Economics 9708/22 — May/June 2018
Cambridge AS Level · AS Level Data Response and Essays · worked solutions for every part, with the mark scheme
Topics Elasticities of Demand · Exchange Rates · Balance of Payments · Aggregate Demand and Aggregate Supply · Fiscal Policy · Monetary Policy · +8 more
Thai Economy’s Prospects Improve
Table 1.1: Total expenditure in Thailand, by category, 2014
| Category of Spending | US dollars (billions) | % National Expenditure |
|---|---|---|
| Household consumption | 243 | 55.6 |
| Capital goods | 98 | 22.4 |
| Government consumption | 69 | 15.8 |
| Exports | 280 | 64.1 |
| Imports | 253 | 57.9 |
Source: United Nations data
Extract 1: Thailand’s economy shows improved health
The latest figures show that Thailand’s economy grew by 3.5% in the second quarter, putting it on track for 3–3.5% growth for the whole of 2016. Thailand has managed to boost its growth after several quarters of disappointing performance by increasing public sector investment in several large infrastructure projects, including roads, railways and airports. These projects will run over the next 3 to 5 years and are worth several hundred billion baht, Thailand’s currency. It is hoped that this public sector investment will encourage the private sector to increase their investment spending.
In addition to increased investment, the Thai economy’s growth is being boosted by recovering private consumption due to increases in farm prices, which are crucial to household purchasing power, as well as a strong tourism sector.
Regarding the export sector, which remains the biggest engine of growth, the outlook is still uncertain but the negative impact from China’s economic slowdown appears to have stabilised with a Chinese growth rate of around 6.6% per annum.
Source: The Nation, 18 August 2016
Extract 2: Thailand’s tourism industry continues to grow
The Thai tourism industry is projected to record international visitor arrivals of 16.67 million between January and June 2016, which will be up by 13% over the same period of 2015. Projected earnings are estimated at 824 billion baht, up 17%. The top three markets in terms of tourism receipts are projected to be China (146 billion baht, +32%), Malaysia (22.5 billion baht, +15%) and Australia (17.8 billion baht, +4%). China is now by far the largest source of visitors, but there has been a resumption of growth from Russia and Thailand’s neighbouring countries of Cambodia, Laos and Myanmar.
Source: Thailand Business News, June 2016
Calculate the level of aggregate demand in Thailand in 2014.
Working
AD = C + I + G + (X - M)
AD = 243 + 98 + 69 + (280 - 253) = 437
Answer
$437 billion
$437 billion
Background Concept
Aggregate demand (AD) is the total planned spending on goods and services produced in an economy over a period of time. In a closed economy, AD = C + I + G. In an open economy, exports (X) are added and imports (M) are subtracted because spending on imports is not part of domestic production. The standard formula is AD = C + I + G + (X - M). Each component is measured in monetary terms, here in US dollars.
Understanding the Question
This part asks you to calculate the level of aggregate demand in Thailand for 2014 using the data in Table 1.1. The table gives total expenditure by category in billions of US dollars. You need to identify which categories correspond to C, I, G, X, and M, then apply the formula. The table includes: Household consumption (C), Capital goods (I – investment), Government consumption (G), Exports (X), and Imports (M). Note that capital goods are a form of investment spending.
Approach
First, identify each component: C = 243, I = 98, G = 69, X = 280, M = 253. Then compute net exports (X - M) = 280 - 253 = 27. Then add all components: 243 + 98 + 69 + 27 = 437. The answer should be in billions of dollars, without 'US' if not required.
Step-by-Step Reasoning
- Read the table: Household consumption = $243 billion. This is C.
- Capital goods = $98 billion. This is investment (I).
- Government consumption = $69 billion. This is G.
- Exports = $280 billion. This is X.
- Imports = $253 billion. This is M.
- Net exports (X - M) = 280 - 253 = 27.
- AD = C + I + G + (X - M) = 243 + 98 + 69 + 27 = 437.
- The answer is $437 billion. No need to specify US because the table already uses US dollars.
Key Takeaways
- The expenditure approach to measuring aggregate demand uses the same components as GDP.
- Always check the table headings and units.
- Net exports can be positive (surplus) or negative (deficit).
Common Mistakes
- Forgetting to subtract imports. Some might add imports instead of subtracting.
- Using the wrong categories: e.g., including capital goods as consumption.
- Omitting the unit ($ billions) or writing the wrong unit.
Things to Be Careful About
- The table shows 'Capital goods' which is investment, not consumption.
- The calculation is straightforward, but ensure you use the correct sign for net exports.
- The answer must be in billions, not millions.
In which category of expenditure would the various infrastructure projects be placed?
Answer
Capital goods (investment).
Capital goods
Background Concept
In national income accounting, total expenditure is divided into consumption, investment, government spending, and net exports. Investment includes spending on capital goods such as machinery, buildings, and infrastructure. Government spending is split into current spending (e.g., wages, supplies) and capital spending (e.g., roads, schools, hospitals). Infrastructure projects like roads, railways, and airports are capital goods because they are physical assets used to produce other goods and services over many years.
Understanding the Question
The question asks: 'In which category of expenditure would the various infrastructure projects be placed?' The extract mentions 'increasing public sector investment in several large infrastructure projects'. These are clearly investment in capital goods. The table categories are Household consumption, Capital goods, Government consumption, Exports, Imports. Infrastructure projects fall under 'Capital goods' because they are long-term assets. Note that the government is the spender, but the category is still capital goods, not government consumption. Government consumption is day-to-day spending on goods and services, not on capital assets.
Approach
Recognise that infrastructure projects are investment spending, which is counted as 'Capital goods' in the expenditure approach. This is a one-word answer: 'Capital goods'.
Step-by-Step Reasoning
- Identify the nature of the spending: infrastructure projects (roads, railways, airports) are capital assets.
- In the expenditure categories, capital goods represent investment in physical capital.
- Therefore, the answer is 'Capital goods'.
Key Takeaways
- Government spending on infrastructure is classified as investment (capital goods), not consumption.
- The expenditure approach distinguishes between consumption and investment based on the nature of the good.
Common Mistakes
- Answering 'Government consumption' because the government is spending. But government consumption is for current spending, not capital.
- Answering 'Investment' which is synonymous but the table uses 'Capital goods'.
Things to Be Careful About
- The table uses 'Capital goods' as the category label. Use that exact term.
- The question is from a data-response, so use the categories provided.
Explain how a fall in the rate of interest would be likely to affect expenditure on
consumption,
Answer
A fall in the rate of interest is likely to increase consumption expenditure. There are two main reasons. First, lower interest rates reduce the cost of borrowing, so consumers are more willing to take out loans for big-ticket items such as cars and houses, leading to higher consumption. Second, lower interest rates reduce the return on savings, making saving less attractive and encouraging households to spend more of their income. Both effects work to raise consumption.
A fall in the rate of interest is likely to increase consumption expenditure.
Background Concept
Consumption is the largest component of aggregate demand. The rate of interest influences consumption through two channels: the cost of credit and the incentive to save. When interest rates fall, borrowing becomes cheaper, so households are more willing to finance purchases of durable goods (cars, furniture, etc.) on credit. Also, the return on savings decreases, reducing the opportunity cost of spending today, so households may choose to consume more rather than save. These effects are consistent with the consumption function, which includes wealth and income effects.
Understanding the Question
This part asks: 'Explain how a fall in the rate of interest would be likely to affect expenditure on consumption.' The command word is 'explain', so you need to provide a clear causal chain. The marking scheme gives credit for either a developed explanation of one reason or brief explanations of both. To get full marks, it is best to cover both channels.
Approach
Start by stating that consumption is likely to increase. Then explain the two channels: (1) cheaper borrowing increases spending on interest-sensitive goods, (2) lower return on savings reduces saving, increasing consumption. Alternatively, you could develop one channel in detail, but covering both is safer.
Step-by-Step Reasoning
- State the outcome: A fall in the rate of interest will likely increase consumption expenditure.
- First channel: Lower interest rates reduce the cost of borrowing. For example, mortgage rates fall, making it cheaper to buy houses; car loan rates fall, making it cheaper to buy cars. This increases demand for these durable goods, raising consumption.
- Second channel: Lower interest rates reduce the return on savings. If the interest rate on savings accounts falls, the opportunity cost of spending now instead of saving decreases. Households may choose to consume more of their disposable income, increasing consumption.
- Note that both effects work in the same direction, so consumption rises.
Key Takeaways
- Interest rates affect consumption through both credit and saving channels.
- The effect is a key transmission mechanism of monetary policy.
- Consumption is sensitive to interest rates, especially for durable goods.
Common Mistakes
- Only mentioning one channel when the mark scheme expects two or a fully developed one.
- Confusing consumption with investment. The question is about consumption, not investment.
- Not explicitly stating that consumption increases.
Things to Be Careful About
- The question says 'expenditure on consumption', so focus on consumption, not other components of AD.
- Use economic terminology: 'cost of borrowing', 'disincentive to save'.
- The answer should be clearly linked to the fall in the interest rate.
exports.
Answer
A fall in the rate of interest is likely to lead to a depreciation of the Thai baht. This makes Thai exports cheaper in foreign currency, so the quantity of exports demanded rises. However, the effect on export expenditure (price × quantity) depends on the price elasticity of demand for Thai exports. If demand is price elastic (PED > 1), the percentage increase in quantity exceeds the percentage fall in price, so export expenditure rises. If demand is price inelastic (PED < 1), expenditure falls. Additionally, lower interest rates may stimulate domestic demand, diverting some exports to the home market, which could reduce export expenditure. Therefore, the overall effect on export expenditure is ambiguous and depends on the specific elasticities and other factors.
The effect on export expenditure is ambiguous; it depends on the price elasticity of demand for exports and other factors.
Background Concept
A fall in the domestic interest rate reduces the return on assets denominated in that currency, leading to a decrease in demand for the currency (or an increase in supply) on the foreign exchange market. This causes the currency to depreciate. A depreciation makes exports cheaper in foreign currency and imports more expensive in domestic currency. The change in export revenue (price × quantity) depends on the price elasticity of demand (PED) for exports. If PED > 1, a price cut raises total revenue; if PED < 1, revenue falls. Additionally, a lower interest rate may boost domestic spending, which could divert some exports to the home market, reducing export volume.
Understanding the Question
This part asks: 'Explain how a fall in the rate of interest would be likely to affect expenditure on exports.' The command word is 'explain', so you need to set out the causal chain. The mark scheme accepts several possible outcomes, so the answer should show the reasoning rather than a single definite result. The key is to link interest rate to exchange rate, then to export prices and quantity, and then to expenditure, noting the role of elasticity.
Approach
First, explain the link from interest rates to exchange rates (depreciation). Then, explain how depreciation affects export prices and quantity. Then, introduce the concept of price elasticity of demand to determine the effect on total export expenditure. Finally, mention the possibility of domestic demand diversion as an additional factor. End with a statement that the outcome is ambiguous.
Step-by-Step Reasoning
- A fall in the rate of interest in Thailand reduces the return on baht-denominated assets, decreasing demand for the baht (or increasing supply). This causes the baht to depreciate.
- Depreciation means the baht becomes weaker against other currencies, so Thai export goods become cheaper for foreign buyers.
- The lower price in foreign currency increases the quantity of exports demanded (law of demand).
- Export expenditure = price per unit × quantity sold. The price in baht may remain the same, but the foreign currency price falls, so the baht price per unit could be unchanged or even rise if exporters raise prices in baht? Typically, the foreign currency price falls, and the baht price received by exporters may stay the same or change. For simplicity, assume the domestic price is unchanged, so the foreign currency price falls proportionally to the depreciation.
- The effect on total export expenditure (in baht) depends on PED: if demand is elastic, the quantity increase outweighs the price fall, so total expenditure rises; if inelastic, expenditure falls.
- Additionally, lower interest rates may stimulate domestic consumption and investment, increasing domestic demand. Some goods that could have been exported may be sold domestically instead, reducing export volume. This could offset the depreciation effect.
- Therefore, the net effect on export expenditure is uncertain; it depends on the price elasticity of demand for exports and the strength of the domestic demand effect.
Key Takeaways
- Interest rate changes affect exchange rates, which in turn affect export competitiveness.
- The price elasticity of demand for exports is crucial in determining the impact on export revenue.
- The overall effect is ambiguous and can be analysed using economic theory.
Common Mistakes
- Stating that export expenditure definitely rises or falls without considering elasticity.
- Ignoring the exchange rate channel and directly linking interest rates to exports.
- Confusing expenditure on exports with the volume of exports.
Things to Be Careful About
- Use the correct terminology: 'depreciation' (floating exchange rate) not 'devaluation'.
- The question asks about 'expenditure on exports', which is the value (price × quantity), not just quantity.
- The answer should reflect the uncertainty, as the mark scheme allows multiple outcomes.
Explain how changes in any three demand factors might account for the greater rate of growth in numbers of visitors into Thailand from China than from other countries.
Answer
Three demand factors can explain the greater rate of growth in visitors from China compared to other countries:
-
Income growth: China has experienced rapid economic growth, increasing the disposable income of its citizens. Tourism is a luxury good with high income elasticity of demand (YED). The higher income growth in China (relative to Malaysia, Australia, etc.) leads to a larger increase in demand for overseas travel, including to Thailand.
-
Changes in tastes: There may have been a shift in preferences among Chinese tourists favouring Thailand as a destination. This could be due to increased marketing, cultural ties, or positive word-of-mouth. Such a change in tastes would increase demand for Thai tourism more than for other destinations.
-
Relative price changes: The Thai baht may have depreciated against the Chinese yuan (or Chinese inflation lower than Thai inflation), making Thailand cheaper for Chinese tourists. If the baht has appreciated against other currencies, the relative price advantage for Chinese tourists is even greater. This price effect increases the quantity demanded of Thai tourism from China more than from other countries.
These factors collectively account for the higher growth rate of Chinese visitors.
The greater growth from China can be explained by higher income growth in China, changing tastes favouring Thailand, and favourable exchange rate movements.
Background Concept
The demand for tourism is influenced by several factors: income (tourism is a normal good, often luxury), tastes and preferences, prices (including exchange rates and relative prices), advertising, population, etc. The law of demand states that a decrease in price increases quantity demanded, but other factors shift the demand curve. Income elasticity of demand (YED) measures the responsiveness of demand to income changes; for luxury tourism, YED > 1. Cross-price elasticity (XED) measures responsiveness to changes in prices of related goods (here, exchange rates affect the price of Thai tourism relative to other destinations).
Understanding the Question
The extract shows that Chinese visitor arrivals to Thailand are projected to grow 32% (January-June 2016 vs same period 2015), compared to Malaysia 15% and Australia 4%. The question asks to explain how changes in any three demand factors might account for this difference. The factors must be demand-side (not supply-side). The marking scheme warns that if two factors are both 'changes in tastes', the maximum marks are limited, so we need three distinct factors.
Approach
Choose three distinct demand factors: income, tastes, and price (exchange rate). For each, explain how it has changed more favourably for China than for other countries. Use the data and economic reasoning. The answer should be structured around each factor, with a clear comparison.
Step-by-Step Reasoning
- Income growth: China's GDP growth rate has been higher than that of Malaysia and Australia (around 6.6% per annum as per extract, while Malaysia and Australia have lower growth). Tourism is income-elastic, so a given percentage increase in income leads to a larger percentage increase in demand for tourism. Therefore, the Chinese demand for Thai tourism grows more rapidly.
- Changes in tastes: The extract mentions that China is now the largest source of visitors. This could be due to increased awareness, marketing campaigns, relaxed visa requirements, or cultural affinity. A change in tastes shifts the demand curve to the right. This shift is likely larger for China than for other countries due to targeted promotion or growing interest in Thailand among Chinese tourists.
- Relative price changes: The exchange rate between the baht and the yuan affects the price of Thai tourism for Chinese tourists. If the baht has depreciated against the yuan, Thai goods and services become cheaper for Chinese tourists. The extract says Chinese growth is 32%, while Malaysian growth is only 15%. If the baht has depreciated more against the yuan than against the ringgit, it would explain the difference. Additionally, domestic inflation in Thailand relative to China could affect real exchange rates.
These three factors together explain why Chinese visitor numbers are growing faster than those from other countries.
Key Takeaways
- Demand factors must be distinct to avoid duplication.
- Use economic concepts like YED and exchange rates to explain differences.
- Always compare with other countries as required by the question.
Common Mistakes
- Using only one or two factors, or using two factors that are both changes in tastes (e.g., 'preference change' and 'fashion' are essentially the same).
- Not comparing with other countries – the question explicitly asks 'from China than from other countries'.
- Using supply-side factors (e.g., hotel capacity) which are not demand factors.
Things to Be Careful About
- The factors must be demand-side: income, tastes, prices, advertising, population, etc.
- Ensure each factor is clearly explained and linked to the difference in growth rates.
- Use data from the extract where possible (e.g., China's growth rate, but not directly for demand factors).
Discuss whether Thailand’s government should be concerned that export and import spending represents the highest proportion of total spending in Thailand.
Answer
Thailand's export and import spending together represent the highest proportion of total spending (64.1% exports, 57.9% imports), indicating a very open economy. There are benefits and risks.
Benefits:
- Thailand can specialise in industries where it has a comparative advantage (e.g., tourism, agriculture), leading to higher efficiency and output.
- Access to a wider variety of goods and services at lower prices improves consumer welfare and living standards.
- Export earnings provide foreign exchange to finance imports of capital goods, boosting investment and growth.
Risks:
- High dependence on exports makes the economy vulnerable to external shocks, such as a slowdown in China or global recession, which can cause sharp falls in export revenue and GDP.
- Import dependence means that a depreciation of the baht could raise the cost of imported inputs, feeding inflation.
- Over-reliance on a few export sectors (e.g., tourism) can lead to instability if those sectors face downturns.
Conclusion:
While the benefits of openness are substantial, the risks are significant, especially for a developing economy. The government should not be overly concerned as long as it maintains a diversified export base and sound macroeconomic policies to cushion external shocks. However, it should monitor the composition of trade and take steps to reduce vulnerability, such as promoting export diversification and building foreign exchange reserves. Therefore, the government should be cautious but not alarmist.
The government should be cautious but not overly concerned; the benefits of openness are significant, but policies to diversify the economy and manage external risks are advisable.
Background Concept
An open economy with a high ratio of trade to GDP (exports + imports as a percentage of GDP) is said to have a high degree of openness. The theory of comparative advantage suggests that countries benefit from specialising in goods they produce relatively efficiently and trading for others. However, such economies are also exposed to external shocks (e.g., changes in world demand, commodity prices, exchange rates). The balance of payments current account records trade flows; a large trade sector means that changes in the trade balance can have significant effects on aggregate demand and national income.
Understanding the Question
The question asks: 'Discuss whether Thailand’s government should be concerned that export and import spending represents the highest proportion of total spending in Thailand.' The data shows exports are 64.1% of national expenditure and imports 57.9%, so the trade sector is very large. 'Discuss' requires a two-sided argument: explain why the government might be concerned (risks) and why it might not (benefits). The mark scheme allocates up to 3 marks for each side, with 1 mark reserved for a conclusion. The conclusion must be justified.
Approach
First, present the benefits of a high degree of openness: comparative advantage, efficiency, consumer welfare, growth. Then, present the risks: vulnerability to external shocks, import dependence, concentration risk. Finally, weigh the two sides and reach a judgement. The conclusion should state whether the government should be concerned and why, possibly with conditions.
Step-by-Step Reasoning
-
Benefits side:
- Thailand can specialise in sectors where it has a comparative advantage, such as tourism and agriculture. This specialisation leads to higher productivity and output.
- Trade allows Thailand to import goods that are not produced efficiently domestically, improving resource allocation and living standards.
- Export earnings provide foreign currency to import capital goods, which can boost investment and economic growth.
- The large trade sector indicates that Thailand is integrated into the global economy, which can attract foreign direct investment and technology transfer.
-
Risks side:
- High export dependence means that a downturn in major trading partners (e.g., China, the US) can significantly reduce export revenue, leading to a fall in aggregate demand and GDP. The extract mentions China's slowdown as a source of uncertainty.
- If exports are concentrated in a few sectors (e.g., tourism, electronics), the economy is vulnerable to sector-specific shocks (e.g., political instability, natural disasters).
- High import dependence means that a depreciation of the baht can increase the cost of imported inputs and consumer goods, causing cost-push inflation.
- The large trade share also makes the economy more sensitive to global commodity price fluctuations.
-
Conclusion:
- The benefits of trade are real and substantial, but the risks cannot be ignored. The government should not be overly concerned because the advantages of openness have contributed to Thailand's growth and development. However, it should be proactive in managing the risks: diversify export markets and products, maintain adequate foreign exchange reserves, and implement counter-cyclical fiscal and monetary policies to cushion external shocks. The level of concern should be moderate, not alarmist.
Key Takeaways
- The degree of openness has both advantages and disadvantages.
- Evaluation requires weighing benefits against costs and reaching a balanced judgement.
- The conclusion must be justified and specific to the question.
Common Mistakes
- One-sided answer: only discussing benefits or only risks, which loses marks for the missing side.
- No conclusion or a vague conclusion (e.g., 'it depends').
- Not using the data from the extract (e.g., the percentages of exports and imports).
- Confusing the issue with other macroeconomic concerns not directly related to trade openness.
Things to Be Careful About
- The question asks 'whether the government should be concerned', so the answer must address the government's perspective.
- Use the extract: the table shows the high proportions; the text mentions China's slowdown and tourism growth.
- The conclusion should clearly state a position (e.g., 'should be concerned' or 'should not be concerned') with reasons.
- Avoid extreme positions; a balanced, nuanced conclusion is best.
The rest of this paper
3 more questions- Q2Economic Systems · Supply-Side Policy20M
- Q3Methods of Government Intervention in Markets · Elasticities of Demand · Consumer and Producer Surplus · Classification of Goods and Services20M
- Q4Price Stability · Exchange Rates · Balance of Payments · Elasticities of Demand20M