1

No. Title Page No.

1 Chapter 1: Scarcity, Choice and Opportunity Cost 2-3
2 Explain two ways in which an economy might move from a point within
its PPC to a point on it.
4
3 Discuss the most effective economic policies to move the PPC outwards. 5
4 What is meant by the basic economic problem of scarcity? 6
5 Discuss whether economic growth solves the problem of scarcity. 7
6 Chapter 2: Resource Allocation in Competitive Markets I 8-9
7 A manufacturer wishes to sell more of his product. How may he try to
achieve his aim?
10
8 Chapter 3: Resource Allocation in Competitive Markets II 11-13
9 Explain price elasticity of demand and income elasticity of demand. 14
10 A government is proposing to increase the tax on petrol. Examine the
relevance of price elasticity of demand and income elasticity of demand
for this proposal.
14
11 Assess the relevance of elasticity concepts in explaining the effects of the
worldwide recession caused by the 911 terrorist attacks on the airline
industry.
15-16
12 Chapter 4: Microeconomic Problems: Market Failure 17-18
13 Policies on Pollution and Evaluation Summary 19-21
14 Policies on Pollution and Congestion caused by Cars Summary 22-23
15 Chapter 5: Government Intervention in the Market I 24
16 Chapter 6: Firms and How They Operate I 25-30
17 Discuss whether rising costs limit the size of firms over time. 31
18 Banking Merger in Singapore Analysis 31
19 Chapter 7: Firms and How They Operate II 32-38
20 Discuss the view that the profit motive will always lead to a few large
firms dominating the market for each and every type of product.
39
21 Explain what is meant by productive and allocative efficiency. 40-41
22 A firm should be encouraged to maximize profits because this makes it
efficient. Discuss whether this argument is true for a firm operating in an
imperfect market.
42
23 Distinguish between monopolistic competition and oligopoly. 43
24 Explain why oligopoly is a common market structure in many economies. 44
25 Explain why governments throughout the world have been involved in
the supply of services such as electricity.
45
26 Chapter 8: Government Intervention in the Market II 46-48
J1 Topics
2
Chapter 1: Scarcity, Choice and Opportunity Cost

1. Introduction
Study of the use of scarce resources to satisfy unlimited human wants
Wants: things people would consume if they had unlimited income
Resources: inputs to produce goods and services
Scarcity exists due to unlimited wants + worn out goods + newer goals
Positive (can be checked by facts) vs. normative (statement of value)

2. Factors of Production
Land: productive resources supplied by nature
Labour: human effort directed to the production of goods and services
Supply: number of workers + average number of hours each worker is
prepared to offer
Specialisation
Dexterity, greater use of machinery and more sophisticated
production techniques
Monotony, loss of craftsmanship, increased risk of structural
unemployment
Capital: man-made resource used in further production
Involves postponing present consumption
Entrepreneurship: takes risk of being in business
Information: data for the basis of knowledge-based economy

3. Opportunity Cost
Real cost in terms of the next best alternative foregone
Calculating opportunity cost requires time and information
Opportunity cost may vary with circumstance
Economic rent: difference between what is earned and what could have been
earned
Used in specialization and trade

4. Production Possibility Curve
Maximum attainable combination of two goods and services that can be produced in
an economy, when all available resources are used fully and efficiently, at a given
state of technology
Assumptions: fixed amount of resources, factors fully and efficiently employed,
technology fixed, time period give, 2-product model
Fully: using all resources available
Efficiently: do as many things you can with the resources used
Scarcity: unattainable combinations outside PPC + society has to choose among
combinations of 2 goods
Shift: quantity and quality of resources (think FOP) + technology skewed?
Choice between instant gratification and improving economy in the future
3













5. The Marginalist Principle
Consume till MPB = MPC: cost of producing an additional unit of good = benefit of
consuming an additional unit of good
For the price mechanism to work, information need not be known with perfect
accuracy by every individual acting in the marketplace: dependent on marginal
buyers who keep suppliers on their toes

6. Efficiency
Static efficiency: how much output can be produced now from a given stock of
resources at a given point in time
Dynamic efficiency: changes in the amount of consumer choice available in markets
together with the quality of goods and services available
Productive efficiency: absence of waste in the production process = minimizing the
opportunity costs for a given value of output
Allocative efficiency: society produces and consumes a combination of goods and
services that maximizes its welfare
Distributive efficiency: goods and services produced to those who want or need
them
Wheat
Cloth 0
*Draw dotted line to show comparison
between 2 countries with a common
yardstick
4
Explain two ways in which an economy might move from a point within its PPC to a
point on it. [10m]

Introduction
Define PPC













Body
A. Increase employment of resources
Lower wages to be more competitive may be enticed to produce more goods
Fiscal policy: increase government spending eg. circle line multiplier effect
Monetary policy: lower interest rate firms borrow more, increase investment

B. Increase efficiency in use of resources
Pay based on productivity: but only for jobs where output can be measured
(factory workers)
Reallocate resources to more efficient uses
Retraining

A
B
Good X
Good Y O
A: resources not fully utilized
underemployment and
unemployment

B: efficient use of resources full
employment
5
Discuss the most effective economic policies to move the PPC outwards. [15m]

Introduction
Outward shift: increase in productive capacity sustain economic growth over long run

Body
A. Labour
Increase birth rate but difficult to do so in developed countries female labour
force participation + need lots of incentives
Education and training but takes long time and does not necessarily yield results
Foreign talent through tax incentives

B. Capital
MNCs investment (machines) + learn their technological knowledge
Invest in r+d

C. Entrepreneurship
Incentives and subsidies to start businesses

D. Land
Reclamation

Conclusion
Depends on which country
Eg. For USA: encourage capital goods, less consumption goods. For China:
entrepreneurship

6
What is meant by the basic economic problem of scarcity? [12m]

Introduction
Scarcity scare resources, unlimited wants

Body
Scarcity choice opportunity cost

1) Individual: time; consumer; how to maximize use of limited resources more labour /
more machines

2) Firm: least-cost combination of resources in order to maximize profits

3) Government: choice between competing projects; cost-benefit analysis

4) Economy: problem of how to allocated scare resources efficiently best illustrated by
the PPC












(Brief) Implications:
Trade as a solution to alleviate scarcity
Trade-off between consumer goods and capital goods
What (how scarcity affects decision-making of an economy), how much, for
whom and what to produce (market system)
E
Good X
Good Y O
6
4
5 6
7
Discuss whether economic growth solves the problem of scarcity. [13m]

Introduction
Economic growth increase in national income generally get to consume more goods
and services

Body
1) Increase in quantity and quality of resources increase in productive capacity
Labour: due to reduction in unemployment and underemployment
Skills and educational level
Land
Capital stock: most effective way to alleviate problem of scarcity more capital
economy produces in one period, more output capital can produce in the next to
satisfy wants in society

2) Technological improvement increase in productive capacity: better and new
methods of producing goods
R + d technological breakthrough new products create more wants

3) Increase in income consumers able to satisfy wants
But with greater affluence, people have more wants due to advertising and
promotions luxury goods of the past may become necessities

4) Supply limited
Demand accelerating China / India economic growth
Crude oil important as it is a source of fuel
Eg. land in Singapore
But technological improvements allow society to make use of renewable
resources as sources of energy
But more wants created

5) Equity in distribution
Economic growth does not guarantee a reduction in income gap
Corruption, food shortages



8
Chapter 2: Resource Allocation in Competitive Markets I
*Assumption: Many buyers and sellers such that no single buyer / seller can exert
control over market price (price takers)

1. Demand Theory
Demand: amount that consumers are willing and able to purchase at each given
price over a given period of time
Demand curve slopes downwards
Income effect: effect of change in real income resulting from change in price
of good
Substitution effect: effect of change in price on quantity demanded arising
from consumer switching to, or from, alternating products
Determinants
Price
Taste: education, culture, age group, health scares
Interrelated goods: substitute vs. complement
Population: absolute change, change in composition
Seasonal changes: climate, festival
Expectations of the future: future changes in price / income
Real disposable income: changes in taxes / money income
Redistribution of income
Consumer surplus: difference between maximum amount consumers willing to pay
for a given quantity of good and what they actually pay

2. Supply Theory
Supply: quantity of a good or service producers are willing and able to offer for sale
at each given price over a given period of time
Determinants
Price
COP: change in price of factor inputs
Other prices: joint / competitive supply
Innovation: lower production costs
Natural factors: climate, unexpected events
Government policies: indirect taxes, subsidies
Number of sellers
Producer surplus: difference between amount received by producers and minimum
amount they are willing and able to accept for the supply of a commodity

3. Market Equilibrium
Buyers and sellers satisfied with current combination of price and quantity bought or
sold, and are under no incentive to change their present economic actions
9
Adjustment to equilibrium
Below equilibrium
Shortage consumers compete for goods, bidding up prices price
increases, quantity supplied increases shortage eliminated market
settles at equilibrium
Above equilibrium
Surplus - producers reduce prices to get rid of stocks increase sales
and decrease production price falls, quantity demanded increases,
surplus eliminated market settles at equilibrium
Shifts in supply and demand: consider individual effects on price and quantity then
sum up
Interrelated demand and surplus
Joint / competitive / derived demand
Joint / competitive supply

4. Case Study
When asked to explain how a group of people intend to affect a certain market,
bring in limitations
Elasticity of demand
Responses of other firms / groups of people
Analyse theoretically first, then see how and why the data fits / does not fit the
theory
Desirability: consider for whom: producer, consumer, society
Effectiveness: limitations, long run vs. short run

10
A manufacturer wishes to sell more of his product. How may he try to achieve his aim?
[12m]

Introduction
Sell more only considering equilibrium quantity increase demand / supply
Effect: long run vs. short run

Body
1) Increase demand: explain effect on quantity demanded
Advertising and promotion: create product differentiation and brand loyalty
Competitive market: other firms will do likewise as they fear losing market
share
Huge funds need to be devoted increase COP reduce profits
If firm passes cost increase to consumers in terms of higher prices
fall in quantity sold assuming demand elastic total revenue falls
But unable to increase price in competitive market firms may
engage in price wars
But in long run if campaign successful in altering peoples taste and
preference rise in quantity sold
Expanding number of markets: go regional / global
Easier to penetrate markets where demand for product more price elastic
Increase supply fall in price more than proportionate rise in
quantity demanded
Improve quality of product / increase product differentiation through better
sales service / improved packaging
Effect of money spent for r+d on
Costs then price of product
Market share in long run (increase)
Deliberate attempt to reduce price of good through discounts
Price elasticity of demand
How long discount can be sustained without eroding profits

2) Increase supply: explain effect on quantity demanded
Investment in r+d
Lower COP, more efficient production methods, better quality products
Raising productivity through greater specialization and better labour-capital
combination
Sourcing cheaper sources of raw materials
Evaluation
Reduces price may conflict with profit maximization
More effective strategy if selling product that is price demand elastic mass
produce reap EOS lower prices increase sales volume more than
proportionately
11
Chapter 3: Resource Allocation in Competitive Markets II

1. Price Elasticity of Demand
Measure of degree of responsiveness of quantity demanded of good to a change in
its price, ceteris paribus
Coefficient: sensitivity of consumers to price changes
Negative: inverse relationship between price and quantity demanded
Determinants
Availability of substitutes
Necessities vs. luxuries
Proportion of income
Time period: longer switch to substitutes more price elastic
Usefulness
Government taxation policies: raise revenue, discourage consumption
Firms pricing policy
Effectiveness of trade unions: can ask for higher wages if demand for product
is price inelastic
Price stability: prices more volatile if demand more price inelastic when
supply shock

2. Income Elasticity of Demand
Measure of degree of responsiveness of demand of good to change in consumers
income, ceteris paribus
Coefficient
Negative: inferior good
Positive: normal good
Less than one: necessities
More than one: luxuries
Usefulness
Production plans: boom vs. recession
Targetting different income groups: segment market

3. Cross Elasticity of Demand
Measure of degree of responsiveness of demand of good to change in price of
another good, ceteris paribus
Coefficient
Negative: complement
Positive: substitute
Usefulness
Effects on products demand when faced with change in price of rivals
product
Strong complements can sell jointly

12
4. Price Elasticity of Supply
Measure of degree of responsiveness of quantity supplied of good to a change in its
price, ceteris paribus
Positive: direct relationship between price and quantity supplied
Determinants
Time period: longer supply more price elastic because possible to change
anything
Factor mobility
Number of firms: more supply more price elastic
Stocks and spare capacity: more can produce more supply more price
elastic
Length of production period: shorter supply more price elastic
Usefulness
Taxation: incidence
Price stability

5. Government Policies
Taxation / subsidies
Demand more price inelastic higher incidence
Incidence: distribution of burden between consumers and sellers
Minimum price
Protect income of producers
Creates surplus for future shortages
Financing annual surpluses burden on taxpayers not good in long run
Cushion inefficiency
New producers attracted increase surpluses unless government has
measures to increase demand
Maximum price
Lower-income consumers to afford necessities
Protect consumers
Allocation of goods may be biased
Black market, especially during war time
Government can encourage supply by drawing on past surpluses, giving
subsidies and tax relief, reducing demand by controlling income

6. Case Study
Note difference between elasticity of the product and the elasticity of the final
product (which involves the use of the product)
Note difference between less inelastic and more elastic
When asked how a strategy might affect a company, consider effect on total
revenue then profits
13
7. Essay
Limitations to using elasticity concepts to explain price changes
Elasticity concepts are static need to relax ceteris paribus assumption in
reality simultaneous changes occur need to consider relative magnitudes
of changes in demand and supply
Coefficients of elasticity mere estimates
Consumers not homogenous group
Among high-income earners, there are the yuppies seeking the high
life and are likely to be more price and income sensitive compared to
foreign investors who would consider socio-political factors
May not consider some goods as substitutes
14
Explain price elasticity of demand and income elasticity of demand. [10m]

Definition
Formula
Sign
Coefficients: range of values for elastic / inelastic
Examples with their estimated values

A government is proposing to increase the tax on petrol. Examine the relevance of
price elasticity of demand and income elasticity of demand for this proposal. [15m]

Introduction
Assume specific tax for simplicity
Uses of petrol: firms and commuters transportation
Normal good: income increase demand for cars increase demand for petrol increase

Body
1) Demand for petrol price inelastic: explain why
Increase in indirect tax supply falls at given price supply curve shifts vertically
upwards by amount of tax
Demand for petrol inelastic fall in quantity demanded less than proportionate
Relevance: need high tax if government wants to reduce consumption to desired
level

2) Income elasticity of demand less relevant because it is due to changes in income tax
on petrol affects price directly, not income
Government likely to be less successful if they increase tax on petrol in period of
economic boom
Boom: incomes rise demand for cars (luxury good) increase by more than
proportionately derived demand increase demand for petrol

15
The terrorist attack on New York on 11 September 2001 caused a worldwide recession
and an increased fear of flying, both of which severely affected the demand for travel
by air. This led to the closure of some of the major airlines in the world.

Assess the relevance of elasticity concepts in explaining the effects of these events on
the airline industry. [15m]

Body
1) Price elasticity of demand
Definition
When supply of airlines fell due to closure of major airlines price expected to
increase quantity demanded fall by more than proportionate total revenue
fall
Relevance
Airlines should expect that reducing supply causing a rise in price can lead to
a fall in total revenue
But the demand for travel for business is likely to be inelastic. So price
increase less than proportionate fall in quantity demanded total revenue
increase
Effect on total revenue depends on size of business market vs. holiday
makers
Due to the ceteris paribus assumption, the above will only take place if other
factors remain constant. In this context, incomes have changed causing
demand curve to shift total revenue fall

2) Income elasticity of demand
Definition
Air travel luxury good for most, necessity for business travelers
Relevance
Recession fall in income fall in demand fall in total revenue
Implication: individual airlines need to reduce price / engage in non-pricing
strategies to increase market share

3) Cross elasticity of demand
Definition
Potential substitutes: train / coach / ship
Degree of substitutability depends on the length of flight
Long haul flights: weak substitutes especially for business travelers
Short distance: stronger substitutes
If another airline (eg. Qantas) reduces price to increase market share fall in
demand for a particular airline (eg. SIA) SIA reduces price price war may not
cover costs erode profits
Budget airlines also pose as competition
16
Airlines close down routes / less schedules fall in supply increase price
Demand inelastic: long haul flights no close substitutes total revenue
increase
Demand elastic: short distance flights switch to trains / coaches total
revenue falls

4) Price elasticity of supply
Definition
Fall in price fall in quantity supplied
But short run: supply price inelastic less than proportionate fall in quantity
supplied
Reasons
Labour: need time to retrench / reallocate labour to other departments
Flight schedule / routes: need time to deliberate which routes / schedules to
close choose the unprofitable / lowest passenger volume

Conclusion
Cannot look at each value separately because in real world many variables change at the
same time
17
Chapter 4: Microeconomic Problems: Market Failure

1. Market Failure
Scarce resources need to allocate resources efficiently objective: maximize
societys welfare (social optimality)
MSB = MSC: benefit to society from one additional unit of good = cost to
society of producing one extra unit of good
Ways to allocate resources
Total government intervention
Free market (based on price mechanism)
Mixed economy (free market with some government intervention)
Free market economy
Private ownership of resources + individual decision-making guided by self-
interest
Price serves as signal for resource allocation
Automatic working of supply and demand spontaneity allocative
efficiency
Equilibrium where demand = supply: maximization of consumer and
producer surplus
Assumes no externalities + perfect competition
Market failure occurs when
Allocative inefficiency: externalities / public goods, imperfect competition
Inability of market to achieve social objective eg. income equity

2. Externalities
Cost / benefit on a third party not involved in the consumption / production of good
Negative
Types: industrial pollution, pollution and congestion from vehicles, demerit
goods eg. cigarettes
External cost: second-hand smoke health problems, fire hazard,
environmental cost littering, anti-smoking campaigns money
comes from taxpayers who largely do not smoke
To tabacco company: profit-maximising private producer: MPB = MPC
To society: to attain social optimality: equilibrium level MSB = MSC = MPC +
MEC
Overproduction: deadweight loss
Positive
Types: merit goods eg. healthcare, education
External benefit: higher standard of living of everyone because of
highly-skilled jobs
Under-production by free market: deadweight loss
Because of partial market failure, government intervention comes in

18
3. Public Goods
Non-excludable: impossible / costly to exclude non-paying consumers from receiving
the good
Non-rivalrous: consumption by one person does not reduce amount available to
others
Eg. National defense
Free rider conceal demand private producer cannot gauge demand will not
produce non-production in free market total market failure
Government provision necessary since public goods are socially desirable and largely
indivisible

4. Inequality
Represented by the Lorenz Curve / Gini coefficient
Singapore: 0.485 in 2007
European countries: 0.25 0.3
Latin America and the Caribbean: 0.6
Average worldwide: 0.4

5. Essay
When asked to suggest new policies, consider whether it is possible / practical to
enact them
Policies may be difficult to administer, and policing expensive
Opportunity costs involved in attempted to control negative externalities
Political implications eg. public satisfaction
19
Policies on Pollution and Evaluation Summary

1) Identify: Taxation

Explain: Tax polluters per unit of MEC COP increases for private firms supply
falls from MPC to MSC by amount of MEC

Evaluate: * Negative externality internalized by firm: incentive for firm to be more -
cost-effective to maximize profits / reduce pollution
* Provides revenue for government to finance other social and
community development projects
* Able to allow market to continue operating according to market forces
and reach state of equilibrium
x Requires accurate valuation of MEC / amount of pollution
- Over-valuation: output below socially optimal level, reducing
societys welfare / deters production affects economic growth
- Under-valuation: output still not brought to socially optimal level
x Difficult to apportion blame
x Effectiveness dependent on price elasticity of demand: if highly price
inelastic, effect of tax on output ineffective unless tax very large / firm
able to move burden to consumers and get away scot-free

2) Identify: Quotas

Explain: Ban production if pollution exceeds a certain limit limits MEC by
restricting output at socially optimal level
Clearly defined amount of pollution each firm can have

Evaluate: * Able to control level of pollution in the country as a whole
X Does not allow price to equilibrate quantity demanded to quantity
supplied: firms may decide to produce less so they do not exceed the
maximum amount of pollution they can have (compare this to taxation)
X Difficult and tedious to gauge how much pollution each firm produces:
waste of resources and time on inspection
X Need vigilance and commitment of government

3) Identify: Legislation

Explain: Force producers to bear costs of more proper disposal of industrial
wastes eg. antipollution equipment

20
Evaluate: x Difficult and costly: spend resources on inspection
X If chances of being caught and penalties are small, legislation
ineffective
X Need vigilance and commitment of government
X Not immediately effective because of bureaucracy involved in
establishing laws
X Lose voters leading to loss in power

4) Identify: Nationalisation

Explain: Government takes over the polluters firms and ensures production at
socially optimal output

Evaluate: x Waste of resources: opportunity cost to other projects because less
funds available
X Difficult to accurately valuate quantity demanded
X No competition: inefficient, no innovation

5) Identify: Campaign / advertisements to educate public

Explain: Raise awareness of pollution situation to public in hope they might do
something to curb problem

Evaluate: x Costs of these measures might outweigh benefits
X Duration needed before effects can be felt and there is no guarantee
that the campaign will be effective
X May be effective for only a short period of time because the public is
constantly bombarded by such campaigns that it is starting to lose its
intended effect

6) Identify: Subsidies

Explain: Subsidise purchase of antipollution equipment so that firms COP does
not increase that much by purchasing these equipment firms more
likely to buy the equipment than before

Evaluate: x Opportunity cost to other public projects
X No guarantee that firms will buy the equipment
X Firms need time to incorporate use of new equipment: but in the long
run probably mitigates the problem of pollution if firms use the
equipment

21
7) Identify: Urban planning

Explain: Locate factories away from residential areas eg. Jurong Island
Greenery (to reduce impact)

Evaluate: x Merely shifting the pollution to another area does not solve the root
of the problem but reduces external cost since less people affected by
pollution
X Contentious as to whether greenery helps to reduce impact

Summation: Air pollution may not be due to the country itself, so need international /
regional cooperation
Can integrate a few policies for better results



22
Policies on Pollution and Congestion caused by Cars Summary

1) Identify: ERP per tax unit

Explain: Restricts car usage (nowadays rely more on this policy)
Increases cost of car journey quantity demanded for car travel falls

Evaluate: x Congestion in other areas / small roads
X Increase business cost pass to consumers

2) Identify: COE

Explain: Restricts car ownership

Evaluate: x Increasing affluence income elasticity of demand for cars
X Cannot stem peoples aspirations
X Needs vigilance and political will (in other countries, government might
not be able to have COE)

3) Identify: Efficient and affordable public transport

Explain: Less pollution and congestion on roads

Evaluate: x Not all countries have resources to build an effective public transport
system LDCs: no money, DCs: complex commuting patterns
X For it to be affordable, possibly need government to finance. Otherwise
if left to the private firm, they would want to charge more to maximize
profits.

4) Identify: Registration tax, annual road license

Explain: Restricts car usage

Evaluate: *May work if there is vigilance and commitment by government

5) Identify: Rebates for green vehicles eg. 20% off purchase price

Explain: Lower price quantity demanded higher

Evaluate: x Still not widely advocated
X May still be too expensive to afford

23
6) Identify: Weekend cars

Explain: Restricts car usage

Evaluate: x Still not widely advocated
X People associate cars with prestige (eg. Americans love for SUVs)



24
Chapter 5: Government Intervention in the Market

1. Tacking Externalities
Negative externalities [details on page 21-23]
Positive externalities
Subsidies: external benefit internalized (works like the tax)
Can be easily implemented to bring about increase in production and
consumption
Difficult to valuate external benefit generated
High government expenditure high tax rates can subsequently
discourage investment in country
Firms lose incentive to be more productively efficient inefficient
firms may survive
Direct provision of merit goods
Social justice: merit goods should be accessible to all and not
provided according to ability to pay
Large positive externalities: eg. free healthcare combats spread of
disease
Dependants: eg. free education to protect children from irresponsible
parents who fail to provide children quality education
Ignorance: consumers may not realize how much they will benefit and
if they had to pay, they would rather go without it

2. Government Failure
Allocative efficiency reduced following government intervention to correct market
failure
Problem of incentives
Imposition of high taxes can distort incentives
High marginal tax removes incentive for people to work harder to
earn more
Disincentive to produce and consume
Desire by politicians to get elected: popular policies introduced (eg. minimum
wage law)
Profit motive of private sector largely removed
Problem of information
Difficult to valuate external cost / benefit
Difficult to accurately estimate level of consumer demand for product
Problem of distribution
Increase inequity
Eg. tax on use of domestic fuel (kerosene in Indonesia) low income
households may feel greatest effect as tax on fuel oil may make life of poor
worse since they use proportionately more domestic fuel than others
Bureaucracy and inefficiency: administrative costs; time lags
Shifts in government policy: too frequent changes difficult for firms to plan ahead
25
Chapter 6: Firms and How They Operate I

1. Production in the Short Run
Short run: at least one fixed factor
Long run: period of time long enough for all factors to vary, except level of
technology, which varies in the very long run
LDMR: as more units of a variable factor are applied to a given quantity of a fixed
factor, there comes a point beyond which the extra output from additional units of
the variable factor will eventually diminish
Stage 1: TP increases at an increasing rate, MP rises due to specialization of
labour
Stage 2: TP increases at a decreasing rate, MP falls, LDMR sets in due
inefficient use of fixed factor
Stage 3: TP falls, MP falls
MP = change in TP / change in L















2. Theory of Costs in the Short Run

Factor Total Fixed Cost Total Variable Cost Marginal Cost
Definition Sum of all costs of
production do not vary
with the level of output
aka overhead costs
Must be paid even
without production
Costs incurred for use of
variable factors like labour
Varies directly with
output level
Additional cost incurred in
producing an extra unit of
output in the short run
while some inputs remain
fixed
MC = change in TC /
change in Q
Examples Rent of factory building,
interest on capital
invested in equipment
Raw materials, labour
26
Graph


Average
curves
ATC =
AVC +
AFC
AFC: amount of fixed
costs per unit of output
AFC = TFC / Q

AVC: total variable costs
per unit of output
AVC = TVC / Q



Stage 1: AVC falls, AFC falls. Since AFC and AVC fall, ATC also falls
Stage 2: AVC rises, AFC falls. Since fall in AFC > rise in AVC, ATC still falls
Stage 3: AVC rises, AFC falls: Since fall in AFC < rise in AVC, ATC rises















27
3. Objectives of Firms
Profit-maximisation: equilibrium level of output since there is no tendency to change
Before equilibrium level, MR > MC so firms want to produce more
After equilibrium level, MR < MC and rational firms will not produce at this
output level
Firm continues production as long as it can cover variable costs
Motivation of owners vs. motivation of managers: separation of control and
ownership principal-agent problem: managers tend to pursue their alternative
goals while maintaining minimum level of profits to appease shareholders
Revenue maximization: managers aim to maximize firms short run total revenue
Long-run profit maximization: managers aim to shift cost and revenue curves so as
to maximize profits over some longer time period
Growth maximization: managers may aim for expansion to maximize growth in sales
volume over time

4. Theory of Costs in the Long Run
Returns to scale: measure of resulting change in output when all inputs are changed
in the same proportion (can be increasing, decreasing or constant)
LRAC: lowest average cost for given level of output when all inputs are variable
Minimum efficient scale: smallest plant size beyond which no significant additional
IEOS can be achieved
IEOS: savings in costs that occur to a firm due to the firms expansion, and have been
created by firms own policies and actions
Technical: concerned with production process
Factor indivisibility economies: larger plant size makes it possible to
effectively use indivisible factors (combine harvesters, power
transmission: large and costly) raises average output and reduces
LRAC
Specialisation of labour: simpler and repetitive jobs which require less
training + more efficient eg. car manufacturing
Managerial: functional specialization by employing experts to increase
efficiency as a whole
Greater use of existing staff
Decentralisation of decision-making: increasing efficiency of
management because of faster flow of information within firm
distortions and delays of information avoided
Commercial
Bargaining advantage and accorded preferential treatment by
suppliers because they buy raw materials in bulk
Bulk sales from bulk advertising and large-scale promotion
28
Financial
Easier and cheaper to raise funds: given lower interest rate and larger
loans because better credit ratings and more collateral
Raise capital through issue of shares to public who has more
confidence in reputed firms
Risk-bearing
Advantage in bearing non-insurable risks eg. conditions of demand for
final products and supply of raw materials
Diversification of products and markets
Diversification in sources of supply
R+d
Better quality products increased market share and demand
Better methods of production more productively efficient lower
average cost
Welfare: making workers feel they belong to the company more apt to
increase efficiency and productivity of company
IDOS
Complexity of management
Principal-agent problem
Bureaucracy
Strained relationships: impersonal no loyalty to firm apathy, strikes
EEOS: savings in costs that occur to all firms in an industry due to the expansion of
the industry
Economies of concentration
Availability of skilled labour: demand for labour large enough
special educational institutions / firms can collaborate to develop
training facilities
No lack of labour to employ because experts want to migrate
there eg. Silicon Valley
Well-developed infrastructure to cater to that industry
Reputation: builds up name which consumers associate with quality
encourages brand loyalty and steady clientele
Economies of disintegration
Subsidiary industries developed to cater to needs of major industry
Eg. car industry in Japan: range of firms specialize in
production of different inputs for car manufacturing provide
output at lower prices to main industry because specialization
allows subsidiary firms to produce at large scale enjoy EOS
Process waste products into useful products and sell them to cover
COP
Economies of information: publications help improve productivity of firms
(research and expertise)
29
EDOS
Increased strain on infrastructure: taxed to limits eg. congestion loss of
time and increased fuel consumption
Rising costs of FOP: growing shortage of specific raw materials / skilled
labour

5. Growth of Firms
Methods of growth
Internal expansion: make more of existing product or extending range of
product when it builds a new bigger plant
Merger
Vertical integration: firms engaged in different stages of productive
process
Backward integration vs. forward integration
Eg. Starbucks merge with firm producing coffee beans wants
guaranteed access to raw materials
Horizontal integration: firm takes over similar firm at same stage of
production in the same industry
Eg. Coffee Bean and Starbucks merge
Eg. DBS and POSB
Market domination
Conglomeration
Eg. bank taking over developing firm to build properties
Diversify output

6. Survival of Small Firms
Demand-side factors
Nature of product
Bulky and perishable goods: small, localized markets eg. fresh fish
Variety preferred to standardization eg. fashion
Specialised products: limited markets eg. highly specialized machines
Prestige markets: limited by price eg. sports cars, luxury yachts
Direct and personalized services eg. lawyers, doctors
Geographical limitations: high transport costs for bulky products local
market rather than national market
Supply-side factors
DEOS set in early: optimum size of firm small
Vertical disintegration: entire production process broken into series of
separate processes and different small firms perform each process
Low BTE
Lack of capital
30
Unwillingness to take greater risks
Larger firm higher expenditure greater risk of investment
Fear of future fall in price of final product: expansion of output
increase market supply excess supply lower prices and lower
profits
Banding: small firms may band to gain advantages of bulk buying while still
retaining their independence
Profit cycles: early stage of product cycle total demand for product low
Non-profit maximization attitudes
Owner values independence or wants to maintain control among
family members
Contented with reasonable income from domestic market
Unwilling to take increased risks associated with expanding into
foreign market

7. Case Study
Factors: think long run vs. short run, demand-side vs. supply-side
EOS lower LRAC able to reduce price
Profits plough to r+d better quality products + further reduction in AC
Block new entrants due to enormous FC less existing competitors
increase market share
Always end EOS with AC
If a particular industry is stated in the extract, try to give egs of EOS specific to the
industry

8. Essay
Survival of small firms: for conclusion, use banding / small firms may want to merge
in the face of globalisation
31

Discuss whether rising costs limit the size of firms over time. [15m]

Introduction
Size: sales revenue / turnover, level of output, market share
Over time long run firm no longer constrained by fixed factor

Body
1) Can limit
Short run cost
Reason: over-use of fixed factor, inefficient labour-capital combination
increase MC eventual increase in AC
Increase costs fall in profits if total revenue is constant constrain firms
ability to expand

2) Will not limit
Long run
All inputs can vary firm can expand enjoy fall in LRAC due to internal EOS
(list 2 egs)
Fall in LRAC fall in price to ward off competitors (erecting barriers to entry)
increase profits plough into r+d better quality products + if yields results
further fall in AC due to better production methods
Size of firm determined by demand for firms product if firm making
supernormal profits can still expand in size even if cost increases eg.
monopoly selling unique products

Conclusion: However, size of firm over time constrained by MES (list 1 eg of internal
DOS). MES huge eg. electricity / water compared to MES limited eg. fashion.

Banking Merger in Singapore Analysis

Why merge?
Face competition from foreign banks Singapore wants to expand beyond our
shores: big enjoy EOS fall in AC can compete with foreign banks
Core part of Singapore economy 1997 Asian financial crisis big stable

Why should not merge?
Possible monopoly power
Increase price
Quality of service
Reduction / removal of familiar products and services affects
consumer satisfaction
Neglect lower-income group
Retrenchment
32
Chapter 7: Firms and How They Operate II

1. Comparison of the 4 Markets

Type Perfect Competition Monopoly Monopolistic Competition Oligopoly
Number of
buyers / sellers
Large
No one buyer / seller
can influence price
Firm price taker
Only one firm
Firm price setter
Large
FOP relatively mobile
When firm makes
decisions, does not
have to worry how its
rivals will react
Few large firms
Interdependent
Barriers to
entry
None
FOP perfectly mobile
No transaction /
transportation costs
Minimal sunk costs

High
Natural: huge sunk costs
(AFC falls over very
large output AC falls
continuously enjoys
huge IEOS), exclusive
ownership of essential
raw materials
Artificial: non-price
competition, contrived
barriers (cartel), legal
protection: exclusive
rights (patents, tariffs to
block foreign firms)
No / Low
Firm lowers price
profits spread thinly
over many rivals
rivals suffer negligibly
Retaliation unlikely
No collusion keen
competition
Substantial
Natural
Artificial: legislation,
collusion / mergers,
non-price
competition,
advertising
Nature of
products
Homogeneous
Buyers no preference
for any firm
No close substitutes
CED and PED very low
Differentiated:
quality, design,
location, promotion
Demand price elastic
Homogeneous /
differentiated
33

Knowledge Perfect
Seller knows rivals
prices, market costs and
available technology
Buyers know all sellers
prices, quality and
availability of products
will not purchase at a
higher price than
equilibrium price
Imperfect
Consumers not fully
aware of COP

Imperfect
Production methods and
prices
Cost structures differ as
some firms enjoy more
favourable locations /
rentals
Imperfect
Firms curve

P = AR = MR

P > MR
Cannot increase both
output and price at the
same time as curve is
downward sloping

P > MR
Some degree of control
over own prices
No single equilibrium
price in market no
market demand curve

P > MR
Firm increases price
other firms will not
Firm decreases price
other firms follow
may lead to price war
Price rigidity: menu
costs, fear of harming
firms image (fall in
price fall in quality)
34
Examples Stock market
Forex market
Agricultural products:
many farmers in LDCs
Utilities
Starhubs EPL coverage
SMRT for NS and EW
lines
Bubble tea UK brewery industry
Taxi companies
OPEC
Mobile service
provision
Firms SR
equilibrium
Supernormal, normal / subnormal profits
MC = MR and MC must be rising
Firms LR
equilibrium
Normal profits
New firms will enter
industry to erode
supernormal profits
Normal / supernormal
profits
Firm will shut down if
subnormal profits
Normal profits Normal /
supernormal
LR
equilibrium
curve


Productive
efficiency
Efficient
Firm produces at MES
Inefficient unless by
coincidence
Inefficient
Will settle at LRAC that
is not necessarily at
MES
Inefficient unless by
coincidence
Firms POV: all points on LRAC
Societys POV: MES
Allocative
efficiency
Efficient
P = MC
Inefficient
P > MC
Could be seen as premium society pays for product differentiation
35
2. Analysis of Imperfect Market Structures

Type Monopoly Monopolistic Competition Oligopoly
Economic
efficiency
Allocative inefficiency: P > MC,
output below optimum
Productive inefficiency
X-inefficiency but increasingly
reduced due to globalisation,
reduced customs duties and
barriers to trade
Dynamic efficiency: r+d
Allocative inefficiency: P > MC
Productive inefficiency: do not
utilise optimal plant capacity, do
not exhaust potential for further
EOS because all small firms
Dynamic inefficiency: no r+d
Allocative inefficiency: P > MC,
output below optimum
Productive inefficiency
Dynamic efficiency: r+d
Variety of
products
Unique
Possible innovation and new
products: BTE stimulus to the
creativity required to destroy
barriers monopoly profits
stimulates new entrants
producing new and competing
products
Large variety increase in
consumer welfare
Differentiated
R+d and
new profits
Profits lead to unequal income
distribution: dollar votes + shift of
consumer surplus to producer
Supernormal profits plough into
r+d better quality products +
better methods of production
lower AC but there is no
guarantee that monopolies will do
this
More equity: no redistribution of
income from consumers to
shareholders
Normal profits: no additional
profits to plough into r+d
Supernormal profits ploughed into
r+d
36

Theory vs
empirical
evidence
MES high IEOS lower MC than
PC industry lower P and higher
o/p but monopolies charge high
prices by restricting output








Practise price discrimination [has
both costs and benefits]
Natural monopolies
Perfectly contestable markets:
costs of entry and exit by
potential rivals are zero, and when
such entries can be made very
rapidly eg. deregulation of airline
industry in 1978
Hit and run competition: market
contestable for certain seasons
eg. parcels service during festivals
Reduces wasteful competition
(instead of extensive advertising,
money can be spent to produce
more goods)
Wasteful competition
Advertising provides better
consumer information which
helps move market structure
closer to PC model but loss of
consumer sovereignty
High price rigidity: price stability
Wasteful competition: more likely
to engage in extensive advertising
encourages price competition,
with increased sales volume and
reaping of EOS, price reduce
further
But possible monopoly power
through collusion
But multiple branding gives
consumers misguided information
in thinking products are from
different firms
P/R/C
Q
AR
MCm
MR
MCpc
Pc
Pm
0
Q

Q

37
3. Price Discrimination
Producer sells specific commodity to different buyers at two or more different prices
Same consumer charged different prices for same product for reasons not
associated with cost differences
Conditions
Possible
Seller has control over market supply
Market segmentation and identifiable groups + no resale
Profitable: each market as different PED
First degree
Practice of charging each customer his reservation price
Captures all consumer surplus as revenue
Eg. auction sites
Impractical to charge each customer a different price
Firm usually does not know the reservation price of each
customer: consumers do not tell and producers may not
want to spend time and resources to find out
Second degree
Charge different prices for different blocks of the same
product to the same buyer
Eg. photocopying shops
Third degree
Sells same product at different prices to different customers
Conditions
Two or more markets which can be separated
PED of each market must be different
Higher price charged in market with more price inelastic demand
Cost: loss of consumer surplus
Benefits
Firm: higher profits and may use these profits from one market to withstand
possible price war in breaking into another market
Consumer
Consumer may not have been able to afford good otherwise
38
Higher profits may be reinvested into r+d better quality products +
better methods of production
Provision of goods that would otherwise not be produced due to high
costs if production and consumption of good is one that confers
positive externalities on society
Additional profits might exceed losses such that firm will still
continue producing the good
39
Discuss the view that the profit motive will always lead to a few large firms
dominating the market for each and every type of product. [15m]

1) Barriers to entry
Few large firms merge greater market share reap EOS fall in LRAC fall in
price ward off rivals / block new entrants (natural BTE) able to maintain
supernormal profits
If plough into r+d better methods of production further fall in AC - make
more profits
But some industries have low BTE (technology easily replicated) low sunk cost
eg. retail, grocery

2) Market size
Small: eg. Singapore television broadcasting Mediacorp vs. Mediaworks
Firms will eat into each others market share erode profits so to keep
profits just let one firm dominate
Market big: eg. US then can afford to have few large firms

3) Nature of product
Large firms: unique products with no close substitutes
Small firms: availability of substitutes, prestige market / services, localized
demand, perishables, limited MES fashion, specialization, personalized services

4) Government Intervention / publics desire
Few large firms will help to reduce price increase in consumer surplus
increase in consumer welfare
Supernormal profits plough into r+d to produce better quality products
Will still have competition unlike monopoly still have the incentive to be more
cost-efficient / innovative

40
Explain what is meant by productive and allocative efficiency. [10m]

1. Allocative efficiency
Definition: situation in which it is impossible to change the allocation of
resources in such a way as to make someone better off without making someone
else worse off
Assumption: no externalities / public goods P = MC right amount + type of
good produced to maximize societal welfare













If MB < MC, last unit of good less than opportunity cost of producing that
unit society benefits from not producing that last unit
If MB > MC, last unit of good more than opportunity cost of producing that
unit society benefits from producing that last unit
Assumption aside, MSB = MSC
Perfect competition: firm price taker
MR = MC = P allocatively efficient












Price
Quantity 0
S (MC)
D (MB)
P/R/C
Quantity
MR
MC
Q1 0
P1
41
2. Productive efficiency
Long run concept
Firms POV
Any given level of firms output produced at lowest possible AC all points
on LRAC curve are productively efficient
Societys POV
LRAC minimum firm is at optimum size / MES all IEOS exploited
P/R/C
Quantity
MR
LRAC
Q1 0
P1
42
A firm should be encouraged to maximize profits because this makes it efficient.
Discuss whether this argument is true for a firm operating in an imperfect market.
[15m]

*When comparing efficiency, only talk about long run

1) Allocative efficiency: P > MC true for all imperfect markets because they are price
setters deadweight loss to society allocatively inefficient

2) Productive efficiency: Not operating at MES (where LRAC cuts MC) not fully
exploited all IEOS productively inefficient












PC industry needs to be at MES because it needs to be as cost-effective as
possible price taker cannot pass cost increase to consumers
Vs. imperfect market need not be at MES because price setter can pass cost
increase to consumers

3) X-inefficiency
Monopoly: lax in cost control no existing competition can pass cost increase
as price increase
But monopoly can also be cost efficient due to fear of new entrants
Globalisation and international competition
If market is contestable
Force monopoly to be cost efficient
Oligopoly more likely to be cost-efficient compared to monopoly but wastage of
resources large scale advertising / promotion increase cost for firm and
opportunity cost to society as the money could have been used to produce more
goods

4) Dynamic efficiency
Supernormal profits in long run able to invest in r+d better methods of
production fall in AC in very long run
Vs. PC industry: no dynamic efficiency
P/R/C
Quantity
AR MR
MC
LRAC
Pm
Pc
Qc Qm 0
Triangle = DWL
43
Distinguish between monopolistic competition and oligopoly. [10m]

Type Monopolistic competition Oligopoly
Number of
sellers
Many one firms
action less likely to
affect others
A few large firms interdependence
one firms action likely to evoke
responses from rivals
Nature of
product
Differentiated eg.
retail: restaurants
affect demand curve
demand price elastic













Homogeneous / differentiated eg.
mobile service provision, petrol
companies / taxi companies, OPEC
kinked demand curve










Firm increase price: rivals will not follow
quantity demanded for firms product
falls more than proportionately
demand price elastic
Firm reduces price: rivals likely to follow
price war + quantity demanded for
firms product increases less than
proportionately demand price inelastic
Non-pricing
competition
Smaller scale Larger scale
Likelihood
of colluding
Less More: large market share
BTE Low / no low sunk
cost + technology
easily replicated long
run normal profits
High natural: high sunk cost eg.
utilities, telecomm TFC very huge
LRAC keeps falling enjoys huge EOS
very low LRAC new entrants cannot
produce at such low LRAC
Artificial: patents
Ensure supernormal profits in long run

P/R/C
Quantity 0
AR
P/R/C
Quantity 0
AR
Pe
44
Explain why oligopoly is a common market structure in many economies. [15m]

1) Firms want to be big to maximize profits
Merger of small firms EOS fall in LRAC fall in price ward off rivals + block
new entrants
Monopoly attracted by supernormal profits monopoly loses its power

2) Society may desire oligopolies
Oligopoly competition greater innovation through r+d which monopolistic
competition cannot afford since it only makes normal profits
Vs. monopoly lax X-inefficiency

3) Governments intervention
Singapore government face of international competition in a free market, local
firms have to be big eg. banking go regional liberalization and deregulation of
industries: mobile service industry, taxi companies
Firms prefer operate in oligopolistic structure rather than monopolistic:
monopolies more closely watched by government vs. oligopolies harder to
observe whether they are colluding

4) Some industries due to huge sunk cost oligopolistic / even natural monopoly eg.
utilities, telecommunications, transport, TV broadcasting in Singapore since market size
is too small one single player most efficient
45
Explain why governments throughout the world have been involved in the supply of
services such as electricity. [12m]

Introduction
Government social benefits + social costs which private firms unlikely to take
into account
Electricity essential good for households and businesses

Body
1) Could be a natural monopoly
Market size cannot operate with more than one player at MES: huge sunk cost
AC keeps falling private firms likely to be monopolistic charge very high prices
need for regulation















2) Private does not cater to lower income group vs. government more likely to do so

3) Huge initial investment private firm likely to charge higher price to cover costs vs.
government can subsidise from revenue / taxes

4) If there is competition among a few private firms wastage + duplication of resources
vs. government: save costs for advertising

5) Earns revenue for government since it is essential

Conclusion
Main point is that government does not want to risk anything because electricity and
similar services are so essential

P/R/C
Quantity 0
AR MR MC
Pm
Pc
Qm Qc
AC
46
Chapter 8: Government Intervention in the Market II

1. Regulation of Natural Monopolies
MC pricing: monopoly charge a price that is equal to MC in order to achieve
allocative efficiency
But monopoly incurs a loss shut down public deprived of vital service
Need to be supplemented with government subsidies: costly to government,
burden on taxpayers
2-tier pricing: consumers pay a fixed sum of money for access to service and
price per unit consumed to cover marginal cost
Eg. electricity, gas
Producer meets all COP and minimizes loss of social welfare
AC pricing: monopoly charge a price equal to AC lower price and greater
output increase in societys welfare
Normal profits viable in long run
Still not allocatively efficient
Firms no incentive to keep costs low since price is at whatever AC they are at
Problems
Difficult to obtain accurate information on demand and cost estimates: firms
tend to overstate cost, market conditions change constantly, costly to
acquire new information
Regulatory lag: firms may have to operate at a loss during time lag
Costly to administer

2. Taxation
Lump-sum tax on monopolists excessive profits shifts AC curve upwards
profits reduced normal profits
Redistribute income from producer to consumer
Use tax revenue to subsidise welfare schemes / production of merit goods
May create disincentive for monopolist to be cost-efficient
Monopoly can pass burden to consumers due to price inelastic demand
Dynamic efficiency compromised

3. Legislation
Anti-trust laws: Anti-trust Act (US) / Competition Law (Singapore): break up
monopoly
Eg. Microsoft Corporation: one firm own Windows operating system, the
other will own applications
May not be applicable to natural monopoly / monopolies with great incentives
to undertake r+d
Forbidding certain practices: eg. predatory pricing: setting price below COP to
eliminate competition
47
Imposing standards of provision eg. Public Transport Authority in Singapore
governs standards of public transportation to ensure guaranteed quality of
product
Insisting on certain levels of competition in industry: Singapore government
increasingly deregulates monopoly

4. Nationalisation
Growth
Industries with major investment eg. steel and coal industry, large spending
on r+d required
Unfair competition of state-owned enterprises with private sector
Efficiency
Natural monopoly, presence of positive externalities, eliminate wasteful
duplication
Lack of competition pressure lack of incentive X-inefficiency
Bureaucracy heavier burden on tax payers
Sunset industry
Decision may be made for political rather than economic reasons eg. just to
keep employment figures high
Equity
Special pricing policies eg. free bus rides for pensioners
Service which would otherwise not be provided eg. bus route to remote
areas
State monopoly no less disadvantageous to consumer than private one no
higher authority to maintain checks and balances
Stability
For strategic reasons eg. national defence
Seen as a move towards communism

5. Privatisation
Competition
Increased competition cost efficiency + benefits for consumers eg. lower
prices, wider choice, improved quality
Unfair competition of state-owned enterprises with private sector
Could be worse outcome
If state monopoly replaced with private monopoly, possibly lower
output and higher price
If high BTE
48
Efficiency
Greater efficiency
Commercially sounder decision making eg. higher returns on
investments
Greater accountability to public constantly need to perform well or
risk takeover by another firm
Natural monopolies, externalities, equity issues
Revenue
Revenue from selling state assets
Higher corporate tax receipts if privatized company is profitable
Long term loss of revenue had the privatized firm been profitable
49
No. Title Page No.
29 Chapter 9: Key Economic Indicators 50-51
30 How far can this information lead you to conclude that there is a rising
standard of living in Singapore?
52-53
31 Discuss the factors that contribute to economic growth in a country. 54
32 Chapter 10: Income and Employment Determination 55-58
33 Explain what information an economist would require to decide whether
the US needed an economic stimulus.
59
34 Explain what is meant by the equilibrium level of national income. 59
35 Analyse the effect on the equilibrium level of income of an increase in
the level of savings and an increase in the level of exports.
60
36 Discuss the extent to which the US fiscal stimulus might lead to a
sustained increase in national income.
61
37 What are the main causes of Singapores recessions? 62
38 Chapter 11: International Economics 63-66
39 Explain the theory of comparative advantage. 67
40 To what extent does the theory of comparative advantage explain the
pattern of trade between Singapore and the rest of the world?
68-69
41 Discuss whether protection offers any advantages over specialization. 70-71
42 Explain the rationale for free trade and discuss the extent to which FTAs
are beneficial.
72-74
43 To what extent can economies benefit from globalisation? 75-76
44 Discuss the opportunities and threats of globalisation for Singapore and
other Asian economies.
77
45 Consider the effects, other than on the general price level, of Singapores
changing tax structure.
78
46 Policies to remedy Singapores recession 79
47 Evaluate methods the Malaysian government might use to slow down
import growth and increase new export business.
80
48 To be considered successful, an economy needs to achieve low
unemployment, low inflation and stable economic growth. How far do
you agree with the statement?
81
49 To be considered successful, an economy needs to achieve low
unemployment, low inflation and stable economic growth. Explain this
statement.
81
50 Discuss whether fiscal policy is the most effective way for Singapore to
sustain a successful economy.
82
51 In the fourth quarter of 2004, Singapores unemployment rate rose to
3.7%. Discuss whether supply-side policies are the best way of achieving
full employment in Singapore.
83
52 Why Singapore does not use interest rate policy 84
53 Problems with exchange rate instability 84

J2 Topics
50
Chapter 9: Key Economic Indicators

1. Key Macroeconomic Aims
Strong sustained economic growth
Low inflation
Low unemployment rate
Healthy BOP

2. National Income Statistics
Gross domestic product: value of all final goods and services produced within a given
country during a given period of time
Measure economic growth
Limitations
Understate nations output: omission of non-market activities
(voluntary welfare services) and underground economy
Difficulties in measuring SOL
Leisure time
Externalities
Production does not equal consumption: expenditure could be
for potential growth
Income distribution
Other social factors: eg. crime rates, freedom
International comparisons
Difference in account procedures and items included
Exchange rates: need to use PPP
Population: need GDP per capita
Difference in climate and culture: different needs different
costs
Difference in underground economy: Swedens underground
economy 13% of GDP
Alternative measures of SOL
HDI: life expectancy, education, GDP per capita at PPP rates
MEW: leisure, GDP per man hour
Gross national product: value of all final goods and services produced by residents of
a country, regardless of the location of production, during a given period
Net national product: GNP depreciation
Nominal: at current prices vs. real: at constant prices

51
3. Inflation Rate
CPI: measures change in price of fixed basket of goods and services commonly
purchased by households in a specified time period
Limitations
Not an accurate measure of COL
Substitution bias: consumers substitute toward goods that have become
relatively cheaper overstates COL
Quality adjustment: CPI increase might be due to quality adjustments
overstate inflation
New products: price declines sharply a few years after introduction not
added to market basket until years after introduction price declines not
recorded

4. Unemployment Rate
Unemployed: people aged 15 and over who are without work but were available for
work and were actively looking for a job
Frictional unemployment: unemployment because time taken for workers to search
jobs and for firms to search for suitable workers
Structural unemployment: workers do not have the skills needed to obtain long-
term employment
Cyclical unemployment: unemployment during recession

5. Balance of Payments
Record of countrys international transactions
Current account
Visible: imports and exports of goods and services BOT
Invisible: profit repatriation, interest, dividends, unilateral transfers
Capital account
Portfolio: bonds, shares, money in banks
Direct: FDI
Financial account: something like bank reserves
52
Singapore has enjoyed another year of robust growth in 2007, and the real GDP
growth was 7.5% for the year. A record 172000 jobs were created in the first 3
quarters. However, in recent months, inflation has picked up and the inflation rate for
the month of November alone was 4.2%.

How far can this information lead you to conclude that there is a rising standard of
living in Singapore? [25m]

Introduction
SOL material and non-material well being of each citizen

Body
A) Material well being
Real GDP per head: on average how much goods / services each citizen gets to
consumer
Real: adjusted for inflation as converted to constant prices
High for a developed country
Limitation: does not show effect of changes in population size
Per head: effect of population size eg. if GDP increases by 7.5% but
population increases by 9%, GDP per head falls
Singapore: over 1 year: changes in population size little but could have been
some increase due to open-door policy
Income gap Gini coefficient
Gini coefficient globally used as a measure of income disparity, with 0
indicating perfect equality and 1 perfect inequality
Singapore: 0.52 in 2006
Increasing gap in Singapore due to globalisation: displaced by machines,
structural changes, influx of foreign workers, outsourcing
Type of spending
Capital vs. consumption goods
Government spending
Defence vs. spending that directly increases SOL
172000 jobs
High incomes increase consumer spending which increases demand for
goods and services, generating more jobs and employment
Due to investments by foreign companies eg. in 2007 plant specializing in
harnessing solar energy set up in Singapore indicates investor confidence
Limitations: 60% jobs went to foreigners, number of jobs destroyed vs.
number of jobs created, size of labour force may have changed so it is not
that unemployment rates fell, composition of jobs (for lower-skilled
workers?), ratio of dependants to working population
53
Inflation rate
Real: adjusted for inflation
Cause: mainly cost factors like high imported oil price, imported food
shortages, partly GST
Lower-income group suffers more in the face of further increase in prices /
income gap

B) Non-material well being
Education literacy rate
Singapore: high literacy rate due to compulsory primary education, heavily
subsidized
Government emphasis on upgrading of skills and training subsidies to firms
for such purposes
Healthcare infant mortality rate / life expectancy
Singapore: individual responsibility + government spending 3M framework
Medisave, Medishield, Medifund
Avoid excessive burden on state and tax payers
With increasing medical costs + ageing population, QOL of some (lower-
income group?) may be affected
Means-testing
Leisure: GDP per man hour
Others: negative externalities eg. pollution

Conclusion
Other indicators: HDI, MEW, GNP
54
Discuss the factors that contribute to economic growth in a country. [12m]

Introduction
Economic growth measured by GDP growth rate and is the means to improve living
standards

Body
1) Quantity and quality of resources
Quantity and availability enhance growth potential
Land: includes natural resources like mineral deposits and oil eg. oil-rich
Saudi Arabia
Labour labour-abundant countries like China and India
Entrepreneurship availability of talents and risk-taking individuals eg. self-
made entrepreneurs in Hong Kong
Quality can be enhanced through government effort and policies
Increase labour productivity through training and education
Entrepreneurship
Capital government efforts to make it more conducive for fixed capital
formation

2) Role of government
Augment quality of labour through education and training
Strategise economic direction eg. change structure of economy in face of loss of
comparative advantage and nurture comparative advantage in new areas
Conducive environment for business
Political stability
Price stability: reflection of good macroeconomic management by
government, competitive price and lowered COP ability to attract FDI due
to lower wages
Efficient infrastructure
Attractive corporate taxes
Less bureaucracy and red tape
Ability to explore new markets / help businesses go global

3) Level of consumption, investment and government spending in economy
High consumption conducive when economy has unutilized resources while high
savings conducive when economy near or at full employment
Savings provide investment funds necessary for growth
Government fiscal and interest rate policies
High export revenue due to competitiveness


55
Chapter 10: Income and Employment Determination

1. Aggregate Demand
Total level of spending in an economy
AD curve slopes downwards because
Wealth / real balance effect: GPL higher purchasing power of financial
assets falls discourages domestic consumption lower level of output
Interest rate effect: higher GPL increase demand for money from
households and firms + might shift wealth out of financial assets decreasing
supply of loanable funds increase in interest rates more expensive to
purchase goods and services on credit households purchase less goods +
businesses invest less lower national output
International substitution effect: higher GPL locals buy more foreign goods
+ foreigners buy less domestic goods net exports fall lower national
output
Factors that cause a shift
Changes in expectations: income and profits, real wealth, inflation
Changes in government policies
Changes in world economy: income abroad, foreign price level, exchange
rates

2. Aggregate Supply
Total output of goods and services that firms as a whole would like to produce and
sell at each possible price level
Shape
Horizontal: producers can produce all they want due to abundant resources
Upward sloping: output rises but pressure on prices
Vertical: need time to adjust to new cost structures
Factors that cause a shift
Change in input prices
Change in quality of labour input
Change in expected rate of inflation
Change in technology
Government policies (local and foreign)

56
3. Consumption Function
Act of using income for the purchase of goods and services to satisfy current wants

















C = a+bY
a represents autonomous consumption: level of consumption that does not
vary with income still need to consume even though no income
bY represents induced consumption: household expenditures that vary
directly with income
b: MPC = change in C / change in Y
Non-income determinants
Wealth: amount of money, fixed assets and financial assets households have
Expectations of future prices and income
Distribution of income
Interest rate and availability on credit
Tastes and attitudes

4. Investment
Act of acquiring new fixed capital assets and accumulating stocks and inventories
Autonomous: not influenced by national income vs. induced
Expected rate of return > rate of interest will invest
Factors that cause shift
Business confidence and expectations
Cost and availability of capital goods
Rate of change of income: accelerator effect
Government policies
Change in technology

Consumption
Income
Y =C
C =a +bY
W
X
Z
W =dissavings, X =breakeven point, Z =savings


57



















5. Equilibrium Level of Income


















At OY1
AE = aY, Y = by AE < Y
unplanned inventory investment ab
next period firms reduce output
Y1 falls to equilibrium Y0
At OY2
AE = dY2, Y = cY2 AE > Y
excess demand, firms draw on stocks
unplanned disinvestments cd
next period firms increase output
Y2 rises to equilibrium Y0
Interest rate
Investment
AE
National output
Y =AE
Y2
c
d
b
a
Autonomous
consumption
Y0
A
B
58
6. The Multiplier Effect
A change in any component of aggregate expenditure (ie. C, I, G or X) will work through
the multiplier to change the national income more than proportionately. As shown in
the diagram below [refer to diagram above], an increase in AE will cause the AE curve to
shift from AE0 to AE1. At the original level of national income Y0, since AE is now greater
than actual national output, there is an unplanned fall in stocks of AB. In the next
period, firms would increase output, causing the level of national income to rise
eventually to Y1, where the new AE equates the national output.

The initial rise in income due to (any rise in component: depends on question context)
will induce consumption by recipients of the income. As one mans spending generates
income for the next person, the national income will eventually rise by a multiple of the
initial rise in the AE. Assuming an initial injection of $100m and a constant MPC of 0.5,
the national income will eventually rise by 2 times the initial injection.

In short, the multiplier measures the change in national income as a result of the change
in AE. It has a direct relationship with the MPC, expressed as k=1/(1-MPC).

Evaluation
Magnitude of increase in NY depends on size of multiplier
Larger the MPW, smaller the multiplier
May lead to demand-pull inflation if near or at full employment
BOP inflation affects price of exports and may have adverse effect on BOT

7. Inflationary / Deflationary Gap
Amount of AE that falls short of (cd)/ exceeds (ab) the level necessary to achieve FE
59
Explain what information an economist would require to decide whether the US
needed an economic stimulus. [10m]

Introduction
Weak economy assume pending recession fall in GDP for 2 consecutive quarters
(negative GDP growth)

Development
Fall in real GDP
Components of AD: fall in AD fall in GDP
Consumption level of households: due to fall in income / saving in fear of
retrenchment
Fall in investment: business pessimism, induced: fall in GDP fall in
investment
Inflation: fall in GDP fall in AD fall in GPL / fall in inflation rate
Need inflation rate to arrive at real GDP
Firms and bankruptcy, firms and decreasing profits
Stock markets: indices fall confidence fall

OR
Fall in real GDP
What causes fall: C/I/G/X-M: BOT: more relevant for Singapore since Singapores
recession mainly due to BOT
GDP income, wages and profits, bankruptcy
Inflation: fall in GPL but stagflation (economy weakening but price increasing) price
increase in US not due to recession: not AD factors but AS factors
Unemployment rate rough guide: 4% - cyclical no job demand deficient
unemployment

Explain what is meant by the equilibrium level of national income. [10m]

NY: as measured by GDP (definition)
Equilibrium: no tendency to move from that equilibrium
Describe briefly components of AE
C (households): shape of AE follows shape of consumption function C=a+by
Simple explanation of components
Sign of 45 degree line: every point is an equilibrium point where AE=Y
Equilibrium level of NY: planned AE = Y. AE curve cuts 45 degree line
Adjustment to equilibrium
Conclusion: when economy is in equilibrium, may not be at full employment /
recession

60
Analyse the effect on the equilibrium level of income of an increase in the level of
savings and an increase in the level of exports. [15m]

A. Savings
Y = C + S
Increase in S fall in C AE falls AE curve shifts from AE1 to AE2
Show adjustment to equilibrium
Summation: increase savings fall in C works through multiplier fall in NY by a
few multiples
Evaluation
Savings can be good for economic growth increase supply of loanable funds
interest rate falls cost of borrowing falls increase I increase productive
capacity increase AS increase NY
Summation: S decreases actual growth but increases potential growth

B. Exports
Increase X increase AE AE curve shifts from AE2 to AE1
Show adjustment to equilibrium
Evaluation
Increase X if have unemployed resources increase NY
Increase X if near / at FE NY may not increase as fast / demand-pull
inflation
Discuss multiplier process in detail

Conclusion
Magnitude of change in national income depends on size of multiplier
Larger MPW, smaller K
Eg. Singapore

61
Discuss the extent to which the US fiscal stimulus might lead to a sustained increase in
national income. [15m]

Introduction
Fiscal: increase G, decrease T
Sustained: actual + potential growth

Development
How fiscal stimulus works: lower taxes (increase C/ increase I) + increase G
increase AD increase NY: actual growth, cannot sustain
Multiplier in detail
Evaluation: depends on size of multiplier
USA MPM could be high because hug e trade deficit may reduce size of k
Crowding out effect: increase in G if borrowed from public decrease in
supply of loanable funds increase in interest rate crowd out C/I cannot
sustain
Effects of taxes on C and I unpredictable due to pessimism
Reaches FE: cannot sustain
Therefore need supply-side measures to increase AS for sustained growth
potential growth / increase in productive capacity
Increase in G on infrastructure facilitates business increase AS
Tax increase NY (potential)
Decrease personal taxes increase incentive to work increase AS
Decrease corporate taxes increase I increase LRAS
Condition: if rebates are permanent but according to preamble, rebates
seem to be one-off

Conclusion
More policies to boost AS education and training increase productivity increase
LRAS

62
What are the main causes of Singapores recessions? [10m]

1) Factors leading to fall in AD
External factors pessimism eg. 911, SARS (only caused a slowdown in Singapores
economy), 1997 Asian crisis C/I fall
Trade deficit: value of X fell due to 911
Lose CA goods more expensive
Fall in income of trading partner

2) External recessions
US recession US GDP fall buy less Singapore goods Singapores X falls AD falls
GDP falls (multiplier effect)
Singapore may not be that affected can ride on growth of China / India
But China huge trade partner of USA
Singapore: international momentum
Extension of MRT increase G k increase NY
IR: increase I increase NY + tourist revenue
YOG: tourist revenue
Cannot sustain since k is small

3) Supply-side factors
Supply shocks: 1973 oil crisis increase COP fall in AS

But overwhelming cause is due to AD, but recognize that fall in AS can also create a
recession

63
Chapter 11: International Economics

1. Theory of International Trade
Exchange of goods and services between countries, involving the use of different
currencies and crossing international borders
Theory of comparative advantage: produce good at lower opportunity cost than
another country
Sources
Differences in factor endowments that can change over time
Differences in technology
Dynamic comparative advantage
Advantages of trade
Greater world output and higher consumption of goods and services
(possible at previously unattainable levels)
Reduction in unit cost of production: EOS, countries gain experience over
time
Stimulate economic development and growth: enlarge market, increase
competition in home market
Facilitate transfer of technology and ideas: increase efficiency of production
economic growth, help developing countries leap frog stages
Promotes beneficial political links
Benefits consumers: more choice and higher satisfaction levels, lower prices
compared with local products, better quality products
Dynamic gains from trade: gains grow larger over time
Disadvantages of trade
Unfair competition and dumping / unnecessary government subsidies
Over dependence on other countries
Import harmful goods
Terms of trade: rate at which country exchanges its exports for imports
Factors
Change in demand conditions: population, income, availability of
substitutes
Change in supply conditions: technology, depletion of natural non-
renewable resources
Consequences of change in TOT
Change in BOT and SOL: dependent on PED of exports and imports,
cause of change, responses that follow
Reallocation of resources
Change in consumption patterns

64
2. Barriers to Trade
Natural
High transport costs raises COP and lowers relative efficiency
Lack of mobility of factors
Increasing COP due to LDMR beyond certain level of output
Other market imperfections: imperfect information and market conditions
may not specialize to extent that theory suggests
Artificial: protectionism
Tariff: custom duties imposed on imports of goods and services by
government
Depends on PED of imports and how much foreign suppliers are
willing to absorb may not protect domestic producers, just a source
of government revenue
Cuts volume of imports improve BOT exchange rate appreciates
exports more expensive abroad reduce exports in the long run
Non-tariff: import quotas
Greater certainty of protection since revenue earned by foreign
suppliers may not be as badly affected as tariff
Export subsidies: cash grants by government to local producers
Reduces COP sell more of good at prevailing price
May induce complacency
Drain on government funds
Foreign exchange control: government control over sale and purchase of
foreign exchange
Financial quotas, charges made on people purchasing foreign
currencies
Malaysia used this method to recover from 1997 Asian financial crisis
Difficult to enforce and might result in black market for foreign
exchange
Works best in communist countries because government
monopolises money conversion
Others: embargo, trade agreements, international cartels
New protectionist measure: technical specifications and standards
which discriminate in favour of domestic producers
Administrative regulations regarding import procedures to delay and
reduce volume of imports
Voluntary export restraints (VER): exporting country voluntarily
reduces its exports under threats of all-round trade restrictions eg. US
automobile industry vs. Japans

65
3. Arguments for Protectionism
Economic
Protect infant industry eg. Singapore had protective duties covering ~300
items in 1960s
Difficult to identify currently unprofitable industries that might
acquire comparative advantage in the long run
Difficult to decide when industry can be independent of protection
Encourage inefficiency
Reduce BOP deficits
Dependent on PED of imports and exports
Need to look at root causes
Invite retaliation reduced exports reduced total volume of world
trade
Prevent unfair trade practices
Dumping distorts market justifiable
If consumers benefit in the long run from lower import prices not
justified
Diversify economic structure
May not support theory of comparative advantage
Pattern of comparative advantage can change over time naturally
(discovery of new raw materials) / through deliberate policies
Protect mature industries
Trade unions
Misuse of resources since protectionism will not increase total
employment
Retaliation
Protect against low-wage foreign labour
Rejection of theory of comparative advantage
Could shut down industries and divert resources to more productive
ones
Consumers denied opportunity to buy from cheaper source benefits
of trade lost
Increase domestic production: counter-cyclical measure
Increase government revenue
To be effective, should be imposed on goods which are price inelastic
Retaliation
Retaliation
Unhealthy for word trade and ineffective
Distort and reduce differences in comparative advantage
Welfare loss
Misallocation of resources: firms unnecessarily retained
Difficult to remove protectionist measures once in place
Other industries may demand for protectionism
Better alternative: stimulate export competitiveness by increasing AS
66
Political
Essential to produce on military weapons in case of crisis subsidies industry
to ensure continuous supply eg. US 1980s semiconductor industry for high-
tech weaponry vs. Japans
Nation poorer but value of national security higher
Trade as weapon of foreign policy eg Gulf war: US imposed trade sanctions
against Iraq
Social
Subsidise agricultural sector to avoid further depletion of population in rural
areas / prevent further rural-urban migration to overpopulated cities
Restrict import of harmful goods

4. Tariff Diagram















Loss in consumer surplus = a + b + c + d
a becomes producer surplus, c become tax revenue, b + d becomes deadweight loss

Consumption effect:
- Reduce consumption from OQ4 to OQ3
- Reduce consumption of imports and switch to domestically produced substitutes
- Pay extra amount (P2 P1)
- Consumer surplus falls

Production effect:
- Expand production from OQ1 to OQ2
- Increase revenue
- Producer surplus increases

Government revenue effect:
- Receives as tax revenue extra amount paid by consumers for the imported quantity
67
Explain the theory of comparative advantage. [10m]

Introduction
Comparative advantage: specialize based on lower opportunity cost less of the
other good foregone

Body
Assumptions: 2 countries 2 goods, no transport costs, constant returns to scale:
LRAC remains constant

Assume USA and China each has 20 units of resources, initially use 10 units to produce
each good

Table 1: Before specialization
Cars Textiles Opportunity Cost
USA 100 60 1C: 0.6T
China 5 10 1C: 2T
Total 105 70
USA: CA in production of cars give up less textile
China: CA in textile give up less cars

USA devotes 1/10 more to car, China complete specialization.

Table 2: After specialization
Cars Textiles
USA 110 54
China 0 20
Total 110 74
World output increases

Terms of trade: mutually beneficial 0.6T < 1C <2T 1C traded for 1T
USA exports 10 cars, gets 10 textiles

Table 3: After trade
Cars Textiles
USA 100 64
China 10 10
Total 110 75

Gains from trade: higher level of consumption
Conclusion
Comparative advantage gains from trade, more choices, increase growth
Limitations of CA: relax assumptions
68
To what extent does the theory of comparative advantage explain the pattern of trade
between Singapore and the rest of the world? [15m]

Introduction
Singapores constraints lack of natural resources; small geographical size and
population human capital our only resource
Singapores relative strengths good geographical location
Our constraints and strengths determine where our CA lies
Pattern of trade: type of exports and imports of goods and services

Body
A) Yes

Type of exports
CA
1970s Textiles and simple manufactured
products
Labour-intensive industries:
Cheap, unskilled and surplus labour
1980s Move towards higher-end products
and electronic products; moving
towards services like banking and
finance, tourism
Capital-intensive industries:
More educated workforce and
improved technology
Loss of CA in labour-intensive
industries to countries like Malaysia
and Indonesia which have huge
labour force
1990s
and
beyond
Electronics, pharmaceuticals,
telecommunication equipment, disk
drives, integrated circuits
Services: banking and finance,
tourism, educational hub, medical
hub
High value-added, knowledge-
intensive, technology-intensive
industries:
Highly qualified labour force, r+d
infrastructure
Continue to lose CA in manufacturing
industries to countries like China and
India

Type of imports
Lack of CA
Imports: consumer items, food, raw
materials, capital goods for
development and infrastructure
building
Lack of natural resources especially
lack of land for agriculture and to
support huge export base

69
B) No, there are other factors
Trade based on world demand
CA only gives rationale for trade but countries try to augment and develop
CA in industries with world demand
For country to develop and provide opportunities for its population of diverse
talents, needs to have spectrum of industries
Diversification to reduce negative consequences of over-dependence
Desire not to rely on foreign supplier for essential goods
National pride / security eg. Newater
Re-exports
70
Discuss whether protection offers any advantages over specialization. [13m]

Introduction
Protectionist measures
Advantages of specialization based on CA: gains from trade, increase X economic
growth, wider choice, EOS fall in LRAC competitive prices, efficiency in resource
allocation in the world, welfare gain if world price cheaper than domestic price

Body
Infant industries
Rationale: NIE, reasons of economic diversification impose quotas / tariffs
allow new industries to grow and develop EOS
SR implications: applies for all reasons to protect as long as use quotas /
tariffs
Society: DWL
Consumers: increase price
Other firms (some extent): increase COP if good protected is
important input eg. steel
LR implications
Grow enjoy EOS lower LRAC lower price of exports able to
compete internationally BOT improves if demand is price elastic
increase in total revenue from exports increase exports increase
NY/N
If do not grow
If government subsidizing waste of resources could have been
used elsewhere education / healthcare / develop infrastructure
Consumers and society continue to suffer from inefficiency higher
prices
Shut down massive retrenchment
Summation: To the extent that infant industries grow. However, the infant
industries normally do not grow and may become inefficient due to
government subsidies. Protectionism cannot be long term.
Inefficient industries
Eg. US steel industry, textile: slap tariffs / quotas on Chinese textiles /
imported steel allow inefficient firms to eventually be able to be more
efficient develop new technology / adjust cost structures
Eg. steel affects COP in many other industries eg. housing, cars cost-push
inflation affects domestic market and erodes export competitiveness
Summation: protect jobs in inefficient industries but more jobs lost
elsewhere eg. car industry
Alternative solution: develop CA in new industries: capital-intensive,
technology-intensive, services, training
71
Dumping
Foreign country selling goods below its actual COP local firms driven out
eventually foreign country gains monopoly power
Difficult to ascertain if it is dumping / country really has CA in production of
these goods Chinese textile + abundance of cheap labour
Could be baseless accusation
Solution: force firms to be more cost-efficient (dont protect), training
(subsidise firms for training), subsidise r+d
Economic diversification
Reduce over-dependence on a few key products / industries
Eg. Zambia: copper exports what if world demand falls
Balance of trade deficit value of imports > value of exports
Eg. US huge trade deficit USA consumes a lot, including on imports breed
further inefficiency
Alternative solution: increase interest rates encourage people to save +
discourage consumption
LR: high C low S low investment affects productive capacity low LRAS
(inefficiency)
National security
Eg. steel war weapons

Conclusion
If country protects, other countries retaliate world inefficiency

72
Explain the rationale for free trade and discuss the extent to which FTAs are
beneficial. [25m]

Introduction
Free trade based on CA lower opportunity cost ratio gains from trade
FTA remove tariff and non-tariff barriers in theory in practice eg Singapores
FTAs also include investment

Development
A) Expounding theory of CA difference in factor endowments
Assumptions
3 tables
Summation: gains from trade, increase choice / increase societys welfare, increase
economic growth and SOL

B) Are FTAs beneficial
On trade
Increase X k increase NY / N associated benefit of large-scale production
EOS fall in LRAC able to price goods more competitively may improve
BOT
Singapore: small domestic market
China: may not be as dependent on X revenue because people are getting
more affluent. C increase can sustain itself based on internal economy
Cambodia / Vietnam: NIEs because people are poor
But increase X demand-pull inflation when near / at FE price of exports
increase volume of exports may affect BOT NY falls affects economic
growth
Inflation
Access to cheaper consumer goods + raw materials / inputs fall in COP fall
in price of exports X increase may increase BOT
Fall in COL extra savings can be used to buy domestic goods increase C /
NY












Price of consumer goods
Quantity of consumer goods
Sdom
Ddom
Pw
P
c
10 0 30 50
a b
73

a+b = welfare gain
a: production effect, inefficient domestic firms forced to reduce output from
30 to 10
b: consumption effect: increase C from 30 to 50
From diagram, firms forced to be more cost-efficient cut costs in order for
profits not to be eroded since P is at Pw
Trade creation / diversion
Creation: increase volume of trade from high-cost producer to low-cost
producer increase welfare of people
Diversion: from low-cost non-member to high-cost member away from
optimum allocation of resources
Draw diagram to illustrate effects
Jobs: increase in X increase N
But loss of CA forced to restructure move towards CA structural
unemployment
Outsourcing firms benefit by relocating increase BOT increase GNP
But cost jobs in previous country
On FDI
Outward investment to China from Singapore
Increase investment increase productive capacity increase AS
Increase investment increase AD increase N / NY
Transfer of technology
Useful for NIEs lack wealth / local entrepreneurs eg. Singapore depends on
MNCs
But footloose
But local firms cannot compete
Others
Vulnerability to external shocks due to over-dependence recession /
imported inflation
Interdependence: economies become intertwined eg. USA recession
Singapore recession, worldwide food prices increase

Conclusion
Possibility of unequal gains
Singapore
More ST capital outflow to China but LT profits increase GNP
Loss of jobs as companies go to China
Shifted focus to capital-intensive / technology-intensive focus on
services
Gain education: Chinese students come here to study
74
USA
USA spend a lot because lost CA in lots of goods need to buy more
imports worsen trade deficit less savings less investment
reduced productive capacity
India
Demand for capital goods
Summation
FTA: macroobjective increase NY increase SOL, fall in price increase BOT
Trade creation > trade diversion

*FTA means freer trade no restrictions among countries vs. free trade, so arguments
similar, only difference is trade creation / diversion
75
To what extent can economies benefit from globalisation? [25m]

Introduction
Globalisation free movement of goods and services, capital, labour
Economic integration: FTA, customs union

Development
A) Goods and services
Trade based on CA gains + EOS
Poor NIEs + Singapore (small domestic market) increase X increase NY / N
increase SOL
Access to cheaper goods
Consumer goods lower COL
Raw materials Singapore / Hong Kong
Capital goods for infrastructure Cambodia / Vietnam increase societal
welfare + potential growth
Draw in free trade diagram and illustrate gains
Trade diversion vs. trade creation: diagram
Loss of CA eg. USA steel and textile industry, Europe car industry but restructure
and move towards new CA
Inter-dependency eg. USA affect China / India
Over-dependency due to CA and complete specialization thats why countries tend
to partially specialize / diversify their economies
Effect on prices imported inflation
Tariffs due to protectionism: draw in diagram

B) Capital (associated technology) FDI (inward and outward)
Receiving country
Increase inward investment increase AS / AD increase NY / N
Growth of local supporting industries
Transfer of technology
Footloose may cause massive retrenchment if suddenly leaves
Local industries cannot compete lack of SMEs
Source country
SR: loss of jobs
SR: outflow of capital
LR: restructuring
LR: More companies internationally increase GNP
LR: Create jobs

76
C) Labour
For LDCs, provide jobs for labour cheap
May be SR exploitation but vs. no jobs
Eg. Vietnam inflation ~19% - lower income wage rise < price rise
Free flow of labour influx of foreign workers depress wages in jobs where supply
elastic (abundant supply of manual workers) no skills
Eg. Singapore / EU influx of workers into UK
Solution: provide training
Brain drain
Inequity issue
Manual workers wages fall
Skills demanded globally increase demand for work increase wages for
skilled jobs
Dual economy
Caters to international market people grow richer
Caters to domestic market people do not really get richer


77
Discuss the opportunities and threats of globalisation for Singapore and other Asian
economies. [12m]

Globalisation: high degree of freedom of movement of goods and services (trade),
capital, technology (MNCs) and talent (labour)

1) Globalisation and free trade
Opportunities
Export revenue and higher rate of economic growth
Increase in X k increase N / NY
Increase M of capital goods / raw materials eg. Vietnam / Cambodia /
Singapore
Threats
Competition causes countries to lose CA
Singapore lost CA in labour-intensive industries in mid-80s to NIEs like
China and Indonesia
SR: structural unemployment
LR: efforts may pay off if country realizes CA in new industries
Singapore shifted to capital-intensive then knowledge-intensive
Specialisation and over-dependency on few major products
If some countries adopt protectionist measures, trading partners
could be adversely affected
Interdependency of countries
Economies of major trading partners take a slide, countries will be
affected eg. 911, US recession

2) Presence of MNCs and out-sourcing
Opportunities
Influx of MNCs in Asian countries helped their economies grow
Creation of jobs and contribution to GDP
Transfer of technical know-how
Outsourcing eg. UK IT companies phone service operations to India
Threats
Fear of over-dependency: MNCs footloose if pull out, adverse effect on jobs
and economic growth
Dearth of local firms

3) Influx of talent
Increase quantity of resources shift PPC outwards
But cheap foreign labour wages in city fall lower income
78
Consider the effects, other than on the general price level, of Singapores changing tax
structure.

A) Inflation
Effect of increased reliance on indirect taxes definite inflation shift in SRAS
Increase indirect taxes increase COP for all firms fall in AS fall in NY
(contractionary) + rise in GPL cost-push inflation BOT may worsen
(depending on PED)
Effect of decreased reliance on direct taxes may or may not have inflation shift in
LRAS and AD
Fall in direct taxes C/I increase AD increase NY increase (growth) / N
increase if near / at FE: demand-pull inflation (a little may be desirable
because increase output) BOT worsen (depending on PED)
Lower income taxes income / substitution effect may increase incentive
to work increase AS increase NY fall in GPL BOT improves
Lower corporate taxes increase I increase NY fall in GPL BOT improves
Singapore: keep / attract talent increase efficiency
Attract MNCS increase FDI increase AD (increase N) and increase AS (increase
productive capacity)

B) Equity
Income taxes (direct) progressive higher the income, the higher the percentage
to tax reduce income gap
Indirect taxes regressive lower the income, the higher percentage to tax
increase income gap affects poor more
Cost-push inflation increase COL affects poor more
Lower direct taxes increase income gap because rich pay proportionately less
(usually reduce the percentage tax of rich more)
Corporate taxes fixed at 18%: neither progressive or regressive

C) Tax base
Increase indirect taxes widens tax base better to rely on due to ageing
population increase number of dependants / decrease in size of labour force
Decrease direct taxes: on working population and firms

D) Ability to evade
Indirect taxes: difficult to evade
Direct taxes: can evade but not in Singapore (jailed) can under-declare




79
Policies to remedy Singapores recession

Recession in Singapore: externally induced: fall in X

1. Fiscal Policy
Increase G to reduce business costs + training need to subsidise firms and training
grants
Fall in COP + increase productivity increase LRAS fall in GPL price of
exports fall volume of exports increase
Evaluation: buy only if they recover from recession
But increase G to boost increase in NY limited effect in Singapore
Small k need huge increase in G
Prudent
Why not increase G on public works
Limited land

2. Monetary Policy
Why not policies to directly increase X with exchange rate management
Short run solution: depreciation of S$ - price of exports fall in foreign dollars
volume of X increase
Government prefers soft option
Price of imports increase in S$ - import all raw materials COP increase
goods more expensive
Long term policy stance: gradual and modest appreciation of S$ - price of imports
lower for S$ - import raw materials more cheaply COP falls prices more
competitive
Modest: small increments export competitiveness not drastically eroded in
the immediate period
Gradual: firms can have time to adjust their cost structures find ways to be
more cost-efficient
Deals with cost-push inflation

3. Other Ways
Explore new markets through trade missions and signing of FTAs reduce over
dependence on a few trading partner
Long term measure

Conclusion
Fall in X is beyond our control
Measures can only be long run or interim ones
80
Evaluate methods the Malaysian government might use to slow down import growth
and increase new export business.

A. Slow down import growth
Devaluation weaken ringgit
Price of exports fall in foreign currency volume of exports increase total
revenue from exports increase
Price of imports in ringgit increase volume of imports fall total
expenditure on imports fall
BOT improves
Depends on price elasticity of demand for X and M Malaysia demand for
imports of capital goods could be price inelastic COP rises
Can only be short term if Malaysia needs to import capital goods and raw
materials
Persistent devaluation can lead to loss of confidence in economy
Tariff tax on imports price of imports rise volume of imports fall total
expenditure on imports fall
Increase in COL
Deadweight loss to society
Retaliation
Contractionary policies: interest rate rise investment and consumption falls AD
falls k fall in NY fall in demand for imports
Malaysia may have small multiplier
Malaysian firms may want to buy capital goods
Malaysia still developing, cannot afford to have fall in rate of growth
Use only if overheating

B. Increase new export business
Subsidies to export firms
COP falls increase AS GPL falls price of exports fall
Inefficiency, burden on government and taxpayers
FTA / Trade missions to new countries increase X k increase NY
Reduce over dependence on just a few major trading partners
Takes time long term
Firms may not want to take the risk uncharted territory businessmen may
be risk averse
Supply-side
Education and training increase productivity increase LRAS fall in GPL
price of exports fall
Best measure, yield results in the long run
81
To be considered successful, an economy needs to achieve low unemployment, low
inflation and stable economic growth. How far DYA with the statement? [12m]

Anti-thesis
Healthy BOPs especially open economy macro objective
Equity in distribution micro objective
Efficiency in resource allocation micro objective

To be considered successful, an economy needs to achieve low unemployment, low
inflation and stable economic growth. Explain this statement. [12m]

A) Low unemployment success [any 2 well-discussed]
Maximise use of resources reduces loss of potential output due to unemployment
Burden on government
Less tax revenue collected
More unemployment benefits
Increase budget deficit, opportunity cost less for other areas healthcare,
education
Singapore: GST offset package, growth dividends, Singapore shares, one-off
rebates
Low unemployment people have jobs higher C fuels growth
Social problems crime rates social unrest loss of man hours + deters
investment (confidence)

B) Low inflation success [internal and external]
Internal: stimulates output, induces confidence, increase investment due to
certainty, increase FDI, encourages savings increase investment in the long run
External: BOT improves [PED]

C) Stable economic growth success [any 2 well-discussed]
Sustained growth: actual and potential growth: increase AD and As continual
increase in SOL
Confidence increase investment + FDI good macroeconomic management of
government
Why unstable growth undesirable
AD keeps increase may cause overheating demand pull inflation
increase COL + affects BOT instability
If economy lapses into recession: negative growth hardship fall in SOL

Conclusion
Brief mention of other criteria for success
Conflict between growth and inflation: relentlessly pursues growth demand-pull
inflation: stable growth vs low inflation
Which criteria most important: low inflation price stability Singapore
82
Discuss whether fiscal policy is the most effective way for Singapore to sustain a
successful economy. [13m]

Introduction
Sustainable + stable growth + low inflation one of the keys to sustainable growth

Development
A) How FP works to attain growth
Increase G + decrease T increase AD k increase NY
K brief + diagram
Evaluation
Size of k small k huge leakages high savings / M need huge increase in
G prudent: budget surplus
Small C / I by domestic firms need export revenue policies should target X
Crowding out: increase G financed by borrowing from public increase
interest rate crowd out C/I/X
May not need to borrow huge reserves reserves can be depleted
More concerned about fall in X
Time lag: recognition, implementation, response
Small shorter time lag
Taxes unpredictable effect on C/I k works only on the extra disposable
income that is spent
Expectations: pessimism / optimism
Fall in direct taxes rely more on indirect taxes (GST) (increase COL)
regressive increase income gap

B) Summation: FP in Singapore limited role
If economy weakens (fall in GDP) usually due to external factors like fall in X eg.
911 US recession policies should target X
Policy exchange rate management sustainable growth
Gradual and modest appreciation of S$
Price of imports fall in S$ - check imported inflation (low inflation) +
Singapore depends a lot on imported raw materials lower COP LT able to
price competitively stable growth BOT increase (PED)
Price of X increases in immediate period
Gradual: Singapore firms to find other ways to reduce cost
Modest: not to totally erode export competitiveness
Supply-side policy: education and training, welfare benefits, taxation incentives

Conclusion
FP in Singapore limited effect on Ad, serves as supply-side measure to increase NY
over long term + exchange rate management to boost long term export
competitiveness
83
In the fourth quarter of 2004, Singapores unemployment rate rose to 3.7%. Discuss
whether supply-side policies are the best way of achieving full employment in
Singapore. [25m]

Introduction
Full employment: natural (frictional) rate of unemployment (some structural)
Cause for concern (very briefly): if structural severe, if cyclical

Development
A) Supply-side
Education and training Budget 08
Schools and vocational institutes gear Singapore workers for the challenges
of new economy grants, scholarships, places in university focus:
biomedical increase employability
Subsidise firms for workers training Skills Development Fund upgrade
skills reduce structural unemployment
Life-long learning knowledge can become obselete constant upgrading of
skills reduces prospect of being structurally unemployed
Long term and may not yield results
Increase employability and attracts MNCs
Welfare benefits
Singapore no unemployment benefits reduce frictional unemployment
Forced to upgrade skills reduce structural unemployment
Reduce power of trade unions
NTUC: government body harmonious relations no labour unrest: attracts
investment (FDI)
NWC: wage recommendations wage increase < productivity increase
keep COP low
Increase employability of workers

B) Policies to deal with cyclical unemployment: fall in AD
Supply-side structural, cannot solve cyclical
FP: increase G, decrease T but small k, external factors
Exchange rate management
Recession due to fall in X: depreciation / appreciation
Depreciation: price of exports fall immediate solution but Singapore cannot
afford to price of imports increase COP increase later price of exports
increase (growth cannot sustain)
Singapores choice: gradual and modest appreciation (long term solution)

Conclusion
Increase G on education and training + taxation incentives supply-side policies
effect on AD and some effect on cyclical unemployment limited role in Singapore
due to small k
84
Why Singapore does not use interest rate policy
Very dependent on overseas funds small
Eg. if Singapores interest rate falls to curb recession hot money outflow - $ in
Singapore banks fall MS falls interest rate increase no control
Discuss interest rate only if not Singapore

Problems with exchange rate instability

Exchange rates determined by
Trade and investment between trading partners
Speculation
Government management / manipulation of exchange rate eg. buy US bonds to
keep USD up

1) Trade
Affects business planning: need for certainty to forecast profits
Eg. If S$ depreciates
Price of Singapore exports fall in foreign currency volume of exports
increase
Price of imports increase in S$: dependent on raw materials (same for
developing countries which need capital goods)
Eg. If S$ appreciates price of exports increase in foreign currency affects export
earnings

2) Investment
Persistent depreciation loss of confidence in economy fall in investment

3) Developing countries
Foreign loans in US$ denomination if your currency depreciates pay back more in
your countrys $