**Indonesia’s Path to Economic Reform**

• Correct Lorenz curve diagram, with correct axes labeling. 1 mark
• Line of perfect equality shown. 1 mark
• Correct shift downward (according to Figure 1, Indonesia's Gini coefficient increased from 0.35 in 2007 to 0.41 in 2013, showing worsening income distribution). 1 mark

• The diagram shows that imposing a tariff raises the price of imported goods from Pw to Pw+t, making them less competitive compared to domestically produced goods.
• As shown in the diagram, domestic production increases from Q1 to Q2 as domestic producers can now capture more market share.
• The case study mentions that Indonesia has "introduced trade protection measures, including tariffs and import restrictions, to shield domestic industries."
• These measures protect emerging industries that Indonesia is trying to develop, such as "transportation, telecommunications, metal production, and agricultural processing."
• By restricting imports (decreasing from Q4-Q1 without tariff to Q3-Q2 with tariff), the government creates space for domestic industries to grow without facing intense foreign competition.
• Tariff revenue (the area between Pw and Pw+t for quantities Q2 to Q3) provides additional government income that can be invested in supporting domestic industries.
• This policy aligns with Indonesia's efforts to respond to "falling global prices of coal, gold, and palm oil" by diversifying its economy and reducing dependence on commodity exports.

2 marks for correct diagram OR explanation

4 marks for correct diagram AND explanation

• The diagram illustrates how reducing fuel subsidies in Indonesia creates cost-push inflation through a leftward shift of the SRAS curve (from SRAS₁ to SRAS₂).
• As mentioned in the case study, the government has "reduced fuel subsidies, despite their role in making energy affordable for low-income households."
• This policy change increases production costs across the economy as fuel is an essential input for transportation, manufacturing, and electricity generation.
• The economy moves from equilibrium E₁ to E₂, resulting in a higher price level (from PL₁ to PL₂) and lower real GDP (from Y₁ to Y₂).
• The case study confirms this effect by stating that reducing fuel subsidies "has contributed to inflation, which has surged to 7.26%, exceeding the central bank's target of 3–5%."
• This higher inflation reduces consumer purchasing power and may explain the "declining consumer confidence" mentioned in the case study.
• The policy creates a difficult trade-off for Indonesia between fiscal sustainability (funding the $22 billion infrastructure projects) and short-term price stability.

2 marks for correct diagram OR explanation

4 marks for correct diagram AND explanation

• The PPC diagram shows Indonesia's current production capacity (the blue PPC curve) and potential improvement from point A to point B through investment in education and vocational training.
• The case study mentions that "the government is focusing on education and vocational training, aiming to reduce unemployment by upskilling its youthful workforce."
• Education and vocational training enhance human capital, allowing the economy to produce more manufactured and agricultural goods with the same resources, shifting production inside the curve (point A) to a point closer to or on the curve (point B).
• This investment represents a long-term growth strategy addressing Indonesia's slowing economic growth, which declined from 6.5% in 2011 to 5.1% in 2014 as shown in Figure 2.
• By improving the skills of Indonesia's workforce, the country can move toward producing higher value-added goods in emerging industries like "transportation, telecommunications, metal production, and agricultural processing."
• Enhanced productivity through education helps the economy become more resilient to external challenges such as "falling global prices of coal, gold, and palm oil."

(Note: the investment in education does not shift the PPC curve outwards because it will increase the use of unutilised labour: "aiming to reduce unemployment by upskilling its youthful workforce").

2 marks for correct diagram OR explanation

4 marks for correct diagram AND explanation

Answers may include:

Definition

• Economic growth: An increase in a country's real output (real GDP) over a period time.

• Economic development: The process of increasing real per capita income while improving living standards and reducing poverty within an economy as whole.

• Economic growth refers to increases in real output over time, whereas economic development refers to a process that leads to improved living standards for a population as a whole.

• Increasing levels of output and incomes resulting from economic growth do not, by itself, guarantee economic development.

Infrastructure Investment and Long-Term Growth

Increased Government Spending and Multiplier Effect

• The government is investing USD 22 billion in infrastructure, which boosts aggregate demand (AD) and creates positive supply-side effects in the long run.
• Improved infrastructure reduces transaction and transportation costs, increasing productivity and attracting private and foreign investment in sectors like transportation and agricultural processing.
• Infrastructure investment has the potential to shift the long-run aggregate supply (LRAS) to the right, enhancing potential output and sustainable growth.

Limitations

• Infrastructure projects are capital-intensive and subject to corruption risks, which could reduce efficiency and misallocate resources.
• Despite investment efforts, GDP growth has slowed from 6.5% in 2011 to 5.1% in 2014 (Figure 2), indicating that the measures have yet to translate into strong short-term growth outcomes.
• High reliance on infrastructure spending without parallel improvements in governance may reduce multiplier effects.

Fuel Subsidy Reduction and Reallocation of Resources

Efficiency and Fiscal Space

• Reducing fuel subsidies reallocates public funds toward education, vocational training, and infrastructure, which are development-enhancing sectors.
• Removing subsidies reduces wasteful consumption, improves price signals, and frees up fiscal resources to support inclusive growth strategies.

Cost-Push Inflation and Regressive Effects

• Inflation surged to 7.26%, exceeding the central bank’s 3–5% target, eroding real incomes and potentially worsening relative poverty for low-income households.
• Without well-targeted compensation mechanisms, the policy is regressive, disproportionately impacting the poor who rely more on subsidized energy.
• Inflation may reduce consumer confidence and private consumption, weakening short-term economic growth.

Human Capital Investment and Labor Productivity

Vocational Training and Education

• Investment in education and vocational training targets structural unemployment and aims to upskill the youthful workforce, improving labor productivity and human capital accumulation.
• Improvements in education contribute to economic development by enabling upward mobility and higher incomes in the long run.
• The HDI has risen from 0.654 in 2008 to 0.684 in 2013, suggesting gradual improvement in human development indicators (Figure 1).

Limitations

• Gains in human capital take time to materialize, and benefits may be unevenly distributed, particularly in rural areas.
• The Gini coefficient increased from 0.35 in 2007 to 0.41 by 2013, indicating rising income inequality despite development efforts.

Tax Incentives and Trade Protectionism

Industrial Growth and Domestic Production

• Tax incentives for sectors like telecommunications, transport, and agriculture aim to support sectoral diversification and reduce overreliance on extractive exports such as coal and palm oil.
• Trade protection through tariffs and import restrictions may protect infant industries, creating jobs and supporting domestic value-added production.

Inefficiency and Global Competitiveness

• Protectionism can lead to inefficient domestic firms, reduced innovation, and resource misallocation, lowering long-term competitiveness.
• Export revenue has declined from USD 230 billion in 2011 to USD 185 billion in 2014 (Figure 2), while the trade balance fell into deficit (-USD 1.2 billion), reflecting external sector weakness.
• Overreliance on protection may undermine Indonesia’s integration into global markets, limiting the benefits of comparative advantage.

Support for SMEs and Inclusive Growth

Micro-credit Access and Entrepreneurship

• Expanding access to micro-credit encourages entrepreneurship, especially in rural areas, promoting inclusive growth and employment.
• SMEs can become engines of job creation and income generation, particularly for women and youth.

Limitations

• Micro-credit alone may not be sufficient if infrastructure, regulatory frameworks, and market access remain underdeveloped.
• Without appropriate training and support, credit may lead to low-return investments and debt traps, especially in vulnerable groups.

Overall Effectiveness in Achieving Growth and Development

Strengths

• The combination of infrastructure investment, human capital development, and industrial incentives addresses both short-term growth and long-term structural transformation.
• HDI improvements and reduced absolute poverty (from 37 million in 2007 to 28 million in 2014) suggest progress toward development goals.
• Micro-credit and SME support contribute to bottom-up economic participation.

Weaknesses

• Slowing GDP growth and rising inflation constrain the effectiveness of current reforms in the short term.
• Income inequality is rising, as shown by the increasing Gini coefficient, indicating that growth may not be inclusive.
• Trade protectionism and inflationary pressure from subsidy cuts may hinder external competitiveness and household welfare, reducing development gains.

Conclusion

Indonesia’s current measures show significant potential for long-term economic growth and development, especially through infrastructure, education, and SME support. However, short-term inflationary pressures, trade imbalances, and inequality pose serious challenges. The overall success of the reforms depends on balancing macroeconomic stability with inclusivity and institutional effectiveness.