econs tut for term 3

8/3/2019 Econs Tut for Term 3

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Contents Page

T2W6-9: Macroeconomic Aims, Issues and Policies Tutorial 2-4T3W2 Lecture Essay Test 5T3W3-7: Monetary Policy and Interconnectedness of Economic

Problems and Policies Tutorial

6-7

T3W8-9: Revision of Essay Writing Skills 8-11Describe the appropriate measures the Singapore governmentcan adopt to deal with the recession.

12

Budget 2007 12Explain the possible links between trade deficit and a budgetdeficit.

12

Explain what causes inflation. 13-14

Discuss why a high rate of inflation might have an adverseeffect on output and employment.

15

What are the advantages of a low rate of inflation? 16Policies to control inflation 17-

19What is liquidity trap? 20Using a diagram, explain what might cause a countrysexchange rate to appreciate in a floating exchange rate system.

21

Explain how exchange rates are determined. 22-23

Discuss the extent to which problems are likely to result from anappreciation of Singapores exchange rate.

24

Discuss how the Singapore government might use the conceptsof price elasticity of demand and income elasticity of demand todetermine the impact of a fall in exchange rates and a rise inworldwide incomes on the current account of the Singaporebalance of payments.

25-26

The government proposes to increase tax on petrol. Assessrelevance of PED and YED for success of proposal.

27

Policies to correct current account deficit 27-28

A governments macroeconomic objectives are economicgrowth, low inflation, full employment and healthy BOP.

Consider some of the difficulties in its attempts to meet themsimultaneously.

29-30

A governments macroeconomic objectives are economicgrowth, low inflation, full employment and healthy BOP. Whichof these aims do you consider most significant for Singaporeand why?

31-32

Discuss how a supplier of a product that is currently fashionablemight use concepts of PED, YED and CED in its price and output

33

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decisions.Healthcare as a source of market failure 34Large firms necessarily become monopolistic. Monopolies adoptpractices that are undesirable. Therefore, large firms should beregulated by governments. Discuss whether there is any truth in

this argument.

35-36

Term 2 Weeks 6 to 9Macroeconomic Aims, Issues and Policies

Data Response Question 3Ai) Deficit. Must say deficit / surplus when asked to comment on

government budget, BOP, current account, BOT. [1m]Possible decreasing. [1m]

ii) Russia surplus vs. China deficit [1m]Both budgets are moving towards a balanced budget [1m]

Bi) Real GDP growth has been adjusted for inflation / at constantprices.Nominal GDP growth is measured based on current prices.

ii) Russia

C) Brazil: falling surplus1. Appreciation of currency (any 2)

Px more expensive in foreign currency + Pm cheaper in localcurrency Marshall Lerner condition volume of exportsdecrease more than proportionately + volume of importsincrease by more than proportionately total revenue fromexports decrease + total expenditure on imports increase BOT falls current account surplus decreases

2. Increase in consumption and investment firms need toimport raw materials and capital goods total expenditureon imports increase current account surplus falls

3. Brazil inflation rate higher than China (if it is a major tradingpartner) price of exports increase + price of importsrelatively cheaper Marshall Lerner condition volume ofexports decrease + Brazilians turn to Chinese goods totalrevenue from exports decrease + total expenditure onimports increase BOT falls current account surplusdecreases

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4. Brazil: strong economic growth- Extract 1: strong- Table 2: GDP increasing at a falling rate = NY increase dueto change in income increase demand for imports if

demand is income elastic eg. luxury goods increase in totalexpenditure on imports even more significantly BOT falls current account surplus falls

5. Depreciation of Chinese yuan [extract 2: trading partner ofChina]- Same elaboration as first point

D) *Must state the indicatorsStandard of living:Material: real GDP per capita, income gap Gini coefficient, type

of spending budget balance (weak link)Non-material: health life expectancy and IMR, education enrolment ratio, negative externality eg. Pollution, averagenumber of working hours

Data: real GDP increases for all 3 economies over periodHowever, population changes not taken into account. Cannotmeasure on average per person amount of goods / servicesconsumed

Type of spending: extract 3: increase G to fuel household

consumption increase NY

Income gap: Russia inflation rate projected to be high affectsCOL increase Gini coefficient

E) Unexpected decline in economic activity fall in world income fall in X ( fall in BOT) + fall in I (pessimism) and FDI fall inAD ( fall in GPL *dont focus here because the benefits of thiscome later) NY / N falls

China vs. Brazili) Brazil: robust (C + I) may offset fall in X

China: slackening demand due to China is tightening contractionary policy to deal with overheating AD falls C/I falls coupled with fall in X

ii) Brazil vs China: current account as % of GDPChina: 5% of GDP vs Brazil: 1% of GDP

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iii) Chinas budget deficit decreasing spending less

iv) Chinese yuan depreciated (mitigate the effect fall in X)while Brazil appreciated

Russia- shaken business confidence C/I may decrease / increasemore slowly- Seems most dependent on trade current account as % of GDP- Rate of inflation highest, price of exports very expensive+ Selling important inputs / raw materials demand is priceinelastic+ Russia adopts expansionary policy: increase G decrease T increase AD increase NY fuel growth

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UCLES June 20074b) Discuss whether a budget deficit should be a cause for concern?[15m]

Budget deficit: revenue (includes tax revenue) < government spending

Issue 1: How it is financedYes: Depletes countrys reserves persistent

If borrow from public increase interest rate C/I increases ADfalls NY falls

If borrow from public increase interest rate hot money inflow currency appreciates price of X increases crowds out X fallin X

Issue 2: How it is spentYes: Finance war no direct impact on SOL

Government bureaucracy + inefficiency wastage increasedexpenditureNo: Merit goods education and training, healthcare, r + d

Capital goodsHealthcare:+ Macro: increase AS increase NY+ Micro: under-consumed if left to the free market

Issue 3: State of economyYes: Worry economy near / at FE demand-pull inflation BOT fallNo: If economy in a recession, need injection of G + decrease in T

multiplier increase NYKeynes: increase G on public works = pump priming

Issue 4: Temporary vs persistentYes: Persistent

- Deplete reserves- Loss of confidence shows poor government macroeconomicmanagement I falls NY falls

Issue 5: Deliberate policy to keep taxes lowNo: Low taxes increase AD increase in C/I

Low taxes increase AS: keep / attract talent, FDI

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Term 3 Week 2 Lecture Essay Test

1a) Intro: Health (not equivalent to SOL)- Attainment of 4 macro objectives- Economic growth (actual + potential: whether it can

sustain) increase SOL

1) Real GDP: 7.7% - value of all final goods / servicesHigh for a DC, adjusted for inflationWhy it indicates health / why desirable:- May be an increase in material SOL able to buy more goods /servicesEvaluation: economic performance real GDP per head GDP increasecould be due to increased labour productivity data missing

2) Inflation: 2.1%

- 25 years, Singapore able to keep it below 3% but need to comparewith other countriesWhy low inflation healthy: stimulates output confidence increase I,increase BOTConcern: global prices increase governments efforts to keep inflationlow may be limited

3) Unemployment decrease to 1.6%Why desirable- Efficient use of resources - PPC- Less potential loss of output

- Social unrest loss of man hours less output / I loss of confidenceEvaluation: who the jobs went to / what jobs created

4) Budget surplus: government revenue > expenditureSign of a booming economy:- Profits increase + incomes increase (progressive tax) more taxrevenue- Buy more property more property tax revenue

Conclusion: limitations- BOP

*Gross fixed capital formation = I future productive capacity- Government expenditure on education

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Term 3 Weeks 3 to 7Monetary Policy and Interconnectedness of Economic Problemsand Policies

November 01: Problems for the Japanese Economy

Ai) 1990s slow down in economic growth GDP increases at aslower rate (positive)1998 recession GDP decrease (negative growth) 2.8%

ii) Achieve BOP + low inflationBut growth slowed down, high unemploymentTo attain low inflation use contractionary policy fall in Ad fallin NY (recession) labour derived demand workers retrenched unemployment rate increasePhillips curve: contractionary policies to reduce inflation

Bi) Yes:Low interest rate hot money outflow yen depreciates priceof exports fallLow interest rate cost of borrowing low C/I increases NYincreases

No:Demand: household, firms, government (interest rate dependenton demand also)Pessimism less business activities low C + low I by firms decrease demand for money interest rate falls. Zero interest

rate reflection of pessimism

Complex:In a recession, GPL fallsReal interest rate = nominal interest rate inflation rate = 0% -(-3%) = 3% - savers gain

ii) Incautious lending bad debts (default) less available to loanout less supply of loanable funds increase interest rate I falls NY falls pessimismBad debts depositors may rush to get back money massive

withdrawal run on the bank pessimism

iii) MP ineffective in stimulating economy proposed increase GMoney supply increase interest rate falls C/I increase ADincrease N/ NY increaseJapan in 1990s: liquidity trap (draw diagram seen in What isliquidity trap notes) increase money supply interest rateunchanged because opportunity cost of holding cash balances

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(earn 0 interest) very low pessimism all that people want tohold are cash balances do not buy bonds less funds availablefor I deters growth no effect on AD no effect on N / NY*Use liquidity trap to evaluate effectiveness of MP / MEI

C) Identify: Lower income taxes

Explain: Increased disposable income increase C increaseAD increase NY / NEvaluate: 1) Effect of T unpredictable due to pessimism zero

interest save more2) Size of k: likely small huge MPS

Identify: Increase G on public works + gift vouchersExplain: Increase AD multiplier increase NY / NEvaluate: G may be a better option: direct injection

+ Vouchers: forced to spend help people stay afloat+ Increase G on public works infrastructure long

term effect of increased efficiency increased AD

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Term 3 Weeks 8 to 9: Revision of Essay Writing Skills

1a) Explain the likely effect of this change in GST on expenditure byconsumers on different types of goods. [10m]

GST (ad valorem) goods and services tax indirect tax falls on firms increase COP fall in SS*Expenditure by consumers = revenue earned by firms = P x Q

Different types of goods1) With price elastic demand- Goods with many close substitutes eg. household products- Luxury goods can do without

- Expenditure by consumers falls: P increase quantity demanded fallsby more than proportionately (can buy other substitutes / dont buy) -

% increase in P < % fall in quantity demanded total expenditurefalls / total revenue of firms fallsTE0: A + B, TE1 = A + C: C


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Price increase quantity demanded falls by less than proportionately -% increase in P > % decrease in quantity demanded totalexpenditure increase / total revenue by firms increaseTE0 = A + B, TE1 = A + C: C > B TE increase

b) Discuss whether the combined effect of the rise in incomes and therise in GST is likely to cause the quantities of different types of goods

sold to rise or fall. [15m]Income YED: % change in quantity / % change in incomeNormal goods: luxury / necessities; inferior goods

1) Inferior goods (normal supply-demand diagram)GST fall in supply fall in quantity demandedIncome increase demand falls quantity fallsCombined effect quantity falls

2) Luxury (normal supply-demand diagram)Income increase demand increase more than proportionately huge

shiftLikely that quantity can increase since income increased by 4.5% whileGST increased by 2%

3) NecessitiesGST quantity demanded fallsIncrease in income demand increase less than proportionately quantity demanded increaseEffect on quantity indeterminate

Conclusion: 4.5% increase may not be for everyone, so predicted

effects may not occur

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3) With reference to examples, discuss whether there is a need tochange the current policies adopted by the Singapore government todeal with market failures caused by externalities. [25m]Market failure failure of free market to allocate resources efficientlyin order to maximize societys welfare: MSB = MSC: no one can be

made better off without someone else being worse offExternalities: third party cost / benefit not involved in production orconsumption of good market failure

Market failure: [draw diagram and explain how externalities causemarket failure]Positive externalities: due to merit goodsNegative externalities:- Production: factory- Demerit goods- Consumption: car usage pollution and congestion

Policies to deal with negative externalities:1) Tax per unit = MEC increase COP for firm reduce supply fromMPC to MSC socially optimal levelEvaluate:- Better than banning production continues- Incentive for firms to find ways to reduce pollution pay less taxes- Difficult to estimate MEC- Demand may become price inelastic in the long run- If demand for good price inelastic higher tax incidence onconsumers firms continue producing

2) Legislation fine

3) Incentives to install anti-pollution equipment

4) Better urban planning relocation to Jurong Island + greenery

5) Public education

6) Special case of car congestion: ERP, COE, affordable / efficient /integrated public transport system, petrol tax, weekend cars, hybrid

cars, car pooling, driving cars on alternative days by legislation*COE targets car ownership while ERP targets car usage

Suggested change in current policies: tradeable pollution permits

Policies to deal with positive externalities:

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1) Subsidy per unit = MEB: subsidy on firm / consumer and at point ofuse: increase demand from MPB to MSB socially optimal level eg.subsidized school fees through edusave

2) Public education / awareness

3) Free vaccinations

4) Compulsory education of primary level

5) Government provision up to pre-university level

(In-depth policy evaluation / suggestions found in Healthcare as asource of market failure notes)

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Other questions / notes

Describe the appropriate measures the Singapore government canadopt to deal with the recession. [25m]Fall in X/I: externally induced

Solutions:- Increase AD (immediate solutions) FP, MP (limited role),

exchange rate (short term depreciation) eg. adopt neutral policy:0% appreciation

- Increase AS (long term solutions potential growth)

Budget 2007Budgeted for a deficit but actually gained a budget surplusBooming economy: companys profits increase corporate tax revenueincreases + property taxGST revenue increase > decrease in tax revenue

Explain the possible links between trade deficit and a budget deficit.[10m]BOT deficit total expenditure on imports > total revenue from exports government uses contractionary demand mananagement to reduceimports decrease G + increase T budget deficit reduced fall in NY fall in demand for import

Budget deficit crowds out C/I BOT deficit

Trade deficit (X-M) falls NY falls post-tax profits fall corporate tax

revenue falls budget deficit

Trade deficit (X-M) falls NY falls retrenched income tax revenuefalls budget deficit

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Explain what causes inflation. [10m]Inflation: persistent and sustained increase in GPL

Increase in AD: demand-pull inflation when near / at FE*Shortage of inputs eg. raw materials, labour cost of input increases

increase price of goods / services

Factors1) Economy boomingEg. China / Vietnam / 07 Singapore real GDP growth 7.7%High incomes high consumption increase demand for goods /services output cannot increase price increase

2) Optimism: increase C/I

3) Increase X:Depreciation of currency dependent on PED: not for allcountries eg. oil-producing countries

Comparative advantageTrading partners boom

4) Government actions:Expansionary policies: increase G / decrease T economy near /at FE demand-pull inflationPrinting money not backed by real growth increase moneysupply increase interest rates increase C/I increase AD near / at FE demand-pull inflationSome governments excessive spending

Fall in AS fall in COP: cost-push inflationFactors1) Wage increase not matched by productivity increase due to

strong / militant trade unions eg. France firms give in increaseCOP fall in AS rise in GPL (pass part of burden to consumers) consumers = workers: demand for higher wages to cope with risein COL firms give in - spiral inflation

14

GPL

Real national output0FE


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2) Imported cost-push inflation especially for Singapore: dependenton imported raw materialsIf foreign prices increase increase COP imported inflationCurrent: increased price of crude oil

*Imported inflation worldwide food shortages increase COL- Biofuel: alternative to crude oil- Change in diet: affluence eat less rice, more meat- Industrialisation: less land for farming- Natural disasters

3) Increase in indirect taxes eg. GST in 07: from 5% to 7%GST falls on firm COP increase AS falls GPL increase (partof price increase passed to consumers)

15

GPL

Real national output0

AS1

AS0

AD0

P1

P0


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Discuss why a high rate of inflation might have an adverse effect onoutput and employment. [15m]High inflation price increase excessively very unstable eg. double-digit

Internal:1) Price increase excessively average households cannot affordbasic necessities demand high wages COP increase AS falls:spirals out of hand NY falls recession (extreme case)

2) High inflation: uncertainty affects firms unable to forecastprofits deter I plans unwilling to take risks fall in AD NYfalls - recession

3) Discourages savings value of savings falls people switch tofixed assets eg. property lower savings (long run) fall in I

affects long term growth*Banks due to uncertainty less willing to extend long termloans to firms fall in I affects long term growth

4) Effect on FDI: high COP deters FDI reflects poormacroeconomic management of government eg. Zimbabwe

External:1) Price increase excessively (inflation much higher than that of

other countries) price of exports very expensive + price ofimports relatively cheaper volume of exports fall + volume of

imports increase Marshall Lerner condition total revenue fromexports fall + total expenditure on imports increase BOT falls X-M component falls NY/N falls

2) Total revenue from exports fall + total expenditure on importsincrease demand for countrys currency drops + demand forforeign currency increases (increase in supply of countryscurrency) forex depreciates speculators sell currency furtherdepreciation loss of confidence in economy deters I

Evaluation: However depreciation price of exports decrease in foreign

currency + price of imports increase in local currency volume of exports increase + volume of imports decrease Marshall Lerner condition total revenue from exportsincrease + total expenditure on imports decrease BOTrecovers

Assume all trading partners have flexible exchange rates

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What are the advantages of a low rate of inflation? [10m]Price rises at a slow steady rate certainty eg. Singapore past 25 years

2 to 3%

Internal:

1) Price increase due to high demand stimulates output increaseI (machines/plants) increase AD increase NY/N*provided wage increase lags behind increase in productivity*provided it is demand-pull inflation (ie. Increase in AD) cost-push inflation never desirable (fall in NY)

2) Certainty firms can forecast profits increase I increase longterm growth

3) FDI lower COP + reflects good macroeconomic management bygovernment

External:1) Price increase slow and steady (inflation lower than othercountries)

Price of exports cheaper + price of imports more expensive volume of exports increase + volume of imports falls MarshallLerner condition total revenue from exports increase + totalexpenditure on imports falls BOT improves increase NY/N

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Policies to control inflationPrescribe appropriate policy depending on the cause of inflation policies usually temporary

Causes: Demand-pull inflation (overheating) China, Vietnam

(20%) AD = C/I/X increase

Identify: Contractionary FPExplain: Decrease G + increase direct taxes to reduce C/I decrease ADEvaluate: 1) G: size of k: if k is small, need huge decrease in G to

effect a significant fall in AD so as to achieve the desiredobjective of reducing inflation

2) Time lag: by the time contractionary policy takes effect,

economy could have gone into a recession on its own (dueto some random factor) double whammy

3) G inflexible: education and training / healthcare meritgoods. Certain projects cannot stop halfway.

4) Taxes: unpopular and unpredictable effect on C and I C/I may not decrease with increase T because people areoptimistic households: better-paying jobs / increase inincome + firms: anticipate higher C

5) Policy conflict: lower rate of economic growth (AD-ASdiagram)Phillips Curve: trade-off between inflation and employment

Identify: Contractionary MPExplain: Decrease money supply increase interest rates fall in

C/I fall in AD fall in GPLEvaluate: 1) Size of k

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Inflationrate

Level ofunemployment

0


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2) Time lag: shorter because of shorter implementation lag

3) Unpredictable effect on C/I

If demand for I is interest inelastic, I falls only from I0 to I1 may

not achieve desired effect of controlling inflation due tooptimismMEI: expected rate of return > higher cost of borrowing

4) Increase in interest rates hot money inflow if exchangerate appreciates

Price of exports rise in foreign currency volume of X falls ADfalls GPL falls

Price of imports falls in local currency (*only put in terms ofwhich currency if talking about exchange rate) ifdependent on imported raw materials COP falls check

imported cost-push inflation

Cause: Cost-push inflation (draw AD-AS diagram)1) Wage-push inflation: militant trade nuions incessant

increase in wages not matched by productivity increase2) Imported: increasing crude oil prices, worldwide food

shortages3) Sg: increase indirect tax GST / VAT4) Profiteering firms

Identify: Reduce power of trade unions

Explain: Sg: NTUC: harmonious tripartite relations in wagenegotiations no labour interest*National Wage Council: wage recommendation: wageincrease < productivity increase output per man hour GDP growth as a gauge08 NWC recommended: 1-time inflation bonus - $300 vs.permanent wage increase spiral inflation

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Interest

rate

Quantity ofinvestment

0

Ii

Ie

I0

P1P0

I1I2


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Identify: Gradual and modest appreciation of S$Explain: Price of imports falls in S$ - COP falls check imported

inflationEvaluate: - Price of exports increase in foreign currency: may affect

short term export price competitiveness BOT may worsen

if demand is price elastic- Appreciation can only mitigate / alleviate, but cannot solve too large and appreciation is detrimental to Singaporeseconomy

Cause: Increase in GST fall in AS cost-push inflationIdentify: Food coupons / exemptionsExplain: Food coupons: help lower income deal with rise in COL

Exempt some goods from GST necessities food / transport /medicine GPL may not rise as significantly

Identify: Deregulation: break up monopolies / collusive oligopolies

Conclusion: Best long term measure: supply-side policyIdentify: Education and training, r+d, tax incentives, reduce welfare

benefitsExplain: Increase productivity increase AS

- Potential growth NY increases- Maintains price stability: GPL falls price of exports fall

demand for exports price elastic BOT rises NY increasesEvaluate: - Takes time

- May not yield results

Comparing use of contractionary policies with supply-side policiesContractionary policies:- Policy conflict- Lower rate of economic growth, employment rate falls+ Reduce inflation

Supply-side policies:+ No policy conflict: price stability, potential growth, BOT increases

Generic question: demand-pull inflation FP and MP, exchange rate,

the restSingapore question: exchange rate, NWC, demand-pull inflation, therest

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What is liquidity trap? (Keynesian explanation)*Draw this

*Dont need to write this because liquidity trap is not in the syllabusLiquidity trap eg. Japan in 1990s for 10 years: demand for moneyperfectly interest elastic all that people want to hold is money (cashbalances) do not buy bonds less loanable funds available totallyaverse to risk due to pessimism

Keynes: money (no interest), bonds (pay interest)

Government increase money supply from MS0 to MS1: interest ratefalls C/I falls NY increases (achieve growth)

*Write this for evaluation only

Implication for economy when at liquidity trapExpansionary MP to lower interest rates ineffectiveReason: Increase in money supply from MS2 to MS3 interest ratedoes not changeWhy? People totally risk averse all they want to hold is money (cashbalances) ie. They do not buy bonds (do not lend out the money)

21

Interestrate

Quantity of money0

MS: perfectly inelastic: can be determined byCentral Bank

MS1

MS2 MS3

Liquidity trap

LP: liquiditypreference


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Using a diagram, explain what might cause a countrys exchange rateto appreciate in a floating exchange rate system. [10m]Basket of currencies: currency of major trading partnersIntro: Price of countrys currency vis--vis to other countries

Floating determined by market forces of demand and supply of

currencyAppreciation of currency (eg. Singapore)Before: 1S$ = US$0.60After: 1S$ = US0.70

Development: In turn determined by trade and investment betweenthe countries1) Trade

- Boom in trading partners economy: increase NY increasedemand for Singapores goods if YED > 1: quality services:luxury goods: medicine, education, tourism very significant rise

in total revenue for Singapore increased demand for S$ - S$appreciates

- Lower inflation rate in Singapore relative to trading partners price of exports drops + price of import relatively moreexpensive Marshall Lerner condition volume of exportsincrease + volume of imports decrease total revenue fromexports increase + total expenditure on imports decrease demand for S$ increase + supply of S$ decrease S$appreciates

- Country has comparative advantage in goodsEg. China labour-intensive products cheap + unskilled labour increase demand for Chinese goods increase total revenue forChina yuan appreciates

2) Investment portfolio + physical / direct by firms

22

US$/S$: US$ perS$

Quantity of S$0

S1

S0

D0

0.60D1

0.70

0.90


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- Increase interest rate hot money inflow increased demandfor countrys currency exchange rate appreciates- Speculators expect further appreciation buy currency furtherappreciation- Huge domestic market, cheap labour increase MNCs in China

increased demand for yuan yuan appreciates

Explain how exchange rates are determined. [10m]Intro: Exchange rate

Flexible / free floating market forces trade and investmentBut government can also interveneFixed: pegged to another countrys currency (eg. to US$: China

before 06)Managed float: allow fluctuations but within a target band (eg.China after 06, Singapore)

Development:1) Flexible any 3 from previous question

2) Fixed increase demand for Chinese yuan value of yuan likelyto increase to keep it fixed: Chinese government increasessupply of yuan sell yuan = buy foreign dollars

3) Managed float - Singapore

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US$/yuan

Quantity of yuan0

S1

S0

D0

D1

0.30

Foreign currency /S$

Quantity ofS$

0

S

DD1

targetband


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US recession fall in XEg. reduce demand for S$ - S$ depreciating beneath the band to bring back within band increase demand for S$ - buy S$ =

sell foreign $ - foreign exchange reserves

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Discuss the extent to which problems are likely to result from anappreciation of Singapores exchange rate. [15m]Intro: Singapore small: no natural resources: very dependent on import

of raw material + open: small domestic market: very dependenton export revenue: 3 times of GDP

Appreciation: Before: 1S$ = US$0.60, After: 1S$ = US0.70

Basic development:Appreciation of S$ - price of export increase in foreign currency + priceof import decrease in local currency Marshall Lerner condition volume of exports drop more than proportionately + volume of importsincrease more than proportionately total revenue from exports drop+ total revenue from imports increase (X-M) (services: tourism /education / medicine) drops BOT drops AD falls fall in NY /employment fall in GPL (reduce demand-pull inflation)Price of import decreases in local currency fall in COP / fall in price of

raw materials (reduce cost-push inflation) increase AS fall in price ofexports in long run if demand for exports price elastic BOTimproves NY / N increases

*Effect depends on extent of appreciation Singapore governmentrecognizes conflict in policy objectives while imported inflationlowered but short term export price competitiveness affected MASstand: gradual and modest appreciation of S$

Complex development:Capital account: portfolio + direct

Direct FDI- MNCs planning to invest in Singapore postpone plans homecurrency converted to less S$ - but MNCs decisions dependent on hostof factors huge domestic market, efficient infrastructure, humancapital- MNCs already in Singapore goods they produce (price of exportsincrease) less competitive but in the long run may be able to buyimports more cheaply to decrease COP+ However appreciation can be a sign of a booming economy andincreasing prospects. MNCs may decide to come after all.

Conclusion: Speculators expect further appreciation buy more S$ -cause S$ to appreciate further. Bu too huge an appreciation is notwhat the government wants.

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Discuss how the Singapore government might use the concepts ofprice elasticity of demand and income elasticity of demand todetermine the impact of a fall in exchange rates and a rise inworldwide incomes on the current account of the Singapore balance ofpayments. [25m]

Intro: DefinitionCurrent account: visible: export and import of goods and services+ invisible: income from I

A) Fall in exchange ratesScenario 1: In a case where demand for export and import both priceelastic / a case which fulfills Marshall Lerner conditionPrice of exports falls in foreign currency + price of imports rises in S$ -Marshall Lerner condition volume of exports increase more thanproportionately + volume of imports decrease more thanproportionately total revenue from exports increase + total

expenditure on imports decrease (X-M) increase BOT increase current account improvesReason: demand for Singapores exports elastic many closesubstitutes

Scenario 2: Import price inelasticReason: no natural resources / no raw materials price of importsincrease in S$ - volume of imports fall less than proportionately totalexpenditure on imports increase total effect on current account C > B

26

Price

Quantity

0

P0

P1

Q0 Q1

A

B C

Exports

Price

Quantity

0

P0

P1

Q0 Q1

A

B C


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Scenario 3: In theory, J-curve in short run, demand for X and M bothprice inelastic take time to adjust (contractual obligations, take timeto find alternative suppliers) current account worsens in the short runbecause inelastic demand

Scenario 4: In long run, Singapore very dependent on imported rawmaterialsPrice of imports increase in S$ - COP increase later: price of exportsincrease demand price elastic total revenue from exports falls current account deterioratesSo J-curve effect may not apply to Singapore

B) Increase in worldwide incomesNormal: Luxury goods + necessities eg. integrated circuits /disk drives:inputs for luxury goods (MP3, laptops): world affluence demand forluxury goods income elastic increase more than proportionately

total revenue increase very significantlyInferior goods

Eg. oil rigs: world affluence demand more products need to producemore goods increase demand for oil rigs to refine oil

Increase in worldwide incomes increase demand for luxury goods andquality services Singapore: services: tourism, education, medical hub Singapore government recognizes this and augments comparativeadvantage in high value-added knowledge-intensive, technologically-intensive, service-oriented total revenue for Singapore increases

Evaluation: - Face competition from other countries they also developcomparative advantage in these areas

- May lose out to Korea eg. cosmetic surgery- Worldwide income increase, Singapore increase may spend

more on imports current account may suffer

Conclusion: - Values only estimates

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Currentaccount

Time

inelastic elastic


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- Ceteris paribus real world many things change at the sametime

The government proposes to increase tax on petrol. Assess relevance

of PED and YED for success of proposal. [15m]Objectives: correct market failure: road congestion + increase taxrevenue

PED: directly relevantTax on petrol COP increase supply decrease vertically upwards byamount of specific tax price of petrol increase (draw diagram to showshift in supply)Demand for petrol price inelastic no close substitutes

YED: not directly relevant because tax on petrol affects price

YED: changes on incomeGovernment likely to be less successful if they increase tax on petrol inperiod of economic boomBoom: incomes rise demand for cars (luxury good) increase bymore than proportionately derived demand increase demand forpetrol

Policies to correct current account deficitCauses: total revenue from exports < total expenditure on imports1) Rise in national income of the country2) Lack of comparative advantage eg. USA

3) No domestic substitutes low productive capacity USA4) Exchange rate strengthened5) Higher relative inflation rate

Identify: Contractionary policiesExplain: FP: increase T decrease G decrease AD NY falls

demand for imports fall total expenditure on imports fallsignificantly especially if demand income elastic

MP: increase interest rate increase AD GPL fall price ofexports fall demand for exports price elastic totalrevenue from exports increase

Evaluate: - Repercussion: lower rate of economic growth thus usefulwhen inflation is cause of deficit because economy possiblyoverheating

Identify: Expenditure-switching policies1) Devaluation fixed exchange rate or devaluation managed

float2) Tariff / quota

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3) Subsidies to export firmsExplain: 2) Price of imports increase volume of imports decrease

total expenditure on imports fall3) Lower COP lower price of exports PED > 1 total revenue

from exports increase

Evaluate: 1) PED > 1J-curve effect (short run)Countries small and open and dependent on raw materials COP

increase BOT falls in long run2) RetaliationSociety: deadweight lossConsumer: price increaseEncourages inefficiencyOther firms may face increase COP if import is raw materials3) Burden on government finances and taxpayersEncourages inefficiency unless subsidy on r+d, education and

trainingRetaliationAllow firms to develop new technology / reap EOS

Identify: Supply-side policies (long term policy)Education and training, r+d, incomes policy, increase export

through FTAs and trade missionExplain: R+d lower AC + better quality products to make demand

price inelasticIncomes policy increase productivity increase AS lower GPL

(citizens buy cheaper home products total expenditure on

imports falls) price of export falls PED > 1 totalrevenue from exports fall

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A governments macroeconomic objectives are economic growth, lowinflation, full employment and healthy BOP. Consider some of thedifficulties in its attempts to meet them simultaneously. [25m]

Objective 1: Pursuit of economic growth (draw in AD/AS diagram)

i) Expansionary FP / MP (increase G, decrease T, decrease interest rate) increase AD near / at FE demand pull inflation if excessive price of exports increase, price of imports fall Marshall Lernercondition BOT fallsIncrease AD increase NY achieve growth demand for importsincrease especially if do not produce much at home BOT deficit

ii) Increase in G financed by borrowing from public increased increaserate external crowding out exchange rate appreciation (secondaryeffect) price of exports increase in foreign currency + price ofimports decrease in local currency Marshall Lerner condition BOT

falls

iii) If country pursues long term growth through restructuring anddeveloping of comparative advantage in new industries structuralunemployment displaced workers in sunset industries do not haveskills for new industries

Objective 2: Low inflation ratei) To reduce demand-pull inflation, use contractionary policies(decrease G, increase T, increase interest rate) decrease AD (NY/Nfalls) decrease GPL inflation controlled

Phillips curve (not necessary). Can just refer to previously drawn AD-ASdiagramSingapores caseii) If Singapore low inflation gradual and modest appreciation priceof imports in S$ falls check imported inflationBut price of exports in foreign currency increases PED>1 BOT fallsin short run

Objective 3: Healthy BOP- If country faces a BOT deficiti) Contractionary policy decrease AD (fall in NY [decrease demand for

imports to correct deficit] and N)

ii) Devaluation (fixed exchange rate) price of exports fall in foreigncurrency + price of imports increase in local currency BOT deficitcorrectedDifficulties:- If dependent on imported raw materials imported cost-push inflation- Possible demand-pull inflation

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- Persistent devaluation loss of confidence deters I fall in NY/N

iii) Tariff: inflation + jobs lost

Objective 4: Achieving full employment (can integrate with objective 1)

Rather similar to objective 1. Economic growth creates jobs.i) Recession: reduce cyclical unemployment expansionary policies underestimate the size of k possible demand-pull inflation BOT falls

ii) Tariffs to protect jobs in industries that have lost comparativeadvantage to other countries eg. USA tariff on Chinese textilesIf tariff is on input (eg. steel / textile) increase COP for domestic firms imported cost-push inflationIf tariff on US firms in China less profits repatriated fall capitalaccount BOP deficit

Conclusion:Supply-side policies: no difficultyIncrease AS price stability PED > 1 BOT improvesIncrease AS potential growth increase N and decrease structuralunemployment

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A governments macroeconomic objectives are economic growth, lowinflation, full employment and healthy BOP. Which of these aims doyou consider most significant for Singapore and why? [25m]Intro: ultimate objective: increase SOL sustainable economic growth low inflation: one of the keys to achieve sustainable growth

Opinion: low inflation most significant aim generally, especially forSingapore

Development:A) Why low inflation (choose 2)Approach A: low inflation desirableExternal: BOP surplusInternal:i) Price increase firms increase output higher profits (if wage lagsbehind productivity) increase I NY/ N increase (provided it isdemand-pull inflation)

ii) Ability to forecast profits increase I NY / N increase

ii) Value of savings less more willing to save more loanable funds lower interest rate increase I NY / N increase

iv) Confidence in government management of economy increase I NY/N increase

v) Low inflation lower COP attracts I / FDI

Summation: I increase AD / increase AS actual + potential growth

Approach B: excessive inflation undesirableExternal: BOP deficit if inflation higher than other countries BOT falls NY/N fallsInternal: the reverse of all discussed in approach Ai) I fallsIf inflation due to cost-push inflation COP increase AS falls GPLincrease workers ask for wage increase to meet rising COL firmsgive in spiral inflation NY falls (draw AD-AS diagram)

Apply to Singapore:- Singapores dependence on imported raw materials makes it all themore important for the control of inflation as primary prerogative fearof increase foreign prices: todays context: crude oil, worldwide foodshortages- Efforts to keep wages competitive (incomes policy) NWC/ NTUC:wage increase < productivity increase control wage-push inflationbecause very vulnerable to it due to tight labour market

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Summation: low inflation increase output, confidence, exports

B) Why not the others?If economic growth most significant aim keep increasing AD demand-pull inflation, if excessive

Evaluation: for potential growth use of supply-side measures increaseAS price stability low inflation important

If BOP most significant aim demand-pull inflation strain on domesticproductionApply to Singapore:Willing to compromise short term export competitiveness (affect BOT)to control imported cost-push inflation long term growthWhy not full employment as most significant aim cyclicalunemployment often beyond our control usually due to tradingpartners

Safest bet: reduce cyclical unemployment able to maintain low andcompetitive prices

Conclusion:However, certain circumstances: 01 recession. Most significant aim iseconomic growth even allow for depreciation of S$ - main objectiveto increase X in short term improve BOT increase NY to mitigaterecession

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Discuss how a supplier of a product that is currently fashionable mightuse concepts of PED, YED and CED in its price and output decisions.[15m]Currently fashionable eg. MP3 player (many close substitutes)

PED: demand price elasticPricing strategy: lower price quantity demanded increase more thanproportionately total revenue increase (include diagram)Output strategy: mass production reap EOS to reduce AC + increasesupply lower price

YED: % change in quantity / % change in incomeLuxury goods eg. sports carBoom: income increase demand increase more than proportionately huge shift in demand curve (include diagram)Output strategy: increase stock

Launch high-end models / limited edition (niche market)Cater different ranges of products to all income groups*Complex: price strategy: increase demand increase price; manyrivals decrease price

CED: % change in quantity of good A / % change in price of good BGood B can be a substitute: if Samsung decreases price of MP3 player close substitutes CED > 1 your firm: demand falls more thanproportionately market share fallsGood B can be a complement: if price of downloading songs falls demand for MP3 increases

Your firm:Pricing strategy: lower price price war does not benefit anyone non-pricing: advertising and promotion, others differentiate product make demand price inelastic OR if market is oligopoly may collude

*Complex: Apple IPOD is a market leader demand price inelastic somay increase price, CED: less fear of rivals, YED same strategies

Conclusion:Values limitations- Estimates

- Ceteris paribus: if firm reduces price expects quantity demanded toincrease more than proportionately but there are other factorsinvolved:

- Switch in taste and preference another firm launches a betterquality product

- Consumers associate fall in price with drop in quality- Recession- Product cycle

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- Need to look at PED / YED / CED trends and taste and preferencestogether

Healthcare as a source of market failure1) Positive externality: under-consume leads to under-production

Subsidies UK vs SingaporeUK: Heavy burden on taxpayers, abuse / overcrowdedness / longwaiting list / poor qualitySingapore: 3M framework: Medisave (individual CPF), Medishield(insurance), Medifund (government help for the needy) individualresponsibility and government help when necessary

Evaluation:Singapore more help for needy / lower-income groupIndividual responsibility ensures users do not abuse the system andmore willing to take care of their health

Increase in medical cost very significant

2) Related to point 1: inequity: lower-income group cannot affordMeans testing: subsidise more for the lower-income group. Singaporecan really implement it

3) Possible monopoly / oligopoly: large MES huge sunk cost(equipment) [draw diagram]High price possible collusion allow more competition coexistenceof private and public sectorChina: public monopoly complacent + bureaucratic needs

regulation

4) Imperfect information because doctor has monopoly power over hisspecialized knowledgeGreater transparency: detailed list of cost consultation fees /surgery / medicine, hospitals publish surgery chargesReduce imperfect information and monopoly power

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Large firms necessarily become monopolistic. Monopolies adoptpractices that are undesirable. Therefore, large firms should beregulated by governments. Discuss whether there is any truth in thisargument. [25m]*Three parts to the question. Must respond to all three but in varying

degrees of importance.

A) Large firms monopolistic [one paragraph]Firms become large due to high demand increase in total revenue /mergers and acquisitions internal EOS (any 2 types) reduce AC(able to block new entrants: natural BTE) able to reduce price demand price elastic increase total revenue increase profits ploughed into r+d and advertising and promotions better technology(further reduce average cost) + better quality products to makedemand more price inelastic increase market share monopolisticsince have the ability to set price price setters

B) Practice: price setters monopolies restrict output to increase price

Undesirable:1) Allocative inefficiency: price > marginal cost vs perfect competitionindustryDraw in diagram: underconsumption need for regulation

2) X-inefficiencyComplacency lax in cost practice able to pass any cost increase toconsumers demand price inelastic need regulation

However, government, instead of regulatingi) Make market more contestable significantly reducing BTE eg.airlines more licenseesii) Allow more competition such as foreign competition big foreignconglomerates domestic monopoly forced to be cost-efficient

3) Price discrimination- 1st degree: zero consumer surplus. But very few industries in theworld need regulation

Desirable:

1) Price discrimination in some cases can be beneficial3rd degree: price elastic vs price inelastic due to smaller proportion ofincome can charge higher priceEg. movie tickets, bus faresLoss-making monopoly due to low demand bus service in a remotetown practise price discrimination in order to continue: shut downand all lose service vs. keep service intact with price discrimination

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2) Where the monopoly enjoys substantial EOS, able to pass costsavings to consumersBut there is no guarantee of monopoly charging at lower price Pm need to regulate to MC or make market more contestable

OR can say that Qm > Qc (socially optimal level) so it can bedetrimental

3) Dynamic efficiency: ability to plough supernormal profits to r+dBut monopoly less likely than competitive oligopoly in investing in r+d regulate through antitrust / competition

Conclusion: certain undesirable practicesRegulate:- Antitrust, lump sum tax, MC pricing: mention- But better to allow more competitive deregulation of industry

P/R/C

Quantity

AR

MCm

MR

MCpc

Pc

Pm

0Qc Qm

econs tut for term 3

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