers from sugar plantations can be trained in skills demanded by expanding sectors such as oil and gas, construction, or services. This improves their occupational mobility and enables them to fill vacancies.
- Subsidies: The government can provide wage subsidies to firms that hire displaced sugar workers, reducing the cost of employment and encouraging job creation.
- Geographical mobility: Providing relocation assistance or housing support can help workers move to areas with job opportunities.
Supply-side policies such as retraining and subsidies can reduce structural unemployment.
Background Concept
Structural unemployment can be reduced through supply-side policies that improve the functioning of labour markets. These include retraining and education to enhance occupational mobility, subsidies to encourage hiring, and measures to improve geographical mobility. The goal is to equip workers with skills demanded by growing industries and to reduce barriers to employment.
Understanding the Question
The question asks how the type of unemployment identified in (i) might be reduced. It requires explanation of policies, with development of at least one example. The mark scheme allows up to 2 marks for a developed example.
Approach
Identify supply-side policies as the main solution. Develop one policy in detail (e.g., retraining programmes) and mention other policies (subsidies, mobility assistance). Ensure the explanation is linked to the context of Guyana (e.g., training for oil sector).
Step-by-Step Reasoning
- Structural unemployment arises from a skills mismatch, so policies must address this mismatch.
- Retraining and skills development: The government can fund training centres that teach skills needed in expanding industries, such as oil and gas technical skills, construction, or hospitality. This enables former sugar workers to qualify for available jobs, reducing unemployment.
- Subsidies: The government can offer wage subsidies to firms that hire displaced workers, reducing the cost of employment and encouraging job creation.
- Geographical mobility: Providing relocation grants or improving transport infrastructure can help workers move to regions with job opportunities, such as the oil-producing areas.
- These are supply-side policies because they increase the efficiency and flexibility of the labour market.
Key Takeaways
- Supply-side policies are the primary tool to reduce structural unemployment.
- Retraining is a key example; it improves occupational mobility.
- Subsidies and mobility assistance are additional measures.
Common Mistakes
- Suggesting demand-side policies (e.g., fiscal stimulus) which are more suited to cyclical unemployment.
- Not developing an example; just listing policies without explanation.
- Forgetting to link to the specific context (sugar workers in Guyana).
Things to Be Careful About
- Develop at least one policy in detail to secure the 2 marks.
- Use economic terminology: "supply-side policies", "occupational mobility", "labour market flexibility".
- Keep the answer focused on structural unemployment.
Explain how an over-valuation of the exchange rate may affect Guyana’s economy.
Answer
An over-valued exchange rate means the Guyana dollar is stronger than its equilibrium value. This raises the foreign price of Guyana's exports and lowers the domestic price of imports. Consequently, export volumes fall and import volumes rise, worsening the trade balance.
This deterioration in net exports reduces aggregate demand, leading to lower economic growth and higher unemployment. Additionally, over-valuation makes Guyana a less attractive destination for foreign direct investment (FDI) because production costs are higher when converted to foreign currency, further harming long-term growth prospects.
An over-valued exchange rate reduces exports and increases imports, worsening the current account and reducing aggregate demand, leading to lower growth and higher unemployment.
Background Concept
An over-valued exchange rate occurs when a currency's value is higher than its market equilibrium level, often due to government intervention or fixed exchange rate systems. This makes exports more expensive for foreign buyers and imports cheaper for domestic consumers, leading to a deterioration in the trade balance. The impact on the economy depends on the Marshall-Lerner condition and can affect inflation, growth, and employment.
Understanding the Question
The question asks how an over-valuation of the exchange rate may affect Guyana's economy. It requires explaining the mechanism and developing the consequences for macroeconomic objectives. The mark scheme awards up to 2 marks for the basic trade effects and up to 2 marks for development (e.g., impact on balance of payments, inflation, unemployment, growth, FDI).
Approach
First, explain what over-valuation means. Then state the effect on export and import prices and volumes. Then develop one or two macroeconomic consequences, such as a worsening current account leading to lower AD, unemployment, and slower growth, or the effect on FDI.
Step-by-Step Reasoning
- An over-valued exchange rate means the Guyana dollar is stronger than its equilibrium value.
- This raises the foreign currency price of Guyana's exports, making them less competitive, so export volumes fall.
- It lowers the domestic currency price of imports, making imports cheaper, so import volumes rise.
- The trade balance (exports minus imports) worsens, leading to a current account deficit.
- The fall in net exports reduces aggregate demand (AD = C+I+G+X-M), causing a contractionary effect on the economy.
- Lower AD leads to lower real GDP growth and higher unemployment (demand-deficient unemployment).
- Cheaper imports may reduce domestic inflation (disinflation), but this is a secondary effect.
- Over-valuation also discourages foreign direct investment (FDI) because production costs in Guyana become higher in foreign currency terms, reducing the attractiveness of Guyana as an investment destination.
- This can harm long-term economic growth and development.
Key Takeaways
- Over-valuation harms export competitiveness and encourages imports, worsening the trade balance.
- It reduces aggregate demand, leading to unemployment and slower growth.
- It can also deter FDI, with negative long-term effects.
Common Mistakes
- Confusing over-valuation with depreciation/appreciation. Over-valuation is a disequilibrium situation.
- Only stating the trade effects without developing macroeconomic consequences.
- Not using the term "aggregate demand" or linking to AD components.
- Forgetting to mention the impact on unemployment or growth.
Things to Be Careful About
- Clearly distinguish between price effects and volume effects.
- Develop at least one macroeconomic consequence for full marks.
- Use appropriate terminology: "trade balance", "current account", "aggregate demand", "FDI".
Discuss, with reference to the article, how the establishment of the new fund may benefit the population of Guyana.
Answer
The article indicates that the new fund will be used to invest in coastal protection. Beyond this, the fund can finance other development projects that benefit the population:
- Coastal protection: The fund invests in defences against rising sea levels, protecting homes, farmland, and infrastructure from flooding and erosion, thereby safeguarding livelihoods and reducing vulnerability.
- Education and training: The fund can finance improvements in schools and vocational training, equipping Guyanese with skills for the growing oil sector and other industries, raising productivity and earning potential.
- Infrastructure development: The fund can invest in roads, energy, and other infrastructure.
Conclusion: By allocating oil revenues to these areas, the fund can transform Guyana's economy, reduce poverty, and improve living standards, provided the investments are well-managed and transparent.
The fund can benefit Guyana's population through investments in coastal protection, education, and infrastructure, leading to improved living standards and sustainable development, provided the funds are managed transparently.
Background Concept
A sovereign wealth fund (SWF) is a state-owned investment fund that manages a country's surplus revenues, often from natural resource exports. The fund can be used to invest in infrastructure, human capital, and other public goods, aiming to convert non-renewable resource wealth into sustainable development and improved living standards. The benefits include higher economic growth, better public services, and poverty reduction.
Understanding the Question
The question asks to discuss, with reference to the article, how the establishment of the new fund may benefit the population of Guyana. The article mentions that the fund will invest in coastal protection. The candidate must identify policies of the fund (3 marks), develop the impact of each (up to 2 marks each, max 4 marks), and provide a conclusion (1 mark). The command word is "Discuss", which implies some evaluation, but the mark scheme only allocates 1 mark for a conclusion, not separate evaluation marks. So it is largely an explanation of benefits, but a conclusion is required. The question is "how the establishment of the new fund may benefit the population", so it is largely positive. However, "discuss" might require some consideration of potential drawbacks or conditions for success. The mark scheme does not explicitly require evaluation, but a conclusion is needed. I will include a brief evaluative comment in the conclusion about the need for good governance.
Approach
Identify three policies from the article (coastal protection) and plausible others (education, infrastructure). For each, explain the mechanism by which it benefits the population. Conclude that the fund can significantly improve living standards if managed effectively.
Step-by-Step Reasoning
- Coastal protection: The article states the fund will invest in coastal protection against rising sea levels. This directly protects communities, farmland, and infrastructure from flooding and erosion, reducing economic losses and safeguarding livelihoods. It also preserves the natural environment and supports tourism and agriculture.
- Education and training: The fund can finance improvements in schools, vocational training, and scholarships. This enhances human capital, enabling Guyanese to access higher-paying jobs in the oil sector and other industries. Better education also improves health outcomes and social mobility, raising living standards.
- Infrastructure development: Investing in roads, ports, electricity, and water supply reduces production costs for businesses, attracts investment, and creates jobs. Improved infrastructure also connects remote communities to markets and services, reducing poverty and inequality.
- Conclusion: The fund has the potential to transform Guyana's economy and improve the well-being of its population. However, the benefits depend on transparent management, avoidance of corruption, and prudent investment to ensure long-term sustainability. If managed well, the fund can convert oil wealth into lasting development.
Key Takeaways
- Sovereign wealth funds can be used to invest in public goods and human capital.
- Benefits include protection from environmental risks, improved education, and better infrastructure.
- Good governance is crucial for the fund to achieve its objectives.
Common Mistakes
- Not referencing the article (coastal protection).
- Listing policies without explaining how they benefit the population.
- Forgetting to include a conclusion.
- Overlooking the need for evaluation (e.g., potential risks of mismanagement).
Things to Be Careful About
- Ensure three distinct policies are identified.
- Develop each policy's impact with a clear chain of reasoning.
- The conclusion should be justified, not just a summary.
- Use the article's specific mention of coastal protection.
The rest of this paper
6 more questions- Q2Externalities, Social Costs and Benefits · Efficiency and Market Failure25M
- Q3Short-Run and Long-Run Production · Costs of Production · Objectives and Pricing Policies of Firms · Market Structures25M
- Q4Wage Determination and Labour Market Intervention25M
- Q5Money and Banking · Effectiveness of Macroeconomic Policies25M
- Q6Exchange Rate Systems · Macroeconomic Objectives and Policy Conflicts · Effectiveness of Macroeconomic Policies25M
- Q7Relationships Between Countries at Different Levels of Development · Economic Development and Living Standards25M