H2 Economics

9732/01

2012

Question 2

(a)(i) Between 2005 and 2009, Chinas balance of trade in goods has improved
whereas Japans balance of trade has worsened. However, the balance of trade
positions of both China and Japan are in surplus.

(a)(ii) With a worsening of the balance of trade for Japan, there would be a fall in
the net exports of the Japanese economy. This results in a fall in Aggregate Demand
of Japans economy. The end result is a fall in economic growth which is reflected in
Table 2 where growth in real domestic product decreases.

(b) A long term need to tackle rising inflation in China would result in a fall in
Aggregate Demand for the Chinese economy due to the increase in interest rates
by the Chinese government that result in a fall in investment. This results in a fall in
the national income of Chinese citizens. As a result, their purchasing power would
fall and they would demand for fewer imports from the rest of the world economies.

(c) When the Chinese Yuan appreciates, it would result in an increase in the value
of Chinese Yuan relative to foreign currencies. This results in Chinese exports being
more expensive in terms of foreign currency, causing a fall in export-price
competitiveness of Chinese exports. Assuming Chinese exports are price elastic in
demand; this would result in a more than proportionate fall in quantity demanded
for Chinese exports. Appreciation of Chinese Yuan would also result in Chinese
exports from other countries to be cheaper in terms of Yuan, causing a more than
proportionate increase in quantity demanded for Chinese imports from other
countries. This would reduce the trade deficit between China and the other
economies. (Extract 5, paragraph 8).

(d) When China is too dependent on exports and investments for growth, China is
putting itself into risk as both investments and exports cannot be directly controlled
by the Chinese government but are affected by external shocks. If there is an
instance of a worldwide recession, there would be a fall in the demand for Chinese
exports due to a fall in the national income of citizens from other countries. There
would also be a fall in foreign direct investment (FDI) during economic recession.
This would result in Chinas AD decreasing due to fall in net exports and investment,
resulting in contraction of the Chinese economy.

(e) When China aims for low growth rates, it may have to do so either via
contractionary policies which would result in a fall in the aggregate demand for the
Chinese economy. It can also be done so via increase in interest rates by the Bank
of China, causing a fall in investment and a subsequent decrease in AD. However,
the goal of achieving a low inflation rate would conflict with the goal of achieving
high employment. Due to the fall in investments, there would be a fall in demand
for employment due to a decrease in need for factors of production as productive
capacity is not expected to increase.
However, China is likely to benefit from such a move for aiming for low growth rates
due to China being able to shift its economic output from higher to lower reliance on
exports of consumer goods to decrease the risk of external shocks (Extract 5,
paragraph 9) from over-reliance on exports and also to compete adequately with
the increase in the import expenditure after the appreciation of the Chinese Yuan
which would result in cheaper foreign imports in terms of the Yuan. This benefits
China in terms of higher quality domestic goods to be produced to compete with
imported goods in China, allowing the consumers to benefit and also the domestic
producers to reap more profits.
There would also be structural changes in the Chinese economy due to a shift in the
output variation from coastal factories to inland production for domestic
consumption. There may be a worsening of income inequity among the citizens as
the wage rate of the workers working in inland areas may increase due to the
increase in demand for such workers. Cost-push inflation would also occur due to
increase in the wage rates, which may also make aiming for low growth rates show
any benefit for China.
However in the long-run, China is able to prevent inflation from occurring in its
economy and to be able to shift its economic output to be less reliant on external
demand and investment for economic growth, with the expense of conflicts with
cost-push inflation.

(f) China has the largest population in the world due to its huge country size.
Whether or not China will grow to become the worlds largest economy would
depend on other factors and not solely on just population size.
The large quantity of labour in China meant that the Chinese economy would have a
relatively large multiplier value as compared to other countries. Therefore, any
stimulation via increase in expenditure in the economy would result in a larger
multiplied increase in the national income of the Chinese economy. (Extract 4,
paragraph 3) In the long run, the increase in AD of China will allow the national
income of China to increase and become the worlds largest economy. This can be
debunked with the fact that China is experiencing an ageing population due to its
One-Child policy ( Extract 5 paragraph 9) which may result in decrease in the
labour force in China and may refute the assumption that China will become the
worlds largest economy just because of its large population.
However, China is able to become the worlds largest economy not merely by its
large population size but also due to free market reforms (Extract 5, paragraph 2),
which allowed China to trade with the international economy. This would increase
the export revenue of the Chinese economy due to more export destinations to
export products such as toys and clothing, which China has the comparative
advantage in the production, increasing the net export of the Chinese economy. This
would increase the AD of the Chinese economy, leading to increase in economic
growth and national income of Chinese citizens due to more profit earned by
Chinese producers who would increase income of their workers to increase
productivity to meet the increase in demand for Chinese exports. In addition, China
is less import reliant on other countries (Extract 5, paragraph 8), thus it would have
lower import expenditure. This increases the AD of China to allow China to become
the largest economy from trade.
The national income of China would increase significantly not due to the large
number or labour force China possess, but the fact that many citizens living at
coastal areas or countryside are moving to the cities (Extract 5, paragraph 5) to find
better jobs and attain the relevant skillsets. Due to the increase in the labour
available for employers in city areas, there would be an increase in the wages of the
workers and lead to an increase in national income due to increase in employment

in China and result in AD increase. This allows China to slowly become the largest
economy.
Therefore, to conclude that China would become the worlds largest economy just
because it has the largest number of people is being short-sighted. Instead, there
are other factors that contribute to Chinas increase in national income that result in
China becoming the worlds largest economy. However, the population and labour
size of China does play a part in amplifying the effects of the other factors
mentioned to allow multiplied effects of a larger scale (such as the movement of
workers from the coastal areas to inland cities) to contribute to China becoming the
worlds largest economy.