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Question 57
During periods of recessions, most governments around the world
ECONOMICS tend to post budget deficits whereas in times of strong economic
growth, governments generally have budget surpluses.
PRE‐PRELIM REVISION To what extent is the choice of government budget positions the best
way for these countries to achieve macroeconomic stability? [25]
MR. LEE KENG HOE
Question 38
Governments have aims in relation to unemployment, economic
[Nothing is impossible, to those who believe] growth and the balance of payments.
a) Explain the consequences of failing to achieve these aims. [10]
b) Discuss whether failure to achieve these macroeconomic aims is
more likely to be caused by domestic or international factors. [15]
QUESTION 57
How can I benefit from the Prelim Revision? During periods of recessions, most governments around the world tend to post
• Read the questions to be discussed. Read the relevant topics linked to questions. budget deficits whereas in times of strong economic growth, governments generally
have budget surpluses.
• Brainstorm and draft essay outlines.
To what extent is the choice of government budget positions the best way for these
• Think about the question: what is the examiner trying to assess?
countries to achieve macroeconomic stability? [25]
• Some general guidelines: QUICK BRAINSTORM
1) What is the topic? Micro or macro or mixed of micro and macro? QUICK BRAINSTORM • Macro topic: Macro goals / FP + MP (i/r) or ER + SS‐side
2) Which sub‐topic(s)? E.g. Macro ‐> problems + policies • Micro or Macro topic? policies
• Which sub‐topics? • Tools of analysis: AD‐AS model, Workings of FP to
3) What tools of analysis (economic theory, model, principle, concepts,
diagram) should I use? Is my analysis balanced? • Which tools of achieve macro goals, multiplier process, limitations.
Answers with real world egs. Is it the best way to
4) Which real world examples can I integrate / apply to my analysis? analysis / real world achieve macro goals? Other policies + limitations
5) What is the context? If no specific context given, can I provide the relevant
examples? • Context: different govts. – countries with budget deficits
context? • Context? vs those with budget surplus. Nature of economy,
6) How can make an evaluation (stand / substantiation) that addresses the
• Evaluation (Stand / economic conditions.
question and based on the context and supported by critical reasoning? Substantiation) • Ev: FP is best way for certain c’tries but not so for others
+ why other policies may be better.
During periods of recessions, most governments around the world
tend to post budget deficits whereas in times of strong economic
growth, governments generally have budget surpluses. Context (L3)
Governments /
To what extent is the choice of government budget countries => nature
of economy,
positions the best way for these countries to achieve economic
conditions, fiscal
macroeconomic stability? [25] situation
Content / Concepts
Command word => Type of govt. budget positions
Evaluative comments required (5m): (=FP) to achieve
Is FP the best way to solve the macro macroeconomic stability (EG,
problems? Limitations? => need other full employment, price stability,
policies? Trade‐off with other goals healthy BOP position)
LEVEL OF RESPONSE APPROACH: To what extent is the choice of govt. budget INTRODUCTION –
positions the best way for these countries to achieve macroeconomic stability? [25] highlighted parts to set direction for essay
GENERAL ANSWERS LEVEL OF RESPONSE (L3) ANSWERS • Establish what is meant by macroeconomic stability:
=> Breadth + Depth • Macroeconomic stability refers to the government successfully guiding the
L1 answers: Definitions of macro stability,
budget positions • Definitions: macro stability, budget deficit economy to achieve the 4 macroeconomic goals.
(expansionary FP) & budget surplus (contractionary • Macroeconomic goals: sustained economic growth, low inflation rate
L2 answers FP) to address diff. economic conditions (e.g. (price stability), low unemployment rate and healthy BOP.
• Under‐developed explanation of recession, unemployment, inflation, BOP deficit)
expansionary FP and how it can achieve • Different economic conditions:
EG, employment. Other goals not • Thesis: FP => best way for c’tries to achieve macro • Recession, high unemployment rate, high inflation rate, BOP => Type of
addressed. No egs. stability. Use real world egs. Ev: effectiveness. FP?
• Some limitations of FP • Anti‐thesis: Not best way => Limitations (context • Strong EG, low unemployment, low inflation rate, BOP => Type of FP?
• Other policies (MP, ER and SS‐side /assumptions)
policies) generally explained & some • Other policies (MP or ER and SS‐side policies) to
• Interpret the choice of government budget positions
limitations. tackle problems + limitations. Compare with FP.
• Definition: budget position refers to govt. revenue – govt. expenditure.
• Budget deficit (govt. expenditure exceeds revenue) => expansionary FP.
No or general evaluation (low E marks) Evaluation with critical analysis / context (higher E marks • Budget surplus (govt. revenue exceeds expenditure) => contractionary FP.
General comments that choice of budget Stand / Substantiation (considers diff. economies with
positions can achieve macro goals. diff. problems, state and nature of economies).
BODY ‐OUTLINE BODY ‐OUTLINE
Thesis: Choice of budget position ‐> best way for these Anti‐thesis: Choice of budget position is not the best way for these
countries to achieve macroeconomic stability countries to achieve macroeconomic stability
1. A: Various limitations in using budget position to manage the economy.
1. A: A budget deficit is incurred (i.e. expansionary FP) during
C/E: Effectiveness of FP affected by crowding out effect for c’tries with
recession to stimulate AD. large & persistent budget deficits (e.g. US / Eurozone). Compared with
C/E: Expansionary FP to tackle negative EG & high SG?
unemployment rate during a recession. CONTEXT OF BALANCED
QUESTION Explain alternative policies & its limitations and compare with FP. ANSWER
2. A: Expansionary MP (i/r) => better alternative to achieve => L3
2. A: A budget surplus is generated during times of strong EG macroeconomic stability during a recession. OR
(i.e. contractionary FP) to lower AD to achieve 3. A: A gradual appreciation of ER (exchange rate policy) for small and open
macroeconomic stability. economies during periods of inflation.
C/E: Rising inflationary pressures when there is strong EG. AND
Use contractionary FP, i.e. govt. running a budget surplus by 4. A: SS‐side policies that does not require changing govt. budget position
decreasing G or increasing T. Can also reduce BOP deficit. might be a better option to achieve macroeconomic stability.
Conclusion and Overall Evaluation
BODY Multiplier process + diagram:
Thesis: The choice of budget position is the best way for these countries to achieve ↑AD => unplanned fall in inventories for firms To what extent is the
macroeconomic stability signal firms to raise production & hire more fop such as choice of government
A: Incur budget deficit (i.e. expansionary FP) during recession to stimulate AD. labour. budget positions the
Hhlds’ income increase rise in induce C of other g&s. best way for these
C/E: Negative EG & high unemployment rate during a recession => use expansionary FP. countries to achieve
Other firms experience an unplanned fall in inventories &
Expansionary FP: budget deficit => increase govt. spending (G) or reduce taxation (T). raise production => NI increases as output rises further. macroeconomic
Initial rise in AD resulted in a multiplied rise in NI. Cyclical stability?
Tools of analysis: unemployment is also reduced. Addresses 1 aspect of
• Govt. increases expd. on public works (e.g. building of roads), & cuts taxes.
question with DEPTH
• Reduce income taxes => increase disposable income / purchasing power => hhlds have • Ev: Such a policy is more appropriate for large economies. => thorough
greater ability to purchase g&s, so ↑C.
• E.g. US ‐ large proportion of domestic sector out of GDP explanation with
• Reduce corporate tax => increase expected net profits after tax => firms’ investments (>60%) & large multiplier size due to high MPC => effective context, real world
now more profitable => ↑I. as expansionary FP would have great on US economy. example => L2 answer
• Rise in G, C, and I will lead to an increase in AD as G, C & I are components of AD. but on the way to L3.
• Infrastructural expd. (eg. roads) => rise in capacity of
economy (rise in AS).
A: Generate budget surplus (contractionary FP) during times of strong EG
to lower AD to achieve macroeconomic stability.
C/E: Rising inflationary pressures when there is strong EG.
Use contrac onary FP, i.e. govt. running a budget surplus by ↓G or ↑T.
Ev: FP will be effective in preventing overheating, prevent
↑ income tax => lower hhlds’ disposable income and ability to buy g&s
whilst wage‐price spiral, & achieve price stability
↑ corporate tax => lower expected rate of returns for firms so making BOP
some investments unprofitable. External => impt. foundation for sustained EG (especially for small
state of the
Fall in G, C and I, => more than proportionate fall in AD due to the
economy
economies as SG is reliant on FDI and X).
downward multiplier‐effect => dampen EG & put a downward pressure on
GPL and inflation rate. Good
coverage
Contractionary FP => also used to reduce BOP deficit through lowering NI for macro
=> lower import expenditure, ceteris paribus => improvement in trade stability
balance and BOP.
Explain alternative policies & its limitations and compare to using budget Exchange rate policy (applicable for SG but not used by US as it is on flexible ER system)
in achieving macroeconomic stability NOTE: A: A gradual appreciation of ER for small and open economies during periods of inflation.
A: Expansionary MP => better alternative to achieve macroeconomic Monetary policy
stability during a recession. refers to using
money supply C/E: Appreciation of currency => increase in Px (in foreign currencies) fall in DD for
and/or interest exports; fall in PM (in domestic currency) more than proportionate increase in Qd for
C/E: ↓i/r => ↑C (lower opp. costs of C as returns to saving fall) & I rate to influence imports assuming PED > 1 => fall in net X, fall in AD => reduce DD‐pull inflation.
(expected rate of returns > i/r). If fall in i/r leads to hot money outflow due AD. Applicable for
to relatively lower returns => cause external value of currency to weaken US but not SG. Due to reliance on imported FOP for small and open economies such as S’pore who lacks
and cause net X to increase. resources, currency appreciation fall in COP, increase in AS and dampen cost‐push
It is NOT inflation.
Increase in C, I and net X => more than proportionate increase in NI due to Exchange Rate
rise in AD and multiplier effect => higher EG and lower unemployment rate. policy. Exchange
rate policy under Ev: Advantages: targets root cause of inflation – imported inflation in small & open
Ev: Advts.: shorter time lags in implementation of MP, greater flexibility, no managed float economies like SG.
foreign exchange
govt. financing. system can affect Disadvantages: if currency appreciates too much fall in X‐competitiveness and cause
Disadvt.: similar to cuts in taxes, MP might not work as effectively during money supply other macro problems. Stronger currency does not address domestic causes of inflation
recession as C and I might not increase significantly due to weak business when central (serious contributors to inflation for some c’tries).
and consumer confidence, small multiplier size. bank intervenes.
Supply‐side policies
Conclusion & Overall Evaluation
A: SS‐side policies that does not require changing govt. budget position might be a
Stand: Choice of budget positions & thus, FP can be effective in helping
better option to achieve macroeconomic stability.
c’tries achieve macroeconomic stability through achieving EG, job
creation and lower inflation rate to a certain extent but whether this
C/E: Explain how SS‐side policy helps to achieve macro goals. choice is the best would often depend on the nature as well as the state Addressing the
E.g. wage policies flexible wages allow wages to fall in times of recession of the economy. question
reduces the firms’ COP this reduces the extent the firms retrench workers. Is FP the
Substantiation: E.g. use of contractionary FP is less effective for small & best way?
• Structural unemployment issues would also require specific SS‐side policies (e.g. open economies to target low inflation during an economic boom
retraining to upgrade skills and improve employability in growth industries) rather because of the imported inflation that they tend to face. Supply‐side Context –
than a large change in budget position. These SS‐side policies would tackle root policy would be the best way for them to achieve macroeconomic
nature of
cause of problems if macroeconomic instability is caused by SS‐side factors. stability, although it would still require funds from govt. & might worsen
budget position. However, these tend to be more targeted. economy,
economic
Ev: But many SS‐side policies take time to take effect as it requires firms or workers In other cases, where conflicts arise from the choice of budget positions, conditions.
to respond to the govt.’s initiatives. the govt. may also need to undertake a combination of policies so that
recession and inflation can be tackled more effectively (such as using
expansionary FP and supply‐side policies together).
Don’t give up! Press on!
Support & care for each other QUESTION 38
Governments have aims in relation to unemployment,
economic growth and the balance of payments.
a) Explain the consequences of failing to achieve these
aims. [10]
b) Discuss whether failure to achieve these
macroeconomic aims is more likely to be caused by
domestic or international factors. [15]
QUESTION 38 Governments have aims in relation to unemployment, economic growth
and the balance of payments. Explain the consequences of failing to
Governments have aims in relation to unemployment, Link to 3 of achieve these aims. [10]
economic growth and the balance of payments. the macro
goals
a) Explain the consequences of failing to achieve these Introduction
aims. [10] Economies aim to achieve macroeconomic goals such as:
Consequences or impact of ‐ Sustained economic growth (actual and potential growth)
Depth of explanation with unemployment, slow /
relevant real world
negative EG, healthy BOP
‐ Low unemployment
examples, context ‐ Healthy BOP
b) Discuss whether failure to achieve these
macroeconomic aims is more likely to be caused by As these macroeconomic goals are inter‐related to one another, failure to
domestic or international factors. [15] achieve any of the above => impact on the other goals => affect a country’s
living standard.
Causes of unemployment, Domestic (C,I) or
slow / negative EG, BOP international (external
deficit => X, FDI) factors
Governments have aims in relation to unemployment, economic growth [A] Failure to achieve low unemployment affects EG
and the balance of payments. Explain the consequences of failing to
achieve these aims. [10] [C, E] Impact of high unemployment (e.g. Greece) on
• Firms → poor business confidence and expecta on →↓ expected rate of return.
Since expected rate of return is now lower than i/r, hence volume of I ↓
Body ‐ Outline • Workers→ gloomy future and fear of possible retrenchment →↑ savings and ↓C
• Failure to achieve low unemployment affects EG • Since both C & I ↓→ AD↓→ downward mul plier effect (explain) → adverse
• Failure to achieve sustained EG affects inflation and BOP impact on actual growth.
• Failure to achieve healthy BOP affects EG. [C,E] Also, prolonged periods of unemployment
Occupational obsolescence and immobility. Discouraged workers may also leave
the labour force
Productive capacity falls as fall in qty. of labour => fall in potential growth.
[A] Failure to achieve sustained EG affects inflation and BOP [A] Failure to achieve healthy BOP affects EG.
[C, E] Sustained EG => increasing an economy’s actual national output [C, E] Persistent BOP deficit can lead to financial crisis.
over time without accelerating inflation rates.
If deficit is due to imports spending exceeding export earnings => fall
in AD and real GDP. Actual growth is adversely affected.
Sustained EG => rise in actual (AD) and potential growth (AS).
Growth rate is thus at a level that is not causing the GPL to accelerate [C, E] BOP surplus can result in appreciation of domestic currency
from its current levels => non‐inflationary growth. (assuming it is on a floating ER) => negative impact on export
compe veness → affects (X‐M) nega vely → reduces AD and hence
Failure to achieve sustained EG => inflation. GDP.
Since price of X becomes less competitive, Qd for exports will fall.
Assume PEDX > 1, TR for exports will fall. If imports are relatively cheaper
(i.e. substitutes), DD for imports will rise, causing TE of imports to rise.
With that, BOP will worsen.
ESSAY OUTLINE – domestic and international factors affecting UN, EG and BOP respectively
QUESTION 38
1. [A] Unemployment caused by domestic factors
Governments have aims in relation to unemployment, [C, E] Cyclical unemployment due to falling AD (domestic C, I due to higher i/r).
economic growth and the balance of payments. [A] Unemployment caused by international factors
[C, E] Cyclical unemployment due to falling AD from international components like FDI, X.
a) Explain the consequences of failing to achieve
these aims. [10] 2. [A] Low economic growth due to domestic factors
[C, E] A country’s qty. and quality of FOP can affect the potential growth rate.
b) Discuss whether failure to achieve these [A] Low economic growth due to international factors
macroeconomic aims is more likely to be caused C/E: Foreign govt. imposing capital controls & preventing their firms from investing
by domestic or international factors. [15] overseas or poor business outlook → inflow of capital stock will be reduced.
Can be Which factors are 3. [A] Explain unhealthy BOP due to domestic factors
Causes of
domestic or more significant? [C/E] Domes c infla on => reduce export compe veness → deteriora on of current
unemployment,
international Depends on account
slow / negative
(external) nature of [A] Explain unhealthy BOP due to international factors. [C]Foreign inflation => rise in
EG, BOP deficit
factors economy price of crude oil => worsen current account balance.
[A] Unemployment caused by domestic factors [A] Unemployment caused by international factors
[C, E] Cyclical unemployment can be due to falling AD (domestic C, I) [C, E] Cyclical unemployment can be due to falling AD from
Rising interest cost fall in C and I. international components like FDI and X.
Higher i/r (e.g. US Federal Reserves raise interest rate)
higher opp. cost for C & higher borrowing costs Fall in foreigners’ income (during the 2008 GFC, Eurozone debt
crisis) => reduce their ability to buy g&s and hence a country’s
discourage households from consuming & firms from investing as i/r > export. Similarly, a fall in FDI due to poor economic condition will
given rate of return => now less profitable to undertake I. So C & I falls. reduce AD => less demand for labour => rise in unemployment.
With fall in AD, firms will cut down on production and reduce demand for
labour => rise in unemployment. [E] For an economy that is very open to trade and international
capital flows (ie. high X component in GDP and reliance on FDI, e.g.
SG with > 200% of X/GDP) => main source of unemployment
international factors.
[A] Low economic growth due to domestic factors
[A] Low economic growth due to international factors
[C, E] A country’s qty. and quality of FOP can affect the potential growth
rate. E.g. less developed country may lack funding and technology.
C/E: In case of foreign govt. imposing capital controls and
preven ng their firms from inves ng overseas → inflow of
Due to lack of technological advancement => factor productivity can
stagnate or fall over time => rising unit COP (assuming unchanged factor capital stock will be reduced.
costs).
Particularly impt. to SG (lack of resources and small domestic
With horizontal AS rising and vertical AS shifting slowly outwards => market) → significant need for external market to drive EG.
c’try will have limited EG.
Hence if FDI is falling, her EG will be adversely affected.
Conclusion
[A] Explain unhealthy BOP due to domestic factors [Stand] Whether domestic or international factors play a more significant part in
failure to achieve macro aims => depend on nature of economies.
[C/E] Higher domestic inflation (relative to other countries)
[Substantiation] In most instances, domestic factors play a more significant role in
Higher GPL of local g&s => reduce export compe veness → achieving macroeconomic goals. However, endowment and size of economies play a
deterioration of current account bal. in BOP. [Explain in details] pivotal role in whether such macroeconomic goals can be achieved.
[A] Explain unhealthy BOP due to international factors More open economy, typically small economies => international factors likely reasons
for country’s inability to achieve full employment and EG. But internal factors are also
[C] Falling foreign incomes (e.g. 2008 GFC) may lead to fall in DD for relevant & can be more significant in achieving sustained EG over time.
exports → export revenue falls, c.p, worsens current account bal. in
BOP. [Elaborate] E.g. For SG, poor external DD can result in slow growth but lack of price
competitiveness due to domestic factors would also determine her ability to sustain
growth and achieve healthy trade balance over time.
External shocks particularly impt. for trade dependent c’tries like SG.
As for BOP, it is hard to attribute BOP imbalance to either domestic or external factors.
Next Lecture
Question 32
Americans are saving more with personal savings rate rising to 5.4%, and it
may become a problem for economic growth.
Discuss the view that an increase in the level of saving is always undesirable for
an economy. [25]
PRE‐PRELIM
Question 45
REVISION LECTURE
The relative importance of the components of the circular flow of income for a
small and open economy, such as Singapore, is likely to be different from a MR. LEE KENG HOE
large and less open economy, such as the USA.
a) Explain this statement. [10]
b) Assess whether a change in the external value of its currency is more likely
to have a larger impact on Singapore or the USA. [15]
Today’s Lecture
Question 32
QUESTION 32
Americans are saving more with personal savings rate rising to 5.4%, and it
may become a problem for economic growth. Americans are saving more with personal savings rate
Discuss the view that an increase in the level of saving is always undesirable for
rising to 5.4%, and it may become a problem for economic
an economy. [25] growth.
Adapted from Businessinsider.sg, May 2016
Question 45
The relative importance of the components of the circular flow of income for a
small and open economy, such as Singapore, is likely to be different from a Discuss the view that an increase in the level of saving is
large and less open economy, such as the USA. always undesirable for an economy. [25]
a) Explain this statement. [10]
b) Assess whether a change in the external value of its currency is more likely
to have a larger impact on Singapore or the USA. [15]
LEVEL OF RESPONSE APPROACH: Discuss the view that an increase in the level of QUESTION 32
saving is always undesirable for an economy. [25]
Americans are saving more with personal savings rate rising to 5.4%, and
GENERAL ANSWERS LEVEL OF RESPONSE (L3) ANSWERS it may become a problem for economic growth. Adapted from
=> Breadth + Depth Businessinsider.sg, May 2016
L1 answers: Definitions of saving,
aggregate demand, aggregate supply, 4 • Definition: saving
goals Discuss the view that an increase in the level of saving is always
• Thesis: Rise in level of savings is undesirable (2‐3 undesirable for an economy. [25]
L2 answers points) with real world example, economic
• Under‐developed explanation of how condition and context of US versus other economy.
rise in savings result in lower Cover other macro goals besides EG, employment. Rise in level of
consumption and its impact on EG, Always undesirable Economy
employment. Brief multiplier effect. No • Anti‐thesis: Can be desirable (2‐3 points) and why. Negative impact Not just EG but savings
egs. Other real world example / context, and economic No: can have +ve the 4 macro goals => autonomous S
• 1‐sided answer. condition. and NOT MPS
impact EG, employment,
Evaluation with critical analysis / context (higher E marks) inflation, BOP (savings rate)
No or general evaluation (low E marks) Stand / Substantiation – not always undesirable
General comments on effect of saving on the (considers diff. economies, different state and nature of Desirability depends on:
economy => didn’t address the question. economies). economic condition, time frame and initial level of saving
Introduction Body
Thesis:
• Saving is defined as the portion of disposable income that is An increase in level of saving is undesirable due to:
not spent on consumption. • ↓C → Fall in current living standards.
• ↓AD → Decline in actual growth
• A rise in the level of saving will impact the macro goals of an
economy. Anti‐thesis (desirable)
An increase in level of saving leads to
• Desirability of an increase in savings is dependent on: • ↑S → ↑I → Potential economic growth
• initial state of economy • ↓AD → Lowering of inflationary pressures
• time frame • ↓AD → ↓M expenditure → Improvement of current account balance
• initial level of saving.
Overall Evaluation (Stand / Substantiation)
Body A: An increase in level of saving is undesirable as it may cause a decline in
actual growth
Thesis: [C/E] Saving is a withdrawal in the circular flow of income.
A: An increase in level of saving is undesirable due to fall in Rise in households’ autonomous S => less disposable income for C fall in
autonomous C fall in AD.
current living standards
[C] As AD decreases from AD1 to AD2 => unplanned rise in inventories, so
firms cut production to meet planned levels of inventories. The national
[C] Household disposable income is either spent on consumption output thus falls. As firms hire fewer fop due to fall in output => hholds
or saved. For same income level, a rise in level of S means a fall in receive less factor income.
level of C in the current period. This means fewer wants and Fall in income from Y1 to Y2 => hholds spend less on domestic g&s fall in
needs are satisfied. induced C. With fall in spending, this creates another round of unplanned
rise in inventories in other industries, & process repeats itself with each
subsequent fall in induced expd. on g&s. There will also be a fall in
withdrawals with every round as households save less, pay lower taxes, and
[E] This leads to a fall in current material living standards. spend less on imports.
Impact on economy depends on initial state of the economy.
• If economy is at / below Yf, fall in AD fall in NI. Further fall in I if
This process will repeat AS
business pessimism. c.p., actual growth becomes negative and
itself until a new lower GPL
demand deficient unemployment increases => undesirable for
equilibrium national economy.
AD1
income at Y2, (which is AD2
greater than the initial Evaluation:
change in autonomous C). • Extent of fall in income depends on multiplier size. Explain.
P0 • Fall in autonomous C greater fall in NI. E.g. US: strong consumerism
There will thus be a O
values and greater access to credit => MPCd is high. Downward
multiplied fall in NI. multiplier effect will be relatively stronger.
Y2 Y1 Real National Income / t
• SG: high MPW due to high MPS (compulsory savings through its CPF
law), high MPM due to limited resources. Since MPW is relatively high
=> weak multiplier & fall in C may not result in a significant fall in NI.
Anti‐thesis (desirable)
A: An increase in level of saving leads to potential economic growth
[C] Rise in saving => excess loanable funds => downward pressure on interest
rate (i/r). Fall in i/r => higher domestic I as a lowered i/r leads to more Evaluation:
investment projects becoming profitable.
[E] With a rise in I, country’s capital stock rises, assuming level of gross I • Rise in I depends on how responsive investments are to
exceeds level of capital depreciation. Rise in the capital stock => rise in TFP as changes in interest rate.
labour becomes more efficient when it has more machinery to work with.
Evaluation:
• Rise in I depends on how responsive investments are to changes in A: An increase in saving may help to ease inflationary pressures
interest rate. During recession, investments may not increase even
though interest rate may have fallen due to a lack of business [C/E] If economy was initially above full employment level, rise in
confidence. S will reduce DD‐pull inflationary pressures.
Fall in AD results in less competition for resources.
• Moreover, the impact on future SOL is also dependent on the extent in
which saving is channelled to productive investments. The assumption Price of fop, e.g. wage rates & rental rates will fall => allow firms
is that the rise in S will be channelled to productive I. But this is not to sell their goods at a lower price as GPL falls.
necessarily so.
Hence, DD‐pull inflationary pressures would be eased.
• In SG, high % of households’ saving goes into owner occupied housing,
=> does not much impact on the country’s potential output.
A: An increase in savings may improve the current account
[Stand] A rise in S is not always undesirable for an economy. It
[C/E] According to circular flow of income, a c’try income is saved, depends on i) initial state of economy, ii) whether considering
taxed, spent on domestic consumer goods or imported g&s. only short term (ST) or also long term (LT) and iii) the initial level
For a given income level and assuming taxes are unchanged, a rise in S of S as % of GDP.
=> hholds spend less on imported g&s. Moreover, with fall in Y, M is
further lowered.
[Substantiation]
Fall in import expd. improve country’s BOT => improve current As a rise in saving has a contractionary effect on the economy, an
account and BOP, ceteris paribus => fall in c’try’s level of external debt economy that is operating at or below Yf => negative impact on
=> improved living standards for future generation. AG.
Evaluation: However, whether the economy is positively or negatively
impacted depends on whether the current account was in deficit or E.g. some European economies are already below Yf & increase
surplus initially. If current account was already in surplus and S rises in savings in ST => decline in AG & greater unemployment =>
further, the surplus will become bigger taking the country further away worsen the recession. Rather, these countries should lower
from the goal of current account balance being close to 0. saving.
Don’t give up! Press on!
LT ‐ rise in S is desirable, but only if it is not already over‐saving. Support & care for each other
Desirable as EG requires I which is only possible with saving. Weigh
cost in terms of forgoing current C against higher level of future
consumption.
However, rise in S is desirable if saving rate was initially very low % of
GDP. E.g. USA ‐ low level of S implies a high level of M & hence large
current account deficit => unsustainable as high level of external
indebtedness => lower SOL for future generation due to the need to
pay back the debt.
A rise in S => good for such a country to lower its current account
deficit and external indebtedness. Rise in domestic investment also
aids PG.
Question 45
Question 45
The relative importance of the components of the circular flow of
The relative importance of the components of the circular income for a small and open economy, such as Singapore, is likely to
be different from a large and less open economy, such as the USA.
flow of income for a small and open economy, such as
Singapore, is likely to be different from a large and less open a) Explain this statement. [10]
economy, such as the USA.
Conceptual Explanation
a) Explain this statement. [10] • Big idea: Equilibrium National Income => Injections =
b) Assess whether a change in the external value of its Withdrawals
currency is more likely to have a larger impact on • Explain what is circular flow of income in a 4‐sector economy.
Singapore or the USA. [15] • Relative importance of the components => important for L3
score
• Higher L3 score => comparison between small, open economy
(SG) and large, less open economy (US)
CIRCULAR FLOW OF INCOME
Question 45
The relative importance of the components of the circular flow of
income for a small and open economy, such as Singapore, is likely to
be different from a large and less open economy, such as the USA.
a) Explain this statement. [10]
Approach:
Explain working of circular flow of income and highlight that in the
case of Singapore, X+M are important components compared to
USA which depends more on domestic C (Cd) to drive the economy.
Introduction Body
[A] Circular flow of income explains how equil. NI is determined in an open
• Circular flow of income => flow of payments from firms to economy
households (to pay for factor services) and from households to [C, E] Circular flow of income = flow of payments from firms to hhlds (to pay for
factor services) and from households to firms (to pay for consumers’ goods and
firms (to pay for consumers’ goods and services). services).
Absence of govt. & international trade => hhlds who own the fop, sell factor
• There are injections into and withdrawals from circular flow and services to firms, who produce g&s. In return, owners of fop receive factor
payments, such as wages, which are then spent on consumer g&s produced by
the relative importance of the components of withdrawals and
domestic firms.
injections depends on the nature of the economy and its
institutions. Hhlds typically don’t spend all their current income. Some is saved, representing
a leakage from the circular flow. Leakage = income receipt that is not passed on
through hhld spending. With addition of the govt. & external sector => additional
leakages in the form of taxes and expenditure on imports.
Spending may originate from:
• firms from investment spending
• govt. spending on public projects, provision of social
welfare and
• firms selling g&s to external sector.
I expd., G expd. and export revenue are income receipts
not caused by hhld. spending => injections to circular flow
of income. From diagram, national expenditure will be: Cd + I + G + X and NI is income received by
hhlds. (for supplying fop) & used to consume domestically produced g&s, with a portion
In the circular flow of income, withdrawals flow back into going to savings, paying taxes and imports: Cd +S+T+M.
the economy as injections. Equilibrium condition for economy occurs when: National income = National expenditure
Cd + S + T + M = Cd + I + G + X OR S + T + M = I + G + X
[A] Nature of an economy determines the relative importance of these
Under this condition, planned expd. of economy is just components in the determination of national income
sufficient to buy up all g&s that firms had produced and [C/E] SG has relatively low Cd as % AD and relatively high X as % of AD
this in turn generates NI when firms pay factor income to Being a very open economy, her (X+M) is > 3 times her GDP.
households.
Small domestic economy (pop. size of < 6 million)
Market is too small
Hence => no tendency for firms to change their level of
Relies less on domestic C as an engine for growth.
production and no tendency for level of NI to change & is Open up to world market ‐ rely on exports as an engine of growth.
said to be in equilibrium. X is relatively more important compared to Cd as a % of AD for SG.
SG also has relatively high M as % of GDP as resource poor => import
i.e. when total withdrawals (W) = total injections (J) for consumption and raw materials to produce her exports.
US, however, has relative high Cd as % of AD as compared to X. • US ‐ relatively lower leakages due to low M as % of GDP. US has
abundant resources (vast land, oil and natural gas deposits) =>
little need to import raw materials and intermediate resources for
• With her large domestic market (>300 million or 50 times size production of her exports.
of SG), US can be self‐sufficient in her consumption =>
relatively high Cd (about 70% of her GDP) as compared to X • US imports are basically to take advt. of low prices (from other
(which is less than 15% of her GDP). countries’ comparative advantage) as well as for varieties =>
relatively low M as compared to small resource‐poor countries.
• Thus for US, growth is largely fueled by domestic DD rather
• As such, M is a relatively lower percentage of GDP as compared to
than external DD. countries like SG.
b) Assess whether a change in the external value of its currency is more b) Assess whether a change in the external value of its currency is
likely to have a larger impact on Singapore or the USA. [15]
more likely to have a larger impact on Singapore or the USA. [15]
Change in external value of a country’s currency
=> either appreciation or depreciation Approach
Assess 1st the impact of a change in external value of a
country’s currency on an economy’s macroeconomic goals –
Impact on Singapore Impact on US EG, employment, inflation and BOP.
Macro goals Macro goals
EG, employment, EG, employment,
Extent of impact depends on:
inflation, BOP inflation, BOP
• Characteristics of the two economies, e.g. openness,
relative importance of the components that are affected by
Larger impact on SG or US depends on: the exchange rate etc.
Characteristics of the 2 economies, e.g. openness, relative importance
of the components affected by the ER.
Body
Introduction
A change in external value of a country’s currency 1. Depreciation of the currency will have impact on a country’s BOP.
Will affect price of its exports in foreign currency and price • How? Deprecia on → ↑(X‐M) → improvement in current
of imports in domestic currency. account balance of BOP
Will affect value of its net exports (X‐M) and the country’s
2. Depreciation of the currency will have impact on a country’s
macroeconomic goals like growth, unemployment and economic growth and employment.
BOP. • How? ↑(X‐M) → ↑AD → ↑EG → Rise in DD for fop
This essay analyses the impact of currency depreciation on 3. Currency depreciation will have impact on a country’s inflation.
the country’s macroeconomic goals. • How? If no spare capacity, rise in AD → DD‐pull inflation
Body
Currency depreciation also results in higher price of imported
[A] Depreciation of the currency will have impact on a country’s BOP inputs => higher COP
[C,E]
• Depreciation of currency fall in PX in foreign currency rise in Effect is bigger for SG since she is very dependent on
DD for exports rise in exports earnings. imported inputs unlike US. Hence, the gain in export
• Depreciation rise in PM in local currency assuming PEDm > 1 competitiveness will be limited for SG but not US.
more than proportionate fall in Qd of imports fall in import
expenditure. Evaluation: Impact of currency depreciation on a current
• Given a rise in total export revenue and a fall in import account is likely to affect SG more as compared to US given
expenditure, current account will improve. that net exports takes up a large percentage of the current
account balance.
Currency depreciation results in better export competitiveness
May attract FDI, resulting in capital inflows and increase in BOP. [A] Depreciation of the currency will have impact on a country’s
However, foreign firms focused more on business expectations, economic growth and employment
COP in considering whether to invest in a country. [C] Currency depreciation will result in (X‐M)↑ AD↑ national
Capital outflow if foreigners expect further depreciation and re‐direct output thus increases.
their funds to where the returns to financial assets are higher.
Explain the multiplier process in details.
Evaluation: Degree of confidence in country’s banking system
&expectations of possibility of further depreciation also matter. Rise in output increase in DD for labour since labour is a derived
Currently, as foreign financial investors are more confident in Asia demand fall in demand‐ deficient unemployment.
compared to US => weaker S$ should not cause much ST capital
outflow from SG.
[A] Depreciation of the currency will have impact on a country’s Growth and Employment
[C] Currency depreciation will result in (X‐M)↑ AD↑ unplanned fall in inventories [E] Magnitude of impact of depreciation is likely to be larger on
firms raise production national output thus increases.
Singapore’s NI due to her high trade dependence.
As firms hire more fop hhlds receive more factor income spend a portion of this
additional income on domestic g&s rise in induced C, AD rise again. Her openness => exports takes up a large % of GDP (over 200%), hence
changes in (X‐M) will have a greater impact on its national income.
With rise in spending, this creates another round of unplanned fall in inventories in other
industries, and the process repeats itself. There will also be an increase in withdrawals with
US growth => largely driven by domestic C => impact of a change in (X‐
every round as households save, pay taxes, and spend on imports with the remaining M) on NI is likely to be smaller.
portion of their additional income. This process will repeat itself until a new equilibrium NI,
(> than initial change in autonomous expd.) is achieved where the rise in J is met by the rise SG also has a relatively smaller multiplier, however, the multiplied rise
in withdrawals. There will thus be a multiplied increase in NI actual growth.
in her NI may still be much larger than US due to significant proportion
Rise in output increase in DD for labour since labour is a derived demand fall in of exports as a % of the country’s GDP.
demand‐ deficient unemployment.
Conclusion:
[A] Currency depreciation will have impact on a country’s inflation
Stand:
A change in external value of its currency affects the external state (BOP) of a country,
[C, E] Depreciation increase in PM in domestic currency. and its attractiveness to foreign investors. This in turn affects the country’s
Higher prices of imports of components / raw materials and macroeconomic goals. Extent of impact depends on characteristic of an economy & is
consumer goods significant impact on unit COP likely to be larger for a small and open economy like SG than for a larger and less open
rise in horizontal AS cost‐push inflation. economy like US.
Substantiation:
Ev: Given that SG lacks natural resources, high dependence on
For SG, her openness and high dependence on trade ((X+M)/GDP > 360%) means that
imports her external and internal economy are more affected by changes on her exports and
=> S$ depreciation will have a significant impact on the country’s imports. Weakening of currency => while AD rises, horizontal AS is also shifting up. Thus
inflation. overall expansion in equil. NI is rather limited. So rise in SG’s equil. NI would be lesser
compared to US due to US lack of dependence on imported inputs.
US however is less dependent on imported goods => changes in price
of imports due to changes in ER is less likely to affect the country’s Moreover, impact on price stability is also more adverse for SG due to her greater
inflation rate. dependence on imported inputs and the current full employment of resources.