H1 Case Study Question 1 Chinas Water Woes

Extract 1: China says water pollution so severe that cities could lack safe supplies China's booming economy is driving a rapid rise in water pollution so severe that densely crowded cities could be left without adequate supplies, a Cabinet minister said Tuesday. Limited water resources are threatened by pollution, and water safety in cities is facing severe challenges, said Qiu Baoxing, deputy minister of construction. The unusually blunt warning came after a separate government report last week said Chinese cities are threatened by rising levels of acid rain from industrial pollution. The reports emphasize the high environmental cost of China's surging economy in a dry, crowded country whose ecology already is strained by the demands of sustaining 1.3 billion inhabitants. The government has tried in recent years to rein in environmental damage, imposing air- and water-quality standards and restricting logging. But such efforts have had only limited success. More than 100 of China's 660 cities face extreme water shortages, Qiu said at a news conference. Intense demand by booming Chinese industries, farms and sprawling cities some of them with more than 10 million people has left many areas without adequate water supplies. China supports 21 percent of the world's population with just 7 percent of its water supplies, Qiu said. Conflicts over water supplies have led to violent clashes. In April, scores of people were injured in the eastern province of Zhejiang when police clashed with villagers who occupied an industrial complex that they said ruined their crops by polluting water supplies. The communist government has tried in recent years to rein in environmental damage, banning the clear-cutting of forests, imposing air-quality standards and forcing paper mills and other heavily polluting industries to close. Premier Wen Jiabao promised in February to make guaranteeing adequate supplies of clean drinking water a priority in his annual report to China's legislature on government plans for the year. This is an urgent matter, Qiu said. The minister called for local governments to step up enforcement of water quality standards, promote conservation and expand use of alternative sources such as rainwater and recycled sewage. But he didn't say how Beijing would finance these steps, leaving it unclear how many would be carried out.

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study Water shortages have been a constant worry for China for centuries. Problems have only worsened in recent decades as the population swelled and largely unregulated factories dumped toxic pollutants into rivers and lakes. Some 90 percent of China's cities and 75 percent of its lakes suffer from some degree of water pollution, Qiu said. The government is building a US$60 billion network of canals meant to move vast amounts of water from China's wetter south to Beijing and other parts of the arid north. The government says building the South-North Water Diversion could take 60 years. China will face growing shortages until 2030, when its population is projected to reach 1.6 billion people, Qiu said. According to the UN definition, at that time we will belong to countries that lack water, he said.
Source: China Daily, 7/6/2005

Extract 2: China should liberalise water pricing How to provide sufficient clean water to the vast and arid north of China has long been a headache for its rulers. Of late they have considered some ambitious proposals. One of the most hotly debated, to divert water hundreds of kilometres from Tibet at a cost of tens of billions of dollars, was scorned this week by the water minister. What about a more modest approach: using market-driven prices to deter waste and pollution? Market solutions do not come naturally to Chinese officials. China has been reluctant to impose tougher penalties on water polluters or higher tariffs on consumers. It fears that higher prices would drive industries away from the north and make it more difficult for struggling state-owned enterprises to turn a profit. It also worries about angering household consumers, particularly in the countryside. According to a government survey, water prices in 36 big cities have risen an average of 10 percent annually for the past three years (Beijing's have risen 30-fold in the past 14 years). But in August a government think-tank said prices remained only about a third of the world average. It called for price reforms to be speeded up. Raising prices, however, does not mean that the water industry itself, a monopoly controlled by local governments, has more incentive to operate efficiently. Although the government often talks of making decision-making more open, very little information is provided about how water rates are fixed. Since 2001 the government has required that public hearings be held before the raising of prices for necessities such as water and electricity. But these hearings have been stage-managed affairs. Mr Ma says the public would be more willing to accept water-price increases if the industry were more accountable.
Source: The Economist, 26th Oct 2006

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study
Table 1: Coverage and Projections for 2015 Urban Water Supply (in thousand) Urban population Country 1990 China India Japan 311,932 220,069 77,916 2002 492,049 293,874 100,295 1990 Served Pop. 311,932 193,660 77,916 2002 Served Pop. 452,686 282,119 100,295 Urban Pop. 694,139 401,341 86,114 Served Urban Pop. 680,256 401,341 86,114 Served urban population Projections for 2015

Source: http://www.adb.org/Documents/Books/Asia-Water-Watch/chap02.pdf

Table 2: Coverage and Projections for 2015 Rural Water Supply (in thousand) Rural population Country 1990 China India Japan 843,373 626,349 45,621 2002 802,818 755,675 27,145 1990 Served Pop. 497,590 382,073 45,621 2002 Served Pop. 545,916 619,654 27,145 Rural Pop. 708,162 845,059 41,086 Served Rural Pop. 601,937 845,059 41,086 Served rural population Projections for 2015

Source: http://www.adb.org/Documents/Books/Asia-Water-Watch/chap02.pdf

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study Tasks (a) (i) Compare the percentage of the coverage of urban water supply with that of rural water supply in China from 1990 to 2015. [2] Is water a public good? Justify. [2]

(ii) (b) (i)

With the aid of a diagram, explain why prices of water in China remained only about a third of the world average. (Extract 2, paragraph 2) [2] Who gains and loses as a result of such a policy mentioned in (b)(i)? [4] With the aid of a diagram, explain and illustrate how water pollution in China results in market failure. [6] If you were the Minister for Environment, explain whether the water industry should be privatised. [6] Evaluate the effectiveness of the current measures taken by the government as mentioned in Extract 1 as well as one other measure to reduce water pollution in China. [8]

(ii)

(iii)

(c)

(i)

(ii)

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study Question 2: Too hot to handle - India's economy

Extract 3: India's economy runs the risk of overheating India's curries can be even hotter than the fieriest of Chinese hotpots; likewise the temperature of the two economies. Despite widespread claims that China's economy is overheating, actually India's shows more signs of boiling over. By mid 2006, India's GDP grew by an impressive 8%, while China's figures show even more breathtaking growth of 10%. But to judge whether an economy is too hot, one needs to compare this expansion in actual demand with potential supply, ie, the sustainable rate of growth. Figure 1
Spicy Ingredients Consumer prices, % change on a year earlier

Source: IMF

India's economy displays an alarming number of signs that things have gone too far. Consumer-price inflation has shot up, well above Asia's average rate of 2.5%. Firms are also experiencing a serious shortage of skilled labour and wages are rocketing. India's recent acceleration is largely thanks to loose monetary and fiscal policy. This makes the economy more vulnerable to a hard landing. The danger of red-hot curries is that they can leave one gasping and in tears.
Source: edited from The Economist, 25 November 2006

Extract 4: Indias infrastructure bottlenecks It is easy, perhaps too easy, to become pessimistic about the deficient Indian infrastructure, which includes everything from potholed roads and clogged airports to frequent power blackouts and creaking urban transportation. Also, the highly indebted Indian government has not the funds to make a decisive improvement, which is estimated to require additional spending equal to 3.4 percent of gross domestic product. Supply-side bottlenecks, may become a short-term impediment, especially if the economy continues to grow at its current pace. The strain on infrastructure is stupendous.
Source: edited from Bloomberg News, 24 November 2006

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study Extract 5: India's central bank lifts key rate to curb inflation The Reserve Bank of India increased its key interest rate for the fourth time this year to rein in inflation even as the Indian economy continued to expand at a furious pace. Experts feel that the rise in interest rates could fail to quell the rapid pace at which the economy is growing. Consumer spending is on the rise, as Indians with disposable incomes are borrowing from banks to splurge on a variety of purchases ranging from homes to cars. The government, too, is stepping up investments in infrastructure like roads, energy plants and ports.
Source: edited from International Herald Tribune, 1 November 2006

Table 3: Fiscal budget (% of GDP) for selected Asian countries

Selected Asian countries China Hong Kong Taiwan India Singapore 2001 -2.3 -4.9 -6.4 -9.9 -0.3 2005 -1.6 0.3 -1.0 -7.6 8.0
Source: ADB (2006)

Table 4: India: Selected Economic Indicators, 2001-2006

2001 Growth rate of GDP (% per year) Inflation rate (% per year) Current account balance (% of GDP) Annual rate of unemployment (%) 5.8 3.9 0.7 9.2 2002 3.8 4.3 1.3 10.5 2003 8.5 3.8 2.3 10.1 2004 7.5 3.9 -0.8 10.4 2005 8.1 4.0 -2.5 8.9 2006 7.6 6.9 -3.0 --

Source: ADB (2006) and India statistics website

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H1 Case Study Tasks (a) (i) Using Figure 1, compare the change in consumer prices for India and China from 2002 onwards. [2] Define the term inflation" and explain its impacts on India. [3]

(ii) (b) (i)

Referring to Table 1, explain the current state of Indias fiscal budget. [2] Explain why the current fiscal budget is unsustainable in the long run. [3] Explain how loose monetary and fiscal policy can result in India running the risk of overheating. (Extract 1, Lines 11-12) [6] Assess the impact of a possible hard landing (Extract 1) of the Indian economy on Indias economic indicators shown in Table 2. [6] Assume you are the economic advisor to India. Justify the economic policies that you would recommend to avert India from overheating. [8]

(ii)

(iii)

(c)

(i)

(ii)

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H2 Case Study Question 1 The petrol retailing industry

Extract 1: Petrol price cut sparks pump war Morrisons has sparked a round of price-cutting among the UK's major petrol retailers in the run up to Christmas. The supermarket chain said it was reducing the price of unleaded petrol by 3.5p to 79.9p per litre. The 4% cut was quickly matched by rivals Asda, Sainsbury's and Tesco while Shell, Esso and BP said they would shave a few pence off prices. Using low petrol prices to get customers into stores is a tactic commonly used by supermarkets. It is designed to increase footfall in stores in the lucrative preChristmas period. The oil giants Shell, Esso and BP also responded, saying they would cut their prices by up to three pence a litre.
Source: BBC News, 10 December 2004
Extract 2: UK

petrol prices continue to rise

UK petrol and diesel prices continued to rise in the wake of Hurricane Katrina, with the average cost of petrol now at 94.6 pence a litre. The average cost of a litre of unleaded petrol rose by more than 2p over the weekend from 92.3p on Friday, according to figures from industry body Catalist. Average diesel prices now stand at 97.3p - up from 95.8p - and are expected to top 1 in the coming weeks. Prices rose sharply after Katrina shut oil rigs and refineries in the US. The price spike has been prompted by fears of supply shortages, with 80% of crude oil production in the Gulf of Mexico still out of action. Of the eight refineries closed in Louisiana and Mississippi following Katrina, only one had managed to restart on Sunday. Officials warned that two of the biggest refineries still out of action could remain closed for months because of extensive flooding damage. Retailers such as BP and Shell have been considering how to alter their signs in anticipation of diesel prices rising above 1 a litre. Ray Holloway, director of the Petrol Retailers Association (PRA), said diesel was almost certain to top the 1 mark. "I regret to say that diesel is (going to go above 1 litre) and that is because we have a shortage of the product," he told the BBC. Prices were expected to rise still further later in the year, he added. "Diesel motorists will be complaining about that and perhaps asking the Chancellor about the tax position."

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H2 Case Study Motoring groups have called on the government to cut fuel excise duty to ease the burden on consumers of higher petrol costs. They argue duty levels should reflect the sharp rise in crude oil prices, which hit a record high of $70.85 last week. "Current hikes are fuelling inflation and hitting those low-income and rural car dependent motorists hardest," said Edmund King, executive director of the RAC Foundation. "The Chancellor could and should introduce a mechanism whereby fuel duty is reduced if world prices hit a certain level."
Source: BBC News, 5 September 2005

Figure 1

Figure 2

Extract 3: The

well that wont dry up

The government is doing very nicely out of rising oil prices, collecting at least 1.5 billion this year alone. If the price stays above $60 a barrel for the foreseeable future that figure could jump to 3.5bn next year. Part of the windfall for the Treasury comes from Britain's motorists, who are paying more than 1.5 million extra VAT a day - or around 500m in a full year compared with the start of 2005, as petrol prices have crept inexorably towards 1 a litre. But the biggest contributors have been the oil companies themselves, who could have to find an extra 1bn in corporation tax this year, according to the Institute for Fiscal Studies.
Source: The Observer, 21 August 2005

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

H2 Case Study Tasks (a) (i) Summarise the changes in the UK petrol prices from 1995 to 2005. [2] (ii) Explain a reason why the government might have imposed a high level of tax on petrol. [2]

(b)

Using demand and supply diagram, show the outcome of Hurricane Katrina on the equilibrium price and quantity of petrol. [2] Justify the type of market structure for the petrol retailing industry in the UK.[8] Discuss how retailers like BP and Shell can increase their profits in the future. [6] In the light of rising petrol prices, is lowering taxes on petrol the best way for the UK government to curb its increase? Discuss. [10]

(c) (d)

(e)

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

10

H2 Case Study Question 2 US Twin Deficits

Extract 4: US deficit may pose 'global risk' Recession, tax cuts and high spending for the war on terrorism have resulted in large deficits, the IMF said. That could place upward pressure on interest rates, and pose risks for the US economy and rest of the world. International investors could also lose confidence in the dollar which could force them to consider investing elsewhere. Noting the dollar's recent slide against the euro, UK pound, and yen, the IMF said an unrestrained drop could have serious consequences at home and abroad. The IMF report said the dollar has been affected by the mushrooming US current account and budget deficits. "This trend (of deficits) is likely to continue to put pressure on the US dollar, particularly because the current account deficit increasingly reflects low saving rather than high investment," the IMF said.
Adapted from: BBC News, 7 Jan 2004

Extract 5: Greenspan Plays Down 2 Threats to U.S. Economy To finance its ballooning budget and trade deficits, US has been borrowing record amounts from foreign investors and banks. The risk is that foreign investors could balk at continuing to lend the money needed just to finance that deficit. This however, has not become a problem so far. Playing down the threat, the Federal Reserve chairman Alan Greenspan said that neither the huge trade deficit nor large currency interventions by Japan and China pose a serious threat to the United States. Mr. Greenspan said the increasing willingness of people around the world to invest outside their home countries had enabled the United States to borrow much more money than it could have comfortably managed several decades ago. And he said that the economy of the United States is flexible enough that a decline in the value of the dollar could lead to a fairly smooth reduction in the nation's trade deficits.
Adapted from: The Straits Times, 13 Jan 2004, The New York Times, 14 Feb & 3 March 2004

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

11

H2 Case Study Extract 6: Asia in a risky tug-of-war over US dollar The current account deficit is more than 5% of GDP. Unless the dollar weakens, it will continue widening, making the imbalance bigger and more dangerous. It would help if Asia just left the dollar alone but Asian central banks are stepping up dollar sales to pull the dollar the other way, fearing stronger currencies will slam growth.
Adapted from: The Straits Times, 27 Jan 2004

Extract 7: An overview of the US economy Optimism is returning after a slowdown in 2000, exacerbated by the September 2001 terrorist attacks, but unemployment is high and the budget and trade deficits are at near-record levels.
FIGURE 3

In the red The Federal government spends about $2 trillion each year. Much political effort in the 1990s reduced the budget deficit, pushing it into surplus in 1998. But the effects of the 2001 recession, tax cuts and increased military spending have pushed it deeply into the red.

FIGURE 4

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

12

H2 Case Study Jobless recovery Unemployment fell sharply during the 1990s economic boom, but the recession pushed it up to 6.4% by mid 2003. It has fallen as economic recovery has begun, but slowly, as high productivity means firms can produce more goods without needing more workers.
FIGURE 5

High imports, low exports The growing size of the trade deficit has worried foreign investors, and they are starting to withdraw funds from the US, thus lowering the value of the dollar.

FIGURE 6

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

13

H2 Case Study Falling inflation Inflation has remained subdued in the US, even during strong growth. It briefly flared up at the end of the boom in 2000, causing a sharp rise in interest rates. But despite deep interest rate cuts during the past two years, inflation is still falling.
FIGURE 7

Low interest rates The US central bank, the Federal Reserve, sets short-term interest rates (the Federal Funds rate). Since the recession began, especially since the 2001 terrorist attacks, it has cut rates 13 times to a 50-year low of 1%, helping boost economic growth. With no signs of inflation, rates are expected to stay at their historic low for most of 2004.

FIGURE 8

Source: BBC News

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

14

H2 Case Study Tasks (a) (i) Describe the trend in the US budget deficit position in the decade 1993 to 2003. [2] Do you agree that such a change in the budget deficit from end of 2003 is a cause for concern for the US government? [5]

(ii)

(b)

To what extent does the data support the theoretical relationship between a country's trade balance and its real GDP? [5] What might have prompted the Federal Reserve Bank to institute a series of rate cuts between 2001 and 2004? Assess the success of such a policy. [8] "Unless the dollar weakens, it (the current account deficit) will continue widening, making the imbalance bigger and more dangerous." (Extract 3) Discuss whether you believe the weakening of the US dollar against the euro, pound and yen in the fourth quarter of 2003 will help US correct its current account deficit. [10]

(c)

(d)

TPJC/Economics/ 2007 Preliminary Examination / H1 H2

15