Term1Week10Tut2_answers

1.Refer to figure 1. Describe the change in investment cost amongst Asian countries in terms of US dollars. (2 marks)

Across Asia, the cost of investment fell [1 mark]
The degrees of reductions vary, for example, cost of investment in Vietnam increased [1 mark]

2.Using examples, suggest 2 reasons for the observation in question 1. (4 marks)

Technology improved with the ICT revolution that took place in the middle of 1990s. This reduced the cost of production, thereby reducing the price of machineries, especially the ICT equipments [2 marks; may use demand supply diagram to illustrate fall in price of ICT equipment, but not necessary]

There may be a fall in demand for investment goods during the 97 – 98 crisis. [1 mark]
Stocks/ inventories of investment goods may have piled up leading to a reduction in price and fall in output. [1 mark]

3.Which country is most likely to have pegged its currency to that of the US dollars? (2 marks)

China. [1 mark]
The fall in cost of investment in terms of the local currency in China is equal to the fall in terms of US dollars. [1 mark]

4.Which country’s currency depreciated the most against the US dollars? (3 marks)
Indonesia [1 mark]
While the cost of investment in Indonesia counted in terms of US dollars had fallen, the same cost increased in terms of Rupiah (Indonesia’s currency). [1 mark]
This suggests that the Rupiah had weakened in its value against the US currency. [1 mark]

5.Suggest and explain a reason for the depreciation amongst Asian currencies against the US dollar (3 marks)

Upon the onset of the Asian financial crisis, there was a massive capital outflow. This can be inferred from the statement that there was a “return” of overseas private capital to the region. There must have been a “departure” of such capital before there is a “return”. [2 or 1 marks]

Such a flight of capital from Asian economies would have reduced the demand for the economies’ currencies. The value of these currencies would hence fall. [1 or 2 marks]

{Candidate may choose to illustrate change in exchange rates via a diagram. }

6.Evaluate the sustainability of the rapid economic growth rate in Asian economies in year after the 1997 – 98 crisis. (8 marks)

Economic growth rates may be defined by actual and potential growth. The former is the rate of change in the volume of output produced within the country in a year. The later shows the increase in the economy’s capacity to produce. Sustainability of economic growth refers to the ability of the growth to be maintained and in the absence of high inflation rates.

Asian economies experienced high rates of actual economic growth after the financial crisis. First, exports increased, led by the electrical and electronic exports to the US. This increment in exports may be due to the depreciation of local currencies against the US and also a strong economic growth rate in the US itself. There is also increase in trade amongst the Asian economies as suggested by the identification of “active intra-regional trade” in the excerpt.

Asian economies also received inflows of international private capital. Short term capital inflow increases the firms’ abilities to increase their investment expenditures and to employ more workers. Long term capital inflow, probably in the form of foreign direct investments increased investments and employment directly, increasing the aggregate demand (AD) in the economy.

Increase in investments also implied that in the long run, aggregate supply (AS) may have increased (fig. 1), increasing potential growth. Output may be increased (Y0 to Y1
) with the lowering of the GPL (P0 to P1 ). Hence, the growth in Asia may be sustained.

The concern however is that AS may not have increased after all. The financial crisis may have caused governments to cut back on their investment spendings to reduce budget defict. This was exemplified by Taiwan (excerpt 2). As argued above, there might have been a capital flight from the economies, reducing investments in the earlier period. Fall in both public and private capitals would shift AS leftwards. With an increase in AD as identified above (increment in exports and consumption) in Asian economies, there may be a problem of inflation (fig. 2)

Depreciation of Asian currencies against the US dollars may also have increased the price of imports in Asian economies. Increment in these prices may have increased the cost of production if the imports are factors of production, and increased the consumer price index if the imports are finished consumer goods. Hence, depreciation of Asian currencies is a double edge sword. On one hand it increases the net exports of the Asian economies, on the other, it may bring about higher rates of inflation.

Reliance on the US economy may also be another problem. AD is sustained by exports to foreign regions such as the US. This makes Asian economies susceptible to adverse economic performances in these foreign regions.

In conclusion, there is much uncertainty revolving the rapid economic growth rates after the financial crisis in Asian economies, making such growth rates unsustainable.