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No. Title Page No. 1 Chapter 1: Scarcity, Choice and Opportunity Cost 2-3 2 Explain two ways in which an economy might move from a point within

its PPC to a point on it. 4

3 Discuss the most effective economic policies to move the PPC outwards. 5 4 What is meant by the basic economic problem of scarcity? 6 5 Discuss whether economic growth solves the problem of scarcity. 7 6 Chapter 2: Resource Allocation in Competitive Markets I 8-9 7 A manufacturer wishes to sell more of his product. How may he try to

achieve his aim? 10

8 Chapter 3: Resource Allocation in Competitive Markets II 11-13 9 Explain price elasticity of demand and income elasticity of demand. 14 10 A government is proposing to increase the tax on petrol. Examine the

relevance of price elasticity of demand and income elasticity of demand for this proposal.

14

11 Assess the relevance of elasticity concepts in explaining the effects of the worldwide recession caused by the 911 terrorist attacks on the airline industry.

15-16

12 Chapter 4: Microeconomic Problems: Market Failure 17-18 13 Policies on Pollution and Evaluation Summary 19-21 14 Policies on Pollution and Congestion caused by Cars Summary 22-23 15 Chapter 5: Government Intervention in the Market I 24 16 Chapter 6: Firms and How They Operate I 25-30 17 Discuss whether rising costs limit the size of firms over time. 31 18 Banking Merger in Singapore Analysis 31 19 Chapter 7: Firms and How They Operate II 32-38 20 Discuss the view that the profit motive will always lead to a few large

firms dominating the market for each and every type of product. 39

21 Explain what is meant by productive and allocative efficiency. 40-41 22 ‘A firm should be encouraged to maximize profits because this makes it

efficient.’ Discuss whether this argument is true for a firm operating in an imperfect market.

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23 Distinguish between monopolistic competition and oligopoly. 43 24 Explain why oligopoly is a common market structure in many economies. 44 25 Explain why governments throughout the world have been involved in

the supply of services such as electricity. 45

26 Chapter 8: Government Intervention in the Market II 46-48

J1 Topics

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Chapter 1: Scarcity, Choice and Opportunity Cost 1. Introduction Study of the use of scarce resources to satisfy unlimited human wants Wants: things people would consume if they had unlimited income Resources: inputs to produce goods and services Scarcity exists due to unlimited wants + worn out goods + newer goals Positive (can be checked by facts) vs. normative (statement of value) 2. Factors of Production Land: productive resources supplied by nature Labour: human effort directed to the production of goods and services

Supply: number of workers + average number of hours each worker is prepared to offer

Specialisation Dexterity, greater use of machinery and more sophisticated

production techniques Monotony, loss of craftsmanship, increased risk of structural

unemployment Capital: man-made resource used in further production

Involves postponing present consumption Entrepreneurship: takes risk of being in business Information: data for the basis of knowledge-based economy 3. Opportunity Cost Real cost in terms of the next best alternative foregone Calculating opportunity cost requires time and information Opportunity cost may vary with circumstance Economic rent: difference between what is earned and what could have been

earned Used in specialization and trade 4. Production Possibility Curve Maximum attainable combination of two goods and services that can be produced in

an economy, when all available resources are used fully and efficiently, at a given state of technology

Assumptions: fixed amount of resources, factors fully and efficiently employed, technology fixed, time period give, 2-product model

Fully: using all resources available Efficiently: do as many things you can with the resources used Scarcity: unattainable combinations outside PPC + society has to choose among

combinations of 2 goods Shift: quantity and quality of resources (think FOP) + technology – skewed? Choice between instant gratification and improving economy in the future

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5. The Marginalist Principle Consume till MPB = MPC: cost of producing an additional unit of good = benefit of

consuming an additional unit of good For the price mechanism to work, information need not be known with perfect

accuracy by every individual acting in the marketplace: dependent on marginal buyers who keep suppliers on their toes

6. Efficiency Static efficiency: how much output can be produced now from a given stock of

resources at a given point in time Dynamic efficiency: changes in the amount of consumer choice available in markets

together with the quality of goods and services available Productive efficiency: absence of waste in the production process = minimizing the

opportunity costs for a given value of output Allocative efficiency: society produces and consumes a combination of goods and

services that maximizes its welfare Distributive efficiency: goods and services produced to those who want or need

them

Wheat

Cloth 0

*Draw dotted line to show comparison between 2 countries with a common yardstick

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Explain two ways in which an economy might move from a point within its PPC to a point on it. [10m] Introduction Define PPC Body A. Increase employment of resources Lower wages to be more competitive – may be enticed to produce more goods Fiscal policy: increase government spending eg. circle line – multiplier effect Monetary policy: lower interest rate – firms borrow more, increase investment

B. Increase efficiency in use of resources Pay based on productivity: but only for jobs where output can be measured

(factory workers) Reallocate resources to more efficient uses Retraining

A

B

Good X

Good Y O

A: resources not fully utilized – underemployment and unemployment B: efficient use of resources – full employment

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Discuss the most effective economic policies to move the PPC outwards. [15m] Introduction Outward shift: increase in productive capacity – sustain economic growth over long run Body A. Labour Increase birth rate but difficult to do so in developed countries – female labour

force participation + need lots of incentives Education and training but takes long time and does not necessarily yield results Foreign talent through tax incentives

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

C. Entrepreneurship Incentives and subsidies to start businesses

D. Land Reclamation

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

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What is meant by the basic economic problem of scarcity? [12m] Introduction Scarcity – scare resources, unlimited wants Body Scarcity – choice – opportunity cost 1) Individual: time; consumer; how to maximize use of limited resources – more labour / more machines 2) Firm: least-cost combination of resources in order to maximize profits 3) Government: choice between competing projects; cost-benefit analysis 4) Economy: problem of how to allocated scare resources efficiently best illustrated by the PPC (Brief) Implications: Trade as a solution to alleviate scarcity Trade-off between consumer goods and capital goods What (how scarcity affects decision-making of an economy), how much, for

whom and what to produce (market system)

E

Good X

Good Y O

6 4

5 6

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Discuss whether economic growth solves the problem of scarcity. [13m] Introduction Economic growth – increase in national income – generally get to consume more goods and services Body 1) Increase in quantity and quality of resources – increase in productive capacity Labour: due to reduction in unemployment and underemployment Skills and educational level Land Capital stock: most effective way to alleviate problem of scarcity – more capital

economy produces in one period, more output capital can produce in the next to satisfy wants in society

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

3) Increase in income – consumers able to satisfy wants But with greater affluence, people have more wants due to advertising and

promotions – luxury goods of the past may become necessities 4) Supply limited Demand accelerating – China / India economic growth Crude oil important as it is a source of fuel Eg. land in Singapore But technological improvements allow society to make use of renewable

resources as sources of energy But more wants created

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

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Chapter 2: Resource Allocation in Competitive Markets I *Assumption: Many buyers and sellers such that no single buyer / seller can exert control over market price (price takers) 1. Demand Theory Demand: amount that consumers are willing and able to purchase at each given

price over a given period of time Demand curve slopes downwards

Income effect: effect of change in real income resulting from change in price of good

Substitution effect: effect of change in price on quantity demanded arising from consumer switching to, or from, alternating products

Determinants Price Taste: education, culture, age group, health scares Interrelated goods: substitute vs. complement Population: absolute change, change in composition Seasonal changes: climate, festival Expectations of the future: future changes in price / income Real disposable income: changes in taxes / money income Redistribution of income

Consumer surplus: difference between maximum amount consumers willing to pay for a given quantity of good and what they actually pay

2. Supply Theory Supply: quantity of a good or service producers are willing and able to offer for sale

at each given price over a given period of time Determinants

Price COP: change in price of factor inputs Other prices: joint / competitive supply Innovation: lower production costs Natural factors: climate, unexpected events Government policies: indirect taxes, subsidies Number of sellers

Producer surplus: difference between amount received by producers and minimum amount they are willing and able to accept for the supply of a commodity

3. Market Equilibrium Buyers and sellers satisfied with current combination of price and quantity bought or

sold, and are under no incentive to change their present economic actions

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Adjustment to equilibrium Below equilibrium

Shortage – consumers compete for goods, bidding up prices – price increases, quantity supplied increases – shortage eliminated – market settles at equilibrium

Above equilibrium Surplus - producers reduce prices to get rid of stocks – increase sales

and decrease production – price falls, quantity demanded increases, surplus eliminated – market settles at equilibrium

Shifts in supply and demand: consider individual effects on price and quantity then sum up

Interrelated demand and surplus Joint / competitive / derived demand Joint / competitive supply

4. Case Study When asked to explain how a group of people intend to affect a certain market,

bring in limitations Elasticity of demand Responses of other firms / groups of people

Analyse theoretically first, then see how and why the data fits / does not fit the theory

Desirability: consider for whom: producer, consumer, society Effectiveness: limitations, long run vs. short run

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A manufacturer wishes to sell more of his product. How may he try to achieve his aim? [12m] Introduction Sell more – only considering equilibrium quantity – increase demand / supply Effect: long run vs. short run Body 1) Increase demand: explain effect on quantity demanded Advertising and promotion: create product differentiation and brand loyalty Competitive market: other firms will do likewise as they fear losing market

share Huge funds need to be devoted – increase COP – reduce profits

If firm passes cost increase to consumers in terms of higher prices – fall in quantity sold – assuming demand elastic – total revenue falls

But unable to increase price in competitive market – firms may engage in price wars

But in long run if campaign successful in altering people’s taste and preference – rise in quantity sold

Expanding number of markets: go regional / global Easier to penetrate markets where demand for product more price elastic

Increase supply – fall in price – more than proportionate rise in quantity demanded

Improve quality of product / increase product differentiation through better sales service / improved packaging Effect of money spent for r+d on

Costs then price of product Market share in long run (increase)

Deliberate attempt to reduce price of good through discounts Price elasticity of demand How long discount can be sustained without eroding profits

2) Increase supply: explain effect on quantity demanded Investment in r+d Lower COP, more efficient production methods, better quality products

Raising productivity through greater specialization and better labour-capital combination

Sourcing cheaper sources of raw materials Evaluation Reduces price – may conflict with profit maximization More effective strategy if selling product that is price demand elastic – mass

produce – reap EOS – lower prices – increase sales volume more than proportionately

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Chapter 3: Resource Allocation in Competitive Markets II 1. Price Elasticity of Demand Measure of degree of responsiveness of quantity demanded of good to a change in

its price, ceteris paribus Coefficient: sensitivity of consumers to price changes Negative: inverse relationship between price and quantity demanded Determinants

Availability of substitutes Necessities vs. luxuries Proportion of income Time period: longer – switch to substitutes – more price elastic

Usefulness Government taxation policies: raise revenue, discourage consumption Firms’ pricing policy Effectiveness of trade unions: can ask for higher wages if demand for product

is price inelastic Price stability: prices more volatile if demand more price inelastic when

supply shock

2. Income Elasticity of Demand Measure of degree of responsiveness of demand of good to change in consumers’

income, ceteris paribus Coefficient

Negative: inferior good Positive: normal good

Less than one: necessities More than one: luxuries

Usefulness Production plans: boom vs. recession Targetting different income groups: segment market

3. Cross Elasticity of Demand Measure of degree of responsiveness of demand of good to change in price of

another good, ceteris paribus Coefficient

Negative: complement Positive: substitute

Usefulness Effects on products’ demand when faced with change in price of rival’s

product Strong complements – can sell jointly

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4. Price Elasticity of Supply Measure of degree of responsiveness of quantity supplied of good to a change in its

price, ceteris paribus Positive: direct relationship between price and quantity supplied Determinants

Time period: longer – supply more price elastic because possible to change anything

Factor mobility Number of firms: more – supply more price elastic Stocks and spare capacity: more – can produce more – supply more price

elastic Length of production period: shorter – supply more price elastic

Usefulness Taxation: incidence Price stability

5. Government Policies Taxation / subsidies

Demand more price inelastic – higher incidence Incidence: distribution of burden between consumers and sellers

Minimum price Protect income of producers Creates surplus for future shortages Financing annual surpluses – burden on taxpayers – not good in long run Cushion inefficiency New producers attracted – increase surpluses unless government has

measures to increase demand Maximum price

Lower-income consumers to afford necessities Protect consumers Allocation of goods may be biased Black market, especially during war time Government can encourage supply by drawing on past surpluses, giving

subsidies and tax relief, reducing demand by controlling income 6. Case Study Note difference between elasticity of the product and the elasticity of the final

product (which involves the use of the product) Note difference between less inelastic and more elastic When asked how a strategy might affect a company, consider effect on total

revenue then profits

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7. Essay Limitations to using elasticity concepts to explain price changes

Elasticity concepts are static – need to relax ceteris paribus assumption in reality – simultaneous changes occur – need to consider relative magnitudes of changes in demand and supply

Coefficients of elasticity mere estimates Consumers not homogenous group

Among high-income earners, there are the yuppies seeking the high life and are likely to be more price and income sensitive compared to foreign investors who would consider socio-political factors

May not consider some goods as substitutes

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Explain price elasticity of demand and income elasticity of demand. [10m] Definition Formula Sign Coefficients: range of values for elastic / inelastic Examples with their estimated values A government is proposing to increase the tax on petrol. Examine the relevance of price elasticity of demand and income elasticity of demand for this proposal. [15m] Introduction Assume specific tax for simplicity Uses of petrol: firms’ and commuters’ transportation Normal good: income increase – demand for cars increase – demand for petrol increase Body 1) Demand for petrol price inelastic: explain why Increase in indirect tax – supply falls at given price – supply curve shifts vertically

upwards by amount of tax Demand for petrol inelastic – fall in quantity demanded less than proportionate Relevance: need high tax if government wants to reduce consumption to desired

level 2) Income elasticity of demand less relevant because it is due to changes in income – tax on petrol affects price directly, not income Government likely to be less successful if they increase tax on petrol in period of

economic boom Boom: incomes rise – demand for cars (luxury good) – increase by more than

proportionately – derived demand – increase demand for petrol

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The terrorist attack on New York on 11 September 2001 caused a worldwide recession and an increased fear of flying, both of which severely affected the demand for travel by air. This led to the closure of some of the major airlines in the world. Assess the relevance of elasticity concepts in explaining the effects of these events on the airline industry. [15m] Body 1) Price elasticity of demand Definition When supply of airlines fell due to closure of major airlines – price expected to

increase – quantity demanded fall by more than proportionate – total revenue fall

Relevance Airlines should expect that reducing supply causing a rise in price can lead to

a fall in total revenue But the demand for travel for business is likely to be inelastic. So price

increase – less than proportionate fall in quantity demanded – total revenue increase

Effect on total revenue depends on size of business market vs. holiday makers

Due to the ceteris paribus assumption, the above will only take place if other factors remain constant. In this context, incomes have changed causing demand curve to shift – total revenue fall

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

strategies to increase market share 3) Cross elasticity of demand Definition Potential substitutes: train / coach / ship Degree of substitutability depends on the length of flight

Long haul flights: weak substitutes especially for business travelers Short distance: stronger substitutes

If another airline (eg. Qantas) reduces price to increase market share – fall in demand for a particular airline (eg. SIA) – SIA reduces price – price war – may not cover costs – erode profits Budget airlines also pose as competition

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Airlines close down routes / less schedules – fall in supply – increase price Demand inelastic: long haul flights – no close substitutes – total revenue

increase Demand elastic: short distance flights – switch to trains / coaches – total

revenue falls 4) Price elasticity of supply Definition Fall in price – fall in quantity supplied But short run: supply price inelastic – less than proportionate fall in quantity

supplied Reasons Labour: need time to retrench / reallocate labour to other departments Flight schedule / routes: need time to deliberate which routes / schedules to

close – choose the unprofitable / lowest passenger volume Conclusion Cannot look at each value separately because in real world many variables change at the same time

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Chapter 4: Microeconomic Problems: Market Failure 1. Market Failure Scarce resources – need to allocate resources efficiently – objective: maximize

society’s welfare (social optimality) MSB = MSC: benefit to society from one additional unit of good = cost to

society of producing one extra unit of good Ways to allocate resources

Total government intervention Free market (based on price mechanism) Mixed economy (free market with some government intervention)

Free market economy Private ownership of resources + individual decision-making guided by self-

interest Price serves as signal for resource allocation Automatic working of supply and demand – spontaneity – allocative

efficiency Equilibrium where demand = supply: maximization of consumer and

producer surplus Assumes no externalities + perfect competition

Market failure occurs when Allocative inefficiency: externalities / public goods, imperfect competition Inability of market to achieve social objective eg. income equity

2. Externalities Cost / benefit on a third party not involved in the consumption / production of good Negative

Types: industrial pollution, pollution and congestion from vehicles, demerit goods eg. cigarettes External cost: second-hand smoke – health problems, fire hazard,

environmental cost – littering, anti-smoking campaigns – money comes from taxpayers who largely do not smoke

To tabacco company: profit-maximising private producer: MPB = MPC To society: to attain social optimality: equilibrium level MSB = MSC = MPC +

MEC Overproduction: deadweight loss

Positive Types: merit goods eg. healthcare, education

External benefit: higher standard of living of everyone because of highly-skilled jobs

Under-production by free market: deadweight loss Because of partial market failure, government intervention comes in

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3. Public Goods Non-excludable: impossible / costly to exclude non-paying consumers from receiving

the good Non-rivalrous: consumption by one person does not reduce amount available to

others Eg. National defense Free rider – conceal demand – private producer cannot gauge demand – will not

produce – non-production in free market – total market failure Government provision necessary since public goods are socially desirable and largely

indivisible 4. Inequality Represented by the Lorenz Curve / Gini coefficient Singapore: 0.485 in 2007 European countries: 0.25 – 0.3 Latin America and the Caribbean: 0.6 Average worldwide: 0.4 5. Essay When asked to suggest new policies, consider whether it is possible / practical to

enact them Policies may be difficult to administer, and policing expensive Opportunity costs involved in attempted to control negative externalities Political implications eg. public satisfaction

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Policies on Pollution and Evaluation Summary 1) Identify: Taxation Explain: Tax polluters per unit of MEC – COP increases for private firms – supply

falls from MPC to MSC by amount of MEC Evaluate: * Negative externality internalized by firm: incentive for firm to be more -

cost-effective to maximize profits / reduce pollution * Provides revenue for government to finance other social and

community development projects * Able to allow market to continue operating according to market forces

and reach state of equilibrium x Requires accurate valuation of MEC / amount of pollution

- Over-valuation: output below socially optimal level, reducing society’s welfare / deters production – affects economic growth - Under-valuation: output still not brought to socially optimal level

x Difficult to apportion blame x Effectiveness dependent on price elasticity of demand: if highly price

inelastic, effect of tax on output ineffective unless tax very large / firm able to move burden to consumers and get away scot-free

2) Identify: Quotas Explain: Ban production if pollution exceeds a certain limit – limits MEC by

restricting output at socially optimal level Clearly defined amount of pollution each firm can have Evaluate: * Able to control level of pollution in the country as a whole X Does not allow price to equilibrate quantity demanded to quantity

supplied: firms may decide to produce less so they do not exceed the maximum amount of pollution they can have (compare this to taxation)

X Difficult and tedious to gauge how much pollution each firm produces: waste of resources and time on inspection

X Need vigilance and commitment of government 3) Identify: Legislation Explain: Force producers to bear costs of more proper disposal of industrial

wastes eg. antipollution equipment

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Evaluate: x Difficult and costly: spend resources on inspection X If chances of being caught and penalties are small, legislation

ineffective X Need vigilance and commitment of government X Not immediately effective because of bureaucracy involved in

establishing laws X Lose voters leading to loss in power 4) Identify: Nationalisation Explain: Government takes over the polluters’ firms and ensures production at

socially optimal output Evaluate: x Waste of resources: opportunity cost to other projects because less

funds available X Difficult to accurately valuate quantity demanded X No competition: inefficient, no innovation 5) Identify: Campaign / advertisements to educate public Explain: Raise awareness of pollution situation to public in hope they might do

something to curb problem Evaluate: x Costs of these measures might outweigh benefits X Duration needed before effects can be felt and there is no guarantee

that the campaign will be effective X May be effective for only a short period of time because the public is

constantly bombarded by such campaigns that it is starting to lose its intended effect

6) Identify: Subsidies Explain: Subsidise purchase of antipollution equipment so that firms’ COP does

not increase that much by purchasing these equipment – firms more likely to buy the equipment than before

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

run probably mitigates the problem of pollution if firms use the equipment

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7) Identify: Urban planning Explain: Locate factories away from residential areas eg. Jurong Island Greenery (to reduce impact) Evaluate: x Merely shifting the pollution to another area – does not solve the root

of the problem but reduces external cost since less people affected by pollution

X Contentious as to whether greenery helps to reduce impact Summation: Air pollution may not be due to the country itself, so need international /

regional cooperation Can integrate a few policies for better results

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Policies on Pollution and Congestion caused by Cars Summary 1) Identify: ERP per tax unit Explain: Restricts car usage (nowadays rely more on this policy) Increases cost of car journey – quantity demanded for car travel falls Evaluate: x Congestion in other areas / small roads X Increase business cost – pass to consumers 2) Identify: COE Explain: Restricts car ownership Evaluate: x Increasing affluence – income elasticity of demand for cars X Cannot stem people’s aspirations

X Needs vigilance and political will (in other countries, government might not be able to have COE)

3) Identify: Efficient and affordable public transport Explain: Less pollution and congestion on roads Evaluate: x Not all countries have resources to build an effective public transport

system – LDCs: no money, DCs: complex commuting patterns X For it to be affordable, possibly need government to finance. Otherwise

if left to the private firm, they would want to charge more to maximize profits.

4) Identify: Registration tax, annual road license Explain: Restricts car usage Evaluate: *May work if there is vigilance and commitment by government 5) Identify: Rebates for green vehicles eg. 20% off purchase price Explain: Lower price – quantity demanded higher Evaluate: x Still not widely advocated X May still be too expensive to afford

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6) Identify: Weekend cars Explain: Restricts car usage Evaluate: x Still not widely advocated X People associate cars with prestige (eg. Americans love for SUVs)

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Chapter 5: Government Intervention in the Market 1. Tacking Externalities Negative externalities [details on page 21-23] Positive externalities

Subsidies: external benefit internalized (works like the tax) Can be easily implemented to bring about increase in production and

consumption Difficult to valuate external benefit generated High government expenditure – high tax rates can subsequently

discourage investment in country Firms lose incentive to be more productively efficient – inefficient

firms may survive Direct provision of merit goods

Social justice: merit goods should be accessible to all and not provided according to ability to pay

Large positive externalities: eg. free healthcare combats spread of disease

Dependants: eg. free education to protect children from irresponsible parents who fail to provide children quality education

Ignorance: consumers may not realize how much they will benefit and if they had to pay, they would rather go without it

2. Government Failure Allocative efficiency reduced following government intervention to correct market

failure Problem of incentives

Imposition of high taxes can distort incentives High marginal tax removes incentive for people to work harder to

earn more Disincentive to produce and consume

Desire by politicians to get elected: popular policies introduced (eg. minimum wage law)

Profit motive of private sector largely removed Problem of information

Difficult to valuate external cost / benefit Difficult to accurately estimate level of consumer demand for product

Problem of distribution Increase inequity Eg. tax on use of domestic fuel (kerosene in Indonesia) – low income

households may feel greatest effect as tax on fuel oil may make life of poor worse since they use proportionately more domestic fuel than others

Bureaucracy and inefficiency: administrative costs; time lags Shifts in government policy: too frequent changes – difficult for firms to plan ahead

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Chapter 6: Firms and How They Operate I 1. Production in the Short Run Short run: at least one fixed factor Long run: period of time long enough for all factors to vary, except level of

technology, which varies in the very long run LDMR: as more units of a variable factor are applied to a given quantity of a fixed

factor, there comes a point beyond which the extra output from additional units of the variable factor will eventually diminish Stage 1: TP increases at an increasing rate, MP rises – due to specialization of

labour Stage 2: TP increases at a decreasing rate, MP falls, LDMR sets in – due

inefficient use of fixed factor Stage 3: TP falls, MP falls MP = change in TP / change in L

2. Theory of Costs in the Short Run Factor Total Fixed Cost Total Variable Cost Marginal Cost Definition Sum of all costs of

production do not vary with the level of output aka overhead costs Must be paid even without production

Costs incurred for use of variable factors like labour Varies directly with output level

Additional cost incurred in producing an extra unit of output in the short run while some inputs remain fixed MC = change in TC / change in Q

Examples Rent of factory building, interest on capital invested in equipment

Raw materials, labour

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Graph

Average curves ATC = AVC + AFC

AFC: amount of fixed costs per unit of output AFC = TFC / Q

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

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

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3. Objectives of Firms Profit-maximisation: equilibrium level of output since there is no tendency to change

Before equilibrium level, MR > MC so firms want to produce more After equilibrium level, MR < MC and rational firms will not produce at this

output level Firm continues production as long as it can cover variable costs

Motivation of owners vs. motivation of managers: separation of control and ownership – principal-agent problem: managers tend to pursue their alternative goals while maintaining minimum level of profits to appease shareholders

Revenue maximization: managers aim to maximize firm’s short run total revenue Long-run profit maximization: managers aim to shift cost and revenue curves so as

to maximize profits over some longer time period Growth maximization: managers may aim for expansion to maximize growth in sales

volume over time 4. Theory of Costs in the Long Run Returns to scale: measure of resulting change in output when all inputs are changed

in the same proportion (can be increasing, decreasing or constant) LRAC: lowest average cost for given level of output when all inputs are variable Minimum efficient scale: smallest plant size beyond which no significant additional

IEOS can be achieved IEOS: savings in costs that occur to a firm due to the firm’s expansion, and have been

created by firm’s own policies and actions Technical: concerned with production process

Factor indivisibility economies: larger plant size makes it possible to effectively use indivisible factors (combine harvesters, power transmission: large and costly) – raises average output and reduces LRAC

Specialisation of labour: simpler and repetitive jobs which require less training + more efficient eg. car manufacturing

Managerial: functional specialization by employing experts to increase efficiency as a whole Greater use of existing staff Decentralisation of decision-making: increasing efficiency of

management because of faster flow of information within firm – distortions and delays of information avoided

Commercial Bargaining advantage and accorded preferential treatment by

suppliers because they buy raw materials in bulk Bulk sales from bulk advertising and large-scale promotion

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Financial Easier and cheaper to raise funds: given lower interest rate and larger

loans because better credit ratings and more collateral Raise capital through issue of shares to public who has more

confidence in reputed firms Risk-bearing

Advantage in bearing non-insurable risks eg. conditions of demand for final products and supply of raw materials

Diversification of products and markets Diversification in sources of supply

R+d Better quality products – increased market share and demand Better methods of production – more productively efficient – lower

average cost Welfare: making workers feel they belong to the company – more apt to

increase efficiency and productivity of company IDOS

Complexity of management Principal-agent problem Bureaucracy

Strained relationships: impersonal – no loyalty to firm – apathy, strikes EEOS: savings in costs that occur to all firms in an industry due to the expansion of

the industry Economies of concentration

Availability of skilled labour: demand for labour large enough – special educational institutions / firms can collaborate to develop training facilities

• No lack of labour to employ because experts want to migrate there eg. Silicon Valley

Well-developed infrastructure to cater to that industry Reputation: builds up name which consumers associate with quality –

encourages brand loyalty and steady clientele Economies of disintegration

Subsidiary industries developed to cater to needs of major industry • Eg. car industry in Japan: range of firms specialize in

production of different inputs for car manufacturing – provide output at lower prices to main industry because specialization allows subsidiary firms to produce at large scale – enjoy EOS

Process waste products into useful products and sell them to cover COP

Economies of information: publications help improve productivity of firms (research and expertise)

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EDOS Increased strain on infrastructure: taxed to limits eg. congestion – loss of

time and increased fuel consumption Rising costs of FOP: growing shortage of specific raw materials / skilled

labour 5. Growth of Firms Methods of growth

Internal expansion: make more of existing product or extending range of product when it builds a new bigger plant

Merger Vertical integration: firms engaged in different stages of productive

process • Backward integration vs. forward integration • Eg. Starbucks merge with firm producing coffee beans – wants

guaranteed access to raw materials Horizontal integration: firm takes over similar firm at same stage of

production in the same industry • Eg. Coffee Bean and Starbucks merge • Eg. DBS and POSB • Market domination

Conglomeration Eg. bank taking over developing firm to build properties Diversify output

6. Survival of Small Firms Demand-side factors

Nature of product Bulky and perishable goods: small, localized markets eg. fresh fish Variety preferred to standardization eg. fashion Specialised products: limited markets eg. highly specialized machines

Prestige markets: limited by price eg. sports cars, luxury yachts Direct and personalized services eg. lawyers, doctors Geographical limitations: high transport costs for bulky products – local

market rather than national market Supply-side factors

DEOS set in early: optimum size of firm small Vertical disintegration: entire production process broken into series of

separate processes and different small firms perform each process Low BTE Lack of capital

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Unwillingness to take greater risks Larger firm – higher expenditure – greater risk of investment Fear of future fall in price of final product: expansion of output –

increase market supply – excess supply – lower prices and lower profits

Banding: small firms may band to gain advantages of bulk buying while still retaining their independence

Profit cycles: early stage of product cycle – total demand for product low Non-profit maximization attitudes

Owner values independence or wants to maintain control among family members

Contented with reasonable income from domestic market Unwilling to take increased risks associated with expanding into

foreign market 7. Case Study Factors: think long run vs. short run, demand-side vs. supply-side EOS – lower LRAC – able to reduce price

Profits plough to r+d – better quality products + further reduction in AC Block new entrants due to enormous FC – less existing competitors –

increase market share Always end EOS with AC If a particular industry is stated in the extract, try to give egs of EOS specific to the

industry 8. Essay Survival of small firms: for conclusion, use banding / small firms may want to merge

in the face of globalisation

31

Discuss whether rising costs limit the size of firms over time. [15m] Introduction Size: sales revenue / turnover, level of output, market share Over time – long run – firm no longer constrained by fixed factor Body 1) Can limit Short run cost Reason: over-use of fixed factor, inefficient labour-capital combination –

increase MC – eventual increase in AC Increase costs – fall in profits if total revenue is constant – constrain firm’s

ability to expand 2) Will not limit Long run All inputs can vary – firm can expand – enjoy fall in LRAC due to internal EOS

(list 2 egs) Fall in LRAC – fall in price to ward off competitors (erecting barriers to entry)

– increase profits – plough into r+d – better quality products + if yields results – further fall in AC due to better production methods

Size of firm determined by demand for firm’s product – if firm making supernormal profits – can still expand in size even if cost increases eg. monopoly selling unique products

Conclusion: However, size of firm over time constrained by MES (list 1 eg of internal DOS). MES huge eg. electricity / water compared to MES limited eg. fashion. Banking Merger in Singapore Analysis Why merge? Face competition from foreign banks – Singapore wants to expand beyond our

shores: big – enjoy EOS – fall in AC – can compete with foreign banks Core part of Singapore economy – 1997 Asian financial crisis – big stable

Why should not merge? Possible monopoly power Increase price Quality of service

Reduction / removal of familiar products and services – affects consumer satisfaction

Neglect lower-income group Retrenchment

32

Chapter 7: Firms and How They Operate II 1. Comparison of the 4 Markets Type Perfect Competition Monopoly Monopolistic Competition Oligopoly Number of buyers / sellers

Large No one buyer / seller

can influence price Firm price taker

Only one firm Firm price setter

Large FOP relatively mobile When firm makes

decisions, does not have to worry how its rivals will react

Few large firms Interdependent

Barriers to entry

None FOP perfectly mobile No transaction /

transportation costs Minimal sunk costs

High Natural: huge sunk costs

(AFC falls over very large output – AC falls continuously – enjoys huge IEOS), exclusive ownership of essential raw materials

Artificial: non-price competition, contrived barriers (cartel), legal protection: exclusive rights (patents, tariffs to block foreign firms)

No / Low Firm lowers price –

profits spread thinly over many rivals – rivals suffer negligibly

Retaliation unlikely No collusion – keen

competition

Substantial Natural Artificial: legislation,

collusion / mergers, non-price competition, advertising

Nature of products

Homogeneous Buyers no preference

for any firm

No close substitutes CED and PED very low

Differentiated: quality, design, location, promotion

Demand price elastic

Homogeneous / differentiated

33

Knowledge Perfect

Seller knows rivals’ prices, market costs and available technology

Buyers know all sellers’ prices, quality and availability of products – will not purchase at a higher price than equilibrium price

Imperfect Consumers not fully

aware of COP

Imperfect Production methods and

prices Cost structures differ as

some firms enjoy more favourable locations / rentals

Imperfect

Firm’s curve

P = AR = MR

P > MR Cannot increase both

output and price at the same time as curve is downward sloping

P > MR Some degree of control

over own prices No single equilibrium

price in market – no market demand curve

P > MR Firm increases price –

other firms will not Firm decreases price

– other firms follow – may lead to price war

Price rigidity: menu costs, fear of harming firm’s image (fall in price – fall in quality)

34

Examples Stock market Forex market Agricultural products:

many farmers in LDCs

Utilities Starhub’s EPL coverage SMRT for NS and EW

lines

Bubble tea UK brewery industry Taxi companies OPEC Mobile service

provision Firm’s SR equilibrium

Supernormal, normal / subnormal profits MC = MR and MC must be rising

Firm’s LR equilibrium

Normal profits New firms will enter

industry to erode supernormal profits

Normal / supernormal profits

Firm will shut down if subnormal profits

Normal profits Normal / supernormal

LR equilibrium curve

Productive efficiency

Efficient Firm produces at MES

Inefficient unless by coincidence

Inefficient Will settle at LRAC that

is not necessarily at MES

Inefficient unless by coincidence

Firm’s POV: all points on LRAC Society’s POV: MES

Allocative efficiency

Efficient P = MC

Inefficient P > MC

Could be seen as premium society pays for product differentiation

35

2. Analysis of Imperfect Market Structures Type Monopoly Monopolistic Competition Oligopoly Economic efficiency

Allocative inefficiency: P > MC, output below optimum

Productive inefficiency X-inefficiency but increasingly

reduced due to globalisation, reduced customs duties and barriers to trade

Dynamic efficiency: r+d

Allocative inefficiency: P > MC Productive inefficiency: do not

utilise optimal plant capacity, do not exhaust potential for further EOS because all small firms

Dynamic inefficiency: no r+d

Allocative inefficiency: P > MC, output below optimum

Productive inefficiency Dynamic efficiency: r+d

Variety of products

Unique Possible innovation and new

products: BTE stimulus to the creativity required to destroy barriers – monopoly profits stimulates new entrants producing new and competing products

Large variety – increase in consumer welfare

Differentiated

R+d and new profits

Profits lead to unequal income distribution: dollar votes + shift of consumer surplus to producer

Supernormal profits – plough into r+d – better quality products + better methods of production – lower AC but there is no guarantee that monopolies will do this

More equity: no redistribution of income from consumers to shareholders

Normal profits: no additional profits to plough into r+d

Supernormal profits ploughed into r+d

36

Theory vs empirical evidence

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

Practise price discrimination [has

both costs and benefits] Natural monopolies Perfectly contestable markets:

costs of entry and exit by potential rivals are zero, and when such entries can be made very rapidly eg. deregulation of airline industry in 1978

Hit and run competition: market contestable for certain seasons eg. parcels service during festivals

Reduces wasteful competition (instead of extensive advertising, money can be spent to produce more goods)

Wasteful competition Advertising provides better

consumer information which helps move market structure closer to PC model but loss of consumer sovereignty

High price rigidity: price stability Wasteful competition: more likely

to engage in extensive advertising – encourages price competition, with increased sales volume and reaping of EOS, price reduce further

But possible monopoly power through collusion

But multiple branding gives consumers misguided information in thinking products are from different firms

P/R/C

Q AR

MCm

MR

MCpc Pc Pm

0 Q

Q

37

3. Price Discrimination Producer sells specific commodity to different buyers at two or more different prices Same consumer charged different prices for same product for reasons not

associated with cost differences Conditions

Possible Seller has control over market supply Market segmentation and identifiable groups + no resale

Profitable: each market as different PED First degree

Practice of charging each customer his reservation price Captures all consumer surplus as revenue Eg. auction sites Impractical to charge each customer a different price Firm usually does not know the reservation price of each

customer: consumers do not tell and producers may not want to spend time and resources to find out

Second degree Charge different prices for different blocks of the same

product to the same buyer Eg. photocopying shops

Third degree Sells same product at different prices to different customers Conditions

Two or more markets which can be separated PED of each market must be different

Higher price charged in market with more price inelastic demand

Cost: loss of consumer surplus Benefits

Firm: higher profits and may use these profits from one market to withstand possible price war in breaking into another market

Consumer Consumer may not have been able to afford good otherwise

38

Higher profits may be reinvested into r+d – better quality products + better methods of production

Provision of goods that would otherwise not be produced due to high costs if production and consumption of good is one that confers positive externalities on society

• Additional profits might exceed losses such that firm will still continue producing the good

39

Discuss the view that the profit motive will always lead to a few large firms dominating the market for each and every type of product. [15m] 1) Barriers to entry Few large firms merge – greater market share – reap EOS – fall in LRAC – fall in

price – ward off rivals / block new entrants (natural BTE) – able to maintain supernormal profits

If plough into r+d – better methods of production – further fall in AC - make more profits

But some industries have low BTE (technology easily replicated) – low sunk cost eg. retail, grocery

2) Market size Small: eg. Singapore television broadcasting Mediacorp vs. Mediaworks Firms will eat into each other’s market share – erode profits – so to keep

profits just let one firm dominate Market big: eg. US then can afford to have few large firms

3) Nature of product Large firms: unique products with no close substitutes Small firms: availability of substitutes, prestige market / services, localized

demand, perishables, limited MES – fashion, specialization, personalized services 4) Government Intervention / public’s desire Few large firms will help to reduce price – increase in consumer surplus –

increase in consumer welfare Supernormal profits – plough into r+d to produce better quality products Will still have competition unlike monopoly – still have the incentive to be more

cost-efficient / innovative

40

Explain what is meant by productive and allocative efficiency. [10m] 1. Allocative efficiency Definition: situation in which it is impossible to change the allocation of

resources in such a way as to make someone better off without making someone else worse off

Assumption: no externalities / public goods – P = MC – right amount + type of good produced to maximize societal welfare

If MB < MC, last unit of good less than opportunity cost of producing that

unit – society benefits from not producing that last unit If MB > MC, last unit of good more than opportunity cost of producing that

unit – society benefits from producing that last unit Assumption aside, MSB = MSC Perfect competition: firm price taker MR = MC = P – allocatively efficient

Price

Quantity 0

S (MC)

D (MB)

P/R/C

Quantity

MR

MC

Q1 0

P1

41

2. Productive efficiency Long run concept Firm’s POV Any given level of firm’s output produced at lowest possible AC – all points

on LRAC curve are productively efficient Society’s POV LRAC minimum – firm is at optimum size / MES – all IEOS exploited

P/R/C

Quantity

MR

LRAC

Q1 0

P1

42

‘A firm should be encouraged to maximize profits because this makes it efficient.’ Discuss whether this argument is true for a firm operating in an imperfect market. [15m] *When comparing efficiency, only talk about long run 1) Allocative efficiency: P > MC true for all imperfect markets because they are price setters – deadweight loss to society – allocatively inefficient 2) Productive efficiency: Not operating at MES (where LRAC cuts MC) – not fully exploited all IEOS – productively inefficient

PC industry needs to be at MES because it needs to be as cost-effective as possible – price taker – cannot pass cost increase to consumers

Vs. imperfect market need not be at MES because price setter – can pass cost increase to consumers

3) X-inefficiency Monopoly: lax in cost control – no existing competition – can pass cost increase

as price increase But monopoly can also be cost efficient due to fear of new entrants Globalisation and international competition If market is contestable Force monopoly to be cost efficient

Oligopoly more likely to be cost-efficient compared to monopoly but wastage of resources – large scale advertising / promotion – increase cost for firm and opportunity cost to society as the money could have been used to produce more goods

4) Dynamic efficiency Supernormal profits in long run – able to invest in r+d – better methods of

production – fall in AC in very long run Vs. PC industry: no dynamic efficiency

P/R/C

Quantity

AR MR

MC

LRAC Pm Pc

Qc Qm 0

Triangle = DWL

43

Distinguish between monopolistic competition and oligopoly. [10m] Type Monopolistic competition Oligopoly Number of sellers

Many – one firm’s action less likely to affect others

A few large firms – interdependence – one firm’s action likely to evoke responses from rivals

Nature of product

Differentiated eg. retail: restaurants – affect demand curve – demand price elastic

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

Firm increase price: rivals will not follow

– quantity demanded for firm’s product falls more than proportionately – demand price elastic

Firm reduces price: rivals likely to follow – price war + quantity demanded for firm’s product increases less than proportionately – demand price inelastic

Non-pricing competition

Smaller scale Larger scale

Likelihood of colluding

Less More: large market share

BTE Low / no – low sunk cost + technology easily replicated – long run normal profits

High – natural: high sunk cost eg. utilities, telecomm – TFC very huge – LRAC keeps falling – enjoys huge EOS – very low LRAC– new entrants cannot produce at such low LRAC

Artificial: patents Ensure supernormal profits in long run

P/R/C

Quantity 0

AR

P/R/C

Quantity 0

AR

Pe

44

Explain why oligopoly is a common market structure in many economies. [15m] 1) Firms want to be big to maximize profits Merger of small firms – EOS – fall in LRAC – fall in price – ward off rivals + block

new entrants Monopoly – attracted by supernormal profits – monopoly loses its power

2) Society may desire oligopolies Oligopoly – competition – greater innovation through r+d which monopolistic

competition cannot afford since it only makes normal profits Vs. monopoly – lax – X-inefficiency

3) Government’s intervention Singapore government – face of international competition in a free market, local

firms have to be big eg. banking – go regional – liberalization and deregulation of industries: mobile service industry, taxi companies

Firms prefer operate in oligopolistic structure rather than monopolistic: monopolies more closely watched by government vs. oligopolies harder to observe whether they are colluding

4) Some industries due to huge sunk cost – oligopolistic / even natural monopoly eg. utilities, telecommunications, transport, TV broadcasting in Singapore since market size is too small – one single player most efficient

45

Explain why governments throughout the world have been involved in the supply of services such as electricity. [12m] Introduction Government – social benefits + social costs which private firms unlikely to take

into account Electricity – essential good for households and businesses

Body 1) Could be a natural monopoly Market size cannot operate with more than one player at MES: huge sunk cost –

AC keeps falling – private firms likely to be monopolistic – charge very high prices – need for regulation

2) Private – does not cater to lower income group vs. government more likely to do so 3) Huge initial investment – private firm likely to charge higher price to cover costs vs. government can subsidise from revenue / taxes 4) If there is competition among a few private firms – wastage + duplication of resources vs. government: save costs for advertising 5) Earns revenue for government since it is essential Conclusion Main point is that government does not want to risk anything because electricity and similar services are so essential

P/R/C

Quantity 0 AR MR MC

Pm

Pc

Qm Qc

AC

46

Chapter 8: Government Intervention in the Market II 1. Regulation of Natural Monopolies MC pricing: monopoly charge a price that is equal to MC in order to achieve

allocative efficiency But monopoly incurs a loss – shut down – public deprived of vital service Need to be supplemented with government subsidies: costly to government,

burden on taxpayers 2-tier pricing: consumers pay a fixed sum of money for access to service and

price per unit consumed to cover marginal cost Eg. electricity, gas Producer meets all COP and minimizes loss of social welfare

AC pricing: monopoly charge a price equal to AC – lower price and greater output – increase in society’s welfare Normal profits – viable in long run Still not allocatively efficient Firms no incentive to keep costs low since price is at whatever AC they are at

Problems Difficult to obtain accurate information on demand and cost estimates: firms

tend to overstate cost, market conditions change constantly, costly to acquire new information

Regulatory lag: firms may have to operate at a loss during time lag Costly to administer

2. Taxation Lump-sum tax on monopolist’s excessive profits – shifts AC curve upwards –

profits reduced – normal profits Redistribute income from producer to consumer Use tax revenue to subsidise welfare schemes / production of merit goods May create disincentive for monopolist to be cost-efficient Monopoly can pass burden to consumers due to price inelastic demand Dynamic efficiency compromised

3. Legislation Anti-trust laws: Anti-trust Act (US) / Competition Law (Singapore): break up

monopoly Eg. Microsoft Corporation: one firm own Windows operating system, the

other will own applications May not be applicable to natural monopoly / monopolies with great incentives

to undertake r+d Forbidding certain practices: eg. predatory pricing: setting price below COP to

eliminate competition

47

Imposing standards of provision eg. Public Transport Authority in Singapore governs standards of public transportation to ensure guaranteed quality of product

Insisting on certain levels of competition in industry: Singapore government increasingly deregulates monopoly

4. Nationalisation Growth Industries with major investment eg. steel and coal industry, large spending

on r+d required Unfair competition of state-owned enterprises with private sector

Efficiency Natural monopoly, presence of positive externalities, eliminate wasteful

duplication Lack of competition pressure – lack of incentive – X-inefficiency Bureaucracy – heavier burden on tax payers Sunset industry Decision may be made for political rather than economic reasons eg. just to

keep employment figures high Equity Special pricing policies eg. free bus rides for pensioners Service which would otherwise not be provided eg. bus route to remote

areas State monopoly no less disadvantageous to consumer than private one – no

higher authority to maintain checks and balances Stability For strategic reasons eg. national defence Seen as a move towards communism

5. Privatisation Competition Increased competition – cost efficiency + benefits for consumers eg. lower

prices, wider choice, improved quality Unfair competition of state-owned enterprises with private sector Could be worse outcome

If state monopoly replaced with private monopoly, possibly lower output and higher price

If high BTE

48

Efficiency Greater efficiency

Commercially sounder decision making eg. higher returns on investments

Greater accountability to public – constantly need to perform well or risk takeover by another firm

Natural monopolies, externalities, equity issues Revenue Revenue from selling state assets Higher corporate tax receipts if privatized company is profitable Long term loss of revenue had the privatized firm been profitable

49

No. Title Page No. 29 Chapter 9: Key Economic Indicators 50-51 30 How far can this information lead you to conclude that there is a rising

standard of living in Singapore? 52-53

31 Discuss the factors that contribute to economic growth in a country. 54 32 Chapter 10: Income and Employment Determination 55-58 33 Explain what information an economist would require to decide whether

the US needed ‘an economic stimulus’. 59

34 Explain what is meant by the equilibrium level of national income. 59 35 Analyse the effect on the equilibrium level of income of an increase in

the level of savings and an increase in the level of exports. 60

36 Discuss the extent to which the US fiscal stimulus might lead to a sustained increase in national income.

61

37 What are the main causes of Singapore’s recessions? 62 38 Chapter 11: International Economics 63-66 39 Explain the theory of comparative advantage. 67 40 To what extent does the theory of comparative advantage explain the

pattern of trade between Singapore and the rest of the world? 68-69

41 Discuss whether protection offers any advantages over specialization. 70-71 42 Explain the rationale for free trade and discuss the extent to which FTAs

are beneficial. 72-74

43 To what extent can economies benefit from globalisation? 75-76 44 Discuss the opportunities and threats of globalisation for Singapore and

other Asian economies. 77

45 Consider the effects, other than on the general price level, of Singapore’s changing tax structure.

78

46 Policies to remedy Singapore’s recession 79 47 Evaluate methods the Malaysian government might use to slow down

import growth and increase new export business. 80

48 “To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” How far do you agree with the statement?

81

49 “To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” Explain this statement.

81

50 Discuss whether fiscal policy is the most effective way for Singapore to sustain a successful economy.

82

51 In the fourth quarter of 2004, Singapore’s unemployment rate rose to 3.7%. Discuss whether supply-side policies are the best way of achieving full employment in Singapore.

83

52 Why Singapore does not use interest rate policy 84 53 Problems with exchange rate instability 84

J2 Topics

50

Chapter 9: Key Economic Indicators 1. Key Macroeconomic Aims Strong sustained economic growth Low inflation Low unemployment rate Healthy BOP 2. National Income Statistics Gross domestic product: value of all final goods and services produced within a given

country during a given period of time Measure economic growth Limitations

Understate nation’s output: omission of non-market activities (voluntary welfare services) and underground economy

Difficulties in measuring SOL • Leisure time • Externalities • Production does not equal consumption: expenditure could be

for potential growth • Income distribution • Other social factors: eg. crime rates, freedom

International comparisons • Difference in account procedures and items included • Exchange rates: need to use PPP • Population: need GDP per capita • Difference in climate and culture: different needs – different

costs • Difference in underground economy: Sweden’s underground

economy 13% of GDP Alternative measures of SOL

HDI: life expectancy, education, GDP per capita at PPP rates MEW: leisure, GDP per man hour

Gross national product: value of all final goods and services produced by residents of a country, regardless of the location of production, during a given period

Net national product: GNP – depreciation Nominal: at current prices vs. real: at constant prices

51

3. Inflation Rate CPI: measures change in price of fixed basket of goods and services commonly

purchased by households in a specified time period Limitations

Not an accurate measure of COL Substitution bias: consumers substitute toward goods that have become

relatively cheaper – overstates COL Quality adjustment: CPI increase might be due to quality adjustments –

overstate inflation New products: price declines sharply a few years after introduction – not

added to market basket until years after introduction – price declines not recorded

4. Unemployment Rate Unemployed: people aged 15 and over who are without work but were available for

work and were actively looking for a job Frictional unemployment: unemployment because time taken for workers to search

jobs and for firms to search for suitable workers Structural unemployment: workers do not have the skills needed to obtain long-

term employment Cyclical unemployment: unemployment during recession 5. Balance of Payments Record of country’s international transactions Current account

Visible: imports and exports of goods and services – BOT Invisible: profit repatriation, interest, dividends, unilateral transfers

Capital account Portfolio: bonds, shares, money in banks Direct: FDI

Financial account: something like bank reserves

52

Singapore has enjoyed another year of robust growth in 2007, and the real GDP growth was 7.5% for the year. A record 172000 jobs were created in the first 3 quarters. However, in recent months, inflation has picked up and the inflation rate for the month of November alone was 4.2%. How far can this information lead you to conclude that there is a rising standard of living in Singapore? [25m] Introduction SOL – material and non-material well being of each citizen Body A) Material well being Real GDP per head: on average how much goods / services each citizen gets to

consumer Real: adjusted for inflation as converted to constant prices High for a developed country Limitation: does not show effect of changes in population size Per head: effect of population size eg. if GDP increases by 7.5% but

population increases by 9%, GDP per head falls Singapore: over 1 year: changes in population size little but could have been

some increase due to open-door policy Income gap – Gini coefficient

Gini coefficient globally used as a measure of income disparity, with 0 indicating perfect equality and 1 perfect inequality

Singapore: 0.52 in 2006 Increasing gap in Singapore due to globalisation: displaced by machines,

structural changes, influx of foreign workers, outsourcing Type of spending

Capital vs. consumption goods Government spending Defence vs. spending that directly increases SOL

172000 jobs High incomes – increase consumer spending which increases demand for

goods and services, generating more jobs and employment Due to investments by foreign companies eg. in 2007 plant specializing in

harnessing solar energy set up in Singapore – indicates investor confidence Limitations: 60% jobs went to foreigners, number of jobs destroyed vs.

number of jobs created, size of labour force may have changed so it is not that unemployment rates fell, composition of jobs (for lower-skilled workers?), ratio of dependants to working population

53

Inflation rate Real: adjusted for inflation Cause: mainly cost factors like high imported oil price, imported food

shortages, partly GST Lower-income group suffers more in the face of further increase in prices /

income gap B) Non-material well being Education – literacy rate

Singapore: high literacy rate due to compulsory primary education, heavily subsidized

Government emphasis on upgrading of skills and training subsidies to firms for such purposes

Healthcare – infant mortality rate / life expectancy Singapore: individual responsibility + government spending – 3M framework

– Medisave, Medishield, Medifund Avoid excessive burden on state and tax payers With increasing medical costs + ageing population, QOL of some (lower-

income group?) may be affected Means-testing

Leisure: GDP per man hour Others: negative externalities eg. pollution Conclusion Other indicators: HDI, MEW, GNP

54

Discuss the factors that contribute to economic growth in a country. [12m] Introduction Economic growth measured by GDP growth rate and is the means to improve living

standards Body 1) Quantity and quality of resources Quantity and availability enhance growth potential

Land: includes natural resources like mineral deposits and oil eg. oil-rich Saudi Arabia

Labour – labour-abundant countries like China and India Entrepreneurship – availability of talents and risk-taking individuals eg. self-

made entrepreneurs in Hong Kong Quality can be enhanced through government effort and policies

Increase labour productivity through training and education Entrepreneurship Capital – government efforts to make it more conducive for fixed capital

formation 2) Role of government Augment quality of labour through education and training Strategise economic direction eg. change structure of economy in face of loss of

comparative advantage and nurture comparative advantage in new areas Conducive environment for business

Political stability Price stability: reflection of good macroeconomic management by

government, competitive price and lowered COP – ability to attract FDI due to lower wages

Efficient infrastructure Attractive corporate taxes Less bureaucracy and red tape Ability to explore new markets / help businesses go global

3) Level of consumption, investment and government spending in economy High consumption conducive when economy has unutilized resources while high

savings conducive when economy near or at full employment Savings provide investment funds necessary for growth Government fiscal and interest rate policies High export revenue due to competitiveness

55

Chapter 10: Income and Employment Determination 1. Aggregate Demand Total level of spending in an economy AD curve slopes downwards because

Wealth / real balance effect: GPL higher – purchasing power of financial assets falls – discourages domestic consumption – lower level of output

Interest rate effect: higher GPL – increase demand for money from households and firms + might shift wealth out of financial assets – decreasing supply of loanable funds – increase in interest rates – more expensive to purchase goods and services on credit – households purchase less goods + businesses invest less – lower national output

International substitution effect: higher GPL – locals buy more foreign goods + foreigners buy less domestic goods – net exports fall – lower national output

Factors that cause a shift Changes in expectations: income and profits, real wealth, inflation Changes in government policies Changes in world economy: income abroad, foreign price level, exchange

rates 2. Aggregate Supply Total output of goods and services that firms as a whole would like to produce and

sell at each possible price level Shape

Horizontal: producers can produce all they want due to abundant resources Upward sloping: output rises but pressure on prices Vertical: need time to adjust to new cost structures

Factors that cause a shift Change in input prices Change in quality of labour input Change in expected rate of inflation Change in technology Government policies (local and foreign)

56

3. Consumption Function Act of using income for the purchase of goods and services to satisfy current wants C = a+bY

a represents autonomous consumption: level of consumption that does not vary with income – still need to consume even though no income

bY represents induced consumption: household expenditures that vary directly with income

b: MPC = change in C / change in Y Non-income determinants

Wealth: amount of money, fixed assets and financial assets households have Expectations of future prices and income Distribution of income Interest rate and availability on credit Tastes and attitudes

4. Investment Act of acquiring new fixed capital assets and accumulating stocks and inventories Autonomous: not influenced by national income vs. induced Expected rate of return > rate of interest – will invest Factors that cause shift

Business confidence and expectations Cost and availability of capital goods Rate of change of income: accelerator effect Government policies Change in technology

Consumption

Income

Y = C

C = a + bY

W X

Z

W = dissavings, X = breakeven point, Z = savings

57

5. Equilibrium Level of Income At OY1 AE = aY, Y = by AE < Y unplanned inventory investment ab next period firms reduce output Y1 falls to equilibrium Y0

At OY2 AE = dY2, Y = cY2 AE > Y excess demand, firms draw on stocks unplanned disinvestments cd next period firms increase output Y2 rises to equilibrium Y0

Interest rate

Investment

AE

National output

Y = AE

Y2

c

d

b

a

Autonomous consumption

Y0

A

B

58

6. The Multiplier Effect A change in any component of aggregate expenditure (ie. C, I, G or X) will work through the multiplier to change the national income more than proportionately. As shown in the diagram below [refer to diagram above], an increase in AE will cause the AE curve to shift from AE0 to AE1. At the original level of national income Y0, since AE is now greater than actual national output, there is an unplanned fall in stocks of AB. In the next period, firms would increase output, causing the level of national income to rise eventually to Y1, where the new AE equates the national output. The initial rise in income due to (any rise in component: depends on question context) will induce consumption by recipients of the income. As one man’s spending generates income for the next person, the national income will eventually rise by a multiple of the initial rise in the AE. Assuming an initial injection of $100m and a constant MPC of 0.5, the national income will eventually rise by 2 times the initial injection. In short, the multiplier measures the change in national income as a result of the change in AE. It has a direct relationship with the MPC, expressed as k=1/(1-MPC). Evaluation Magnitude of increase in NY depends on size of multiplier Larger the MPW, smaller the multiplier May lead to demand-pull inflation if near or at full employment BOP – inflation affects price of exports and may have adverse effect on BOT 7. Inflationary / Deflationary Gap Amount of AE that falls short of (cd)/ exceeds (ab) the level necessary to achieve FE

59

Explain what information an economist would require to decide whether the US needed ‘an economic stimulus’. [10m] Introduction Weak economy – assume pending recession – fall in GDP for 2 consecutive quarters (negative GDP growth) Development Fall in real GDP Components of AD: fall in AD – fall in GDP

Consumption level of households: due to fall in income / saving in fear of retrenchment

Fall in investment: business pessimism, induced: fall in GDP – fall in investment

Inflation: fall in GDP – fall in AD – fall in GPL / fall in inflation rate Need inflation rate to arrive at real GDP

Firms and bankruptcy, firms and decreasing profits Stock markets: indices fall – confidence fall OR Fall in real GDP What causes fall: C/I/G/X-M: BOT: more relevant for Singapore since Singapore’s

recession mainly due to BOT GDP – income, wages and profits, bankruptcy Inflation: fall in GPL but stagflation (economy weakening but price increasing) – price

increase in US not due to recession: not AD factors but AS factors Unemployment rate – rough guide: 4% - cyclical – no job – demand deficient

unemployment Explain what is meant by the equilibrium level of national income. [10m] NY: as measured by GDP (definition)

Equilibrium: no tendency to move from that equilibrium Describe briefly components of AE

C (households): shape of AE follows shape of consumption function C=a+by Simple explanation of components

Sign of 45 degree line: every point is an equilibrium point where AE=Y Equilibrium level of NY: planned AE = Y. AE curve cuts 45 degree line Adjustment to equilibrium Conclusion: when economy is in equilibrium, may not be at full employment /

recession

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Analyse the effect on the equilibrium level of income of an increase in the level of savings and an increase in the level of exports. [15m] A. Savings Y = C + S Increase in S – fall in C – AE falls – AE curve shifts from AE1 to AE2 Show adjustment to equilibrium Summation: increase savings – fall in C – works through multiplier – fall in NY by a

few multiples Evaluation

Savings can be good for economic growth – increase supply of loanable funds – interest rate falls – cost of borrowing falls – increase I – increase productive capacity – increase AS – increase NY

Summation: S decreases actual growth but increases potential growth B. Exports Increase X – increase AE – AE curve shifts from AE2 to AE1 Show adjustment to equilibrium Evaluation

Increase X – if have unemployed resources – increase NY Increase X – if near / at FE – NY may not increase as fast / demand-pull

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

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Discuss the extent to which the US fiscal stimulus might lead to a sustained increase in national income. [15m] Introduction Fiscal: increase G, decrease T Sustained: actual + potential growth Development How fiscal stimulus works: lower taxes (increase C/ increase I) + increase G –

increase AD – increase NY: actual growth, cannot sustain Multiplier in detail Evaluation: depends on size of multiplier

USA – MPM could be high because hug e trade deficit – may reduce size of k Crowding out effect: increase in G if borrowed from public – decrease in

supply of loanable funds – increase in interest rate – crowd out C/I – cannot sustain

Effects of taxes on C and I unpredictable due to pessimism Reaches FE: cannot sustain

Therefore need supply-side measures to increase AS for sustained growth – potential growth / increase in productive capacity

Increase in G on infrastructure – facilitates business – increase AS Tax – increase NY (potential)

Decrease personal taxes – increase incentive to work – increase AS Decrease corporate taxes – increase I – increase LRAS Condition: if rebates are permanent but according to preamble, rebates

seem to be one-off Conclusion More policies to boost AS – education and training – increase productivity – increase

LRAS

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What are the main causes of Singapore’s recessions? [10m] 1) Factors leading to fall in AD External factors – pessimism eg. 911, SARS (only caused a slowdown in Singapore’s

economy), 1997 Asian crisis – C/I fall Trade deficit: value of X fell due to 911

Lose CA – goods more expensive Fall in income of trading partner

2) External recessions US recession – US GDP fall – buy less Singapore goods – Singapore’s X falls – AD falls

– GDP falls (multiplier effect) Singapore may not be that affected – can ride on growth of China / India But China huge trade partner of USA Singapore: international momentum

Extension of MRT – increase G – k – increase NY IR: increase I – increase NY + tourist revenue YOG: tourist revenue Cannot sustain since k is small

3) Supply-side factors Supply shocks: 1973 oil crisis – increase COP – fall in AS But overwhelming cause is due to AD, but recognize that fall in AS can also create a recession

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Chapter 11: International Economics 1. Theory of International Trade Exchange of goods and services between countries, involving the use of different

currencies and crossing international borders Theory of comparative advantage: produce good at lower opportunity cost than

another country Sources

Differences in factor endowments that can change over time Differences in technology Dynamic comparative advantage

Advantages of trade Greater world output and higher consumption of goods and services

(possible at previously unattainable levels) Reduction in unit cost of production: EOS, countries gain experience over

time Stimulate economic development and growth: enlarge market, increase

competition in home market Facilitate transfer of technology and ideas: increase efficiency of production

– economic growth, help developing countries leap frog stages Promotes beneficial political links Benefits consumers: more choice and higher satisfaction levels, lower prices

compared with local products, better quality products Dynamic gains from trade: gains grow larger over time

Disadvantages of trade Unfair competition and dumping / unnecessary government subsidies Over dependence on other countries Import harmful goods

Terms of trade: rate at which country exchanges its exports for imports Factors

Change in demand conditions: population, income, availability of substitutes

Change in supply conditions: technology, depletion of natural non-renewable resources

Consequences of change in TOT Change in BOT and SOL: dependent on PED of exports and imports,

cause of change, responses that follow Reallocation of resources Change in consumption patterns

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2. Barriers to Trade Natural

High transport costs – raises COP and lowers relative efficiency Lack of mobility of factors Increasing COP due to LDMR beyond certain level of output Other market imperfections: imperfect information and market conditions –

may not specialize to extent that theory suggests Artificial: protectionism

Tariff: custom duties imposed on imports of goods and services by government Depends on PED of imports and how much foreign suppliers are

willing to absorb – may not protect domestic producers, just a source of government revenue

Cuts volume of imports – improve BOT – exchange rate appreciates – exports more expensive abroad – reduce exports in the long run

Non-tariff: import quotas Greater certainty of protection since revenue earned by foreign

suppliers may not be as badly affected as tariff Export subsidies: cash grants by government to local producers

Reduces COP – sell more of good at prevailing price May induce complacency Drain on government funds

Foreign exchange control: government control over sale and purchase of foreign exchange Financial quotas, charges made on people purchasing foreign

currencies Malaysia used this method to recover from 1997 Asian financial crisis Difficult to enforce and might result in black market for foreign

exchange Works best in communist countries because government

monopolises money conversion Others: embargo, trade agreements, international cartels

New protectionist measure: technical specifications and standards which discriminate in favour of domestic producers

Administrative regulations regarding import procedures to delay and reduce volume of imports

Voluntary export restraints (VER): exporting country voluntarily reduces its exports under threats of all-round trade restrictions eg. US automobile industry vs. Japan’s

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3. Arguments for Protectionism Economic

Protect infant industry eg. Singapore had protective duties covering ~300 items in 1960s Difficult to identify currently unprofitable industries that might

acquire comparative advantage in the long run Difficult to decide when industry can be independent of protection Encourage inefficiency

Reduce BOP deficits Dependent on PED of imports and exports Need to look at root causes Invite retaliation – reduced exports – reduced total volume of world

trade Prevent unfair trade practices

Dumping – distorts market – justifiable If consumers benefit in the long run from lower import prices – not

justified Diversify economic structure

May not support theory of comparative advantage Pattern of comparative advantage can change over time naturally

(discovery of new raw materials) / through deliberate policies Protect mature industries

Trade unions Misuse of resources since protectionism will not increase total

employment Retaliation

Protect against low-wage foreign labour Rejection of theory of comparative advantage Could shut down industries and divert resources to more productive

ones Consumers denied opportunity to buy from cheaper source – benefits

of trade lost Increase domestic production: counter-cyclical measure Increase government revenue

To be effective, should be imposed on goods which are price inelastic Retaliation

Retaliation Unhealthy for word trade and ineffective Distort and reduce differences in comparative advantage Welfare loss Misallocation of resources: firms unnecessarily retained Difficult to remove protectionist measures once in place Other industries may demand for protectionism Better alternative: stimulate export competitiveness by increasing AS

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Political Essential to produce on military weapons in case of crisis – subsidies industry

to ensure continuous supply eg. US 1980s semiconductor industry for high-tech weaponry vs. Japan’s

Nation poorer but value of national security higher Trade as weapon of foreign policy eg Gulf war: US imposed trade sanctions

against Iraq Social

Subsidise agricultural sector to avoid further depletion of population in rural areas / prevent further rural-urban migration to overpopulated cities

Restrict import of harmful goods 4. Tariff Diagram Loss in consumer surplus = a + b + c + d a becomes producer surplus, c become tax revenue, b + d becomes deadweight loss Consumption effect: - Reduce consumption from OQ4 to OQ3 - Reduce consumption of imports and switch to domestically produced substitutes - Pay extra amount (P2 – P1) - Consumer surplus falls Production effect: - Expand production from OQ1 to OQ2 - Increase revenue - Producer surplus increases Government revenue effect: - Receives as tax revenue extra amount paid by consumers for the imported quantity

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Explain the theory of comparative advantage. [10m] Introduction Comparative advantage: specialize based on lower opportunity cost – less of the

other good foregone Body Assumptions: 2 countries 2 goods, no transport costs, constant returns to scale:

LRAC remains constant Assume USA and China each has 20 units of resources, initially use 10 units to produce each good Table 1: Before specialization Cars Textiles Opportunity Cost USA 100 60 1C: 0.6T China 5 10 1C: 2T Total 105 70 USA: CA in production of cars – give up less textile China: CA in textile – give up less cars USA devotes 1/10 more to car, China complete specialization. Table 2: After specialization Cars Textiles USA 110 54 China 0 20 Total 110 74 World output increases Terms of trade: mutually beneficial 0.6T < 1C <2T – 1C traded for 1T USA exports 10 cars, gets 10 textiles Table 3: After trade Cars Textiles USA 100 64 China 10 10 Total 110 75 Gains from trade: higher level of consumption Conclusion Comparative advantage – gains from trade, more choices, increase growth Limitations of CA: relax assumptions

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To what extent does the theory of comparative advantage explain the pattern of trade between Singapore and the rest of the world? [15m] Introduction Singapore’s constraints – lack of natural resources; small geographical size and

population – human capital our only resource Singapore’s relative strengths – good geographical location Our constraints and strengths determine where our CA lies Pattern of trade: type of exports and imports of goods and services Body A) Yes Type of exports CA 1970s Textiles and simple manufactured

products Labour-intensive industries: Cheap, unskilled and surplus labour

1980s Move towards higher-end products and electronic products; moving towards services like banking and finance, tourism

Capital-intensive industries: More educated workforce and improved technology Loss of CA in labour-intensive industries to countries like Malaysia and Indonesia which have huge labour force

1990s and beyond

Electronics, pharmaceuticals, telecommunication equipment, disk drives, integrated circuits Services: banking and finance, tourism, educational hub, medical hub

High value-added, knowledge-intensive, technology-intensive industries: Highly qualified labour force, r+d infrastructure Continue to lose CA in manufacturing industries to countries like China and India

Type of imports Lack of CA Imports: consumer items, food, raw

materials, capital goods for development and infrastructure building

Lack of natural resources especially lack of land for agriculture and to support huge export base

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B) No, there are other factors Trade based on world demand

CA only gives rationale for trade but countries try to augment and develop CA in industries with world demand

For country to develop and provide opportunities for its population of diverse talents, needs to have spectrum of industries

Diversification to reduce negative consequences of over-dependence Desire not to rely on foreign supplier for essential goods National pride / security eg. Newater Re-exports

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Discuss whether protection offers any advantages over specialization. [13m] Introduction Protectionist measures Advantages of specialization based on CA: gains from trade, increase X – economic

growth, wider choice, EOS – fall in LRAC – competitive prices, efficiency in resource allocation in the world, welfare gain if world price cheaper than domestic price

Body Infant industries

Rationale: NIE, reasons of economic diversification – impose quotas / tariffs – allow new industries to grow and develop EOS

SR implications: applies for all reasons to protect as long as use quotas / tariffs Society: DWL Consumers: increase price Other firms (some extent): increase COP if good protected is

important input eg. steel LR implications

Grow – enjoy EOS – lower LRAC – lower price of exports – able to compete internationally – BOT improves if demand is price elastic – increase in total revenue from exports – increase exports – increase NY/N

If do not grow If government subsidizing – waste of resources – could have been

used elsewhere – education / healthcare / develop infrastructure Consumers and society continue to suffer from inefficiency – higher

prices Shut down – massive retrenchment

Summation: To the extent that infant industries grow. However, the infant industries normally do not grow and may become inefficient due to government subsidies. Protectionism cannot be long term.

Inefficient industries Eg. US steel industry, textile: ‘slap’ tariffs / quotas on Chinese textiles /

imported steel – allow inefficient firms to eventually be able to be more efficient – develop new technology / adjust cost structures

Eg. steel – affects COP in many other industries eg. housing, cars – cost-push inflation – affects domestic market and erodes export competitiveness

Summation: protect jobs in inefficient industries but more jobs lost elsewhere eg. car industry

Alternative solution: develop CA in new industries: capital-intensive, technology-intensive, services, training

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Dumping Foreign country selling goods below its actual COP – local firms driven out –

eventually foreign country gains monopoly power Difficult to ascertain if it is dumping / country really has CA in production of

these goods – Chinese textile + abundance of cheap labour Could be baseless accusation Solution: force firms to be more cost-efficient (don’t protect), training

(subsidise firms for training), subsidise r+d Economic diversification

Reduce over-dependence on a few key products / industries Eg. Zambia: copper exports – what if world demand falls

Balance of trade deficit – value of imports > value of exports Eg. US huge trade deficit – USA consumes a lot, including on imports – breed

further inefficiency Alternative solution: increase interest rates – encourage people to save +

discourage consumption LR: high C – low S – low investment – affects productive capacity – low LRAS

(inefficiency) National security

Eg. steel – war weapons Conclusion If country protects, other countries retaliate – world inefficiency

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Explain the rationale for free trade and discuss the extent to which FTAs are beneficial. [25m] Introduction Free trade – based on CA – lower opportunity cost ratio – gains from trade FTA – remove tariff and non-tariff barriers – in theory – in practice eg Singapore’s

FTAs – also include investment Development A) Expounding theory of CA – difference in factor endowments Assumptions 3 tables Summation: gains from trade, increase choice / increase society’s welfare, increase

economic growth and SOL B) Are FTAs beneficial On trade

Increase X – k – increase NY / N – associated benefit of large-scale production – EOS – fall in LRAC – able to price goods more competitively – may improve BOT

Singapore: small domestic market China: may not be as dependent on X revenue because people are getting

more affluent. C increase can sustain itself based on internal economy Cambodia / Vietnam: NIEs because people are poor But increase X – demand-pull inflation when near / at FE – price of exports

increase – volume of exports – may affect BOT – NY falls affects economic growth

Inflation Access to cheaper consumer goods + raw materials / inputs – fall in COP – fall

in price of exports – X increase – may increase BOT Fall in COL – extra savings can be used to buy domestic goods – increase C /

NY

Price of consumer goods

Quantity of consumer goods

Sdom

Ddom

Pw

P c

10 0 30 50

a b

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a+b = welfare gain a: production effect, inefficient domestic firms forced to reduce output from

30 to 10 b: consumption effect: increase C from 30 to 50 From diagram, firms forced to be more cost-efficient – cut costs in order for

profits not to be eroded since P is at Pw Trade creation / diversion

Creation: increase volume of trade – from high-cost producer to low-cost producer – increase welfare of people

Diversion: from low-cost non-member to high-cost member – away from optimum allocation of resources

Draw diagram to illustrate effects Jobs: increase in X – increase N

But loss of CA – forced to restructure – move towards CA – structural unemployment

Outsourcing – firms benefit by relocating – increase BOT – increase GNP But cost jobs in previous country

On FDI Outward investment to China from Singapore Increase investment – increase productive capacity – increase AS Increase investment – increase AD – increase N / NY Transfer of technology Useful for NIEs – lack wealth / local entrepreneurs eg. Singapore depends on

MNCs But footloose But local firms cannot compete

Others Vulnerability to external shocks due to over-dependence – recession /

imported inflation Interdependence: economies become intertwined eg. USA recession –

Singapore recession, worldwide food prices increase Conclusion Possibility of unequal gains

Singapore More ST capital outflow to China but LT profits – increase GNP Loss of jobs as companies go to China Shifted focus to capital-intensive / technology-intensive – focus on

services Gain – education: Chinese students come here to study

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USA USA spend a lot because lost CA in lots of goods – need to buy more

imports – worsen trade deficit – less savings – less investment – reduced productive capacity

India Demand for capital goods

Summation FTA: macroobjective – increase NY – increase SOL, fall in price – increase BOT Trade creation > trade diversion

*FTA means freer trade – no restrictions among countries vs. free trade, so arguments similar, only difference is trade creation / diversion

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To what extent can economies benefit from globalisation? [25m] Introduction Globalisation – free movement of goods and services, capital, labour Economic integration: FTA, customs union Development A) Goods and services Trade based on CA – gains + EOS Poor – NIEs + Singapore (small domestic market) – increase X – increase NY / N –

increase SOL Access to cheaper goods

Consumer goods – lower COL Raw materials – Singapore / Hong Kong Capital goods for infrastructure – Cambodia / Vietnam – increase societal

welfare + potential growth Draw in free trade diagram and illustrate gains Trade diversion vs. trade creation: diagram Loss of CA eg. USA steel and textile industry, Europe car industry – but restructure

and move towards new CA Inter-dependency eg. USA affect China / India Over-dependency due to CA and complete specialization – that’s why countries tend

to partially specialize / diversify their economies Effect on prices – imported inflation Tariffs due to protectionism: draw in diagram B) Capital (associated technology) – FDI (inward and outward) Receiving country

Increase inward investment – increase AS / AD – increase NY / N Growth of local supporting industries Transfer of technology Footloose – may cause massive retrenchment if suddenly leaves Local industries cannot compete – lack of SMEs

Source country SR: loss of jobs SR: outflow of capital LR: restructuring LR: More companies internationally – increase GNP LR: Create jobs

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C) Labour For LDCs, provide jobs for labour – cheap

May be SR exploitation – but vs. no jobs Eg. Vietnam – inflation ~19% - lower income wage rise < price rise

Free flow of labour – influx of foreign workers – depress wages in jobs where supply elastic (abundant supply of manual workers) – no skills Eg. Singapore / EU – influx of workers into UK Solution: provide training Brain drain

Inequity issue Manual workers wages fall Skills demanded globally – increase demand for work – increase wages for

skilled jobs Dual economy

Caters to international market – people grow richer Caters to domestic market – people do not really get richer

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Discuss the opportunities and threats of globalisation for Singapore and other Asian economies. [12m] Globalisation: high degree of freedom of movement of goods and services (trade), capital, technology (MNCs) and talent (labour) 1) Globalisation and free trade Opportunities

Export revenue and higher rate of economic growth Increase in X – k – increase N / NY Increase M of capital goods / raw materials eg. Vietnam / Cambodia /

Singapore Threats

Competition causes countries to lose CA Singapore lost CA in labour-intensive industries in mid-80s to NIEs like

China and Indonesia SR: structural unemployment LR: efforts may pay off if country realizes CA in new industries Singapore shifted to capital-intensive then knowledge-intensive

Specialisation and over-dependency on few major products If some countries adopt protectionist measures, trading partners

could be adversely affected Interdependency of countries

Economies of major trading partners take a slide, countries will be affected eg. 911, US recession

2) Presence of MNCs and out-sourcing Opportunities

Influx of MNCs in Asian countries helped their economies grow Creation of jobs and contribution to GDP Transfer of technical know-how

Outsourcing eg. UK IT companies phone service operations to India Threats

Fear of over-dependency: MNCs footloose – if pull out, adverse effect on jobs and economic growth

Dearth of local firms 3) Influx of talent Increase quantity of resources – shift PPC outwards But cheap foreign labour – wages in city fall – lower income

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Consider the effects, other than on the general price level, of Singapore’s changing tax structure. A) Inflation Effect of increased reliance on indirect taxes – definite inflation – shift in SRAS

Increase indirect taxes – increase COP for all firms – fall in AS – fall in NY (contractionary) + rise in GPL – cost-push inflation – BOT may worsen (depending on PED)

Effect of decreased reliance on direct taxes – may or may not have inflation – shift in LRAS and AD Fall in direct taxes – C/I increase – AD increase – NY increase (growth) / N

increase – if near / at FE: demand-pull inflation (a little may be desirable because increase output) – BOT worsen (depending on PED)

Lower income taxes – income / substitution effect – may increase incentive to work – increase AS – increase NY – fall in GPL – BOT improves

Lower corporate taxes – increase I – increase NY – fall in GPL – BOT improves Singapore: keep / attract talent – increase efficiency Attract MNCS – increase FDI – increase AD (increase N) and increase AS (increase

productive capacity) B) Equity Income taxes (direct) – progressive – higher the income, the higher the percentage

to tax – reduce income gap Indirect taxes – regressive – lower the income, the higher percentage to tax –

increase income gap – affects poor more Cost-push inflation – increase COL – affects poor more Lower direct taxes – increase income gap because rich pay proportionately less

(usually reduce the percentage tax of rich more) Corporate taxes fixed at 18%: neither progressive or regressive C) Tax base Increase indirect taxes – widens tax base – better to rely on due to ageing

population – increase number of dependants / decrease in size of labour force Decrease direct taxes: on working population and firms D) Ability to evade Indirect taxes: difficult to evade Direct taxes: can evade but not in Singapore (jailed) – can under-declare

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Policies to remedy Singapore’s recession Recession in Singapore: externally induced: fall in X 1. Fiscal Policy Increase G to reduce business costs + training – need to subsidise firms and training

grants Fall in COP + increase productivity – increase LRAS – fall in GPL – price of

exports fall – volume of exports increase Evaluation: buy only if they recover from recession

But increase G to boost increase in NY limited effect in Singapore Small k – need huge increase in G Prudent

Why not increase G on public works Limited land

2. Monetary Policy Why not policies to directly increase X with exchange rate management

Short run solution: depreciation of S$ - price of exports fall in foreign dollars – volume of X increase

Government prefers soft option Price of imports increase in S$ - import all raw materials – COP increase –

goods more expensive Long term policy stance: gradual and modest appreciation of S$ - price of imports

lower for S$ - import raw materials more cheaply – COP falls – prices more competitive Modest: small increments – export competitiveness not drastically eroded in

the immediate period Gradual: firms can have time to adjust their cost structures – find ways to be

more cost-efficient Deals with cost-push inflation

3. Other Ways Explore new markets through trade missions and signing of FTAs – reduce over

dependence on a few trading partner Long term measure Conclusion Fall in X is beyond our control Measures can only be long run or interim ones

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Evaluate methods the Malaysian government might use to slow down import growth and increase new export business. A. Slow down import growth Devaluation – weaken ringgit

Price of exports fall in foreign currency – volume of exports increase – total revenue from exports increase

Price of imports in ringgit increase – volume of imports fall – total expenditure on imports fall

BOT improves Depends on price elasticity of demand for X and M – Malaysia demand for

imports of capital goods could be price inelastic – COP rises Can only be short term if Malaysia needs to import capital goods and raw

materials Persistent devaluation can lead to loss of confidence in economy

Tariff – tax on imports – price of imports rise – volume of imports fall – total expenditure on imports fall Increase in COL Deadweight loss to society Retaliation

Contractionary policies: interest rate rise – investment and consumption falls – AD falls – k – fall in NY – fall in demand for imports Malaysia may have small multiplier Malaysian firms may want to buy capital goods Malaysia still developing, cannot afford to have fall in rate of growth Use only if overheating

B. Increase new export business Subsidies to export firms

COP falls – increase AS – GPL falls – price of exports fall Inefficiency, burden on government and taxpayers

FTA / Trade missions to new countries – increase X – k – increase NY Reduce over dependence on just a few major trading partners Takes time – long term Firms may not want to take the risk – uncharted territory – businessmen may

be risk averse Supply-side

Education and training – increase productivity – increase LRAS – fall in GPL – price of exports fall

Best measure, yield results in the long run

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“To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” How far DYA with the statement? [12m] Anti-thesis Healthy BOPs – especially open economy – macro objective Equity in distribution – micro objective Efficiency in resource allocation – micro objective “To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” Explain this statement. [12m] A) Low unemployment – success [any 2 well-discussed] Maximise use of resources – reduces loss of potential output due to unemployment Burden on government

Less tax revenue collected More unemployment benefits Increase budget deficit, opportunity cost – less for other areas – healthcare,

education Singapore: GST offset package, growth dividends, Singapore shares, one-off

rebates Low unemployment – people have jobs – higher C – fuels growth Social problems – crime rates – social unrest – loss of man hours + deters

investment (confidence) B) Low inflation – success [internal and external] Internal: stimulates output, induces confidence, increase investment due to

certainty, increase FDI, encourages savings – increase investment in the long run External: BOT improves [PED] C) Stable economic growth – success [any 2 well-discussed] Sustained growth: actual and potential growth: increase AD and As – continual

increase in SOL Confidence – increase investment + FDI – good macroeconomic management of

government Why unstable growth undesirable

AD keeps increase may cause overheating – demand –pull inflation – increase COL + affects BOT – instability

If economy lapses into recession: negative growth – hardship – fall in SOL Conclusion Brief mention of other criteria for success Conflict between growth and inflation: relentlessly pursues growth – demand-pull

inflation: stable growth vs low inflation Which criteria most important: low inflation – price stability – Singapore

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Discuss whether fiscal policy is the most effective way for Singapore to sustain a successful economy. [13m] Introduction Sustainable + stable growth + low inflation – one of the keys to sustainable growth Development A) How FP works to attain growth Increase G + decrease T – increase AD – k – increase NY K brief + diagram Evaluation

Size of k – small k – huge leakages – high savings / M – need huge increase in G – prudent: budget surplus

Small C / I by domestic firms – need export revenue – policies should target X Crowding out: increase G financed by borrowing from public – increase

interest rate – crowd out C/I/X May not need to borrow – huge reserves – reserves can be depleted More concerned about fall in X

Time lag: recognition, implementation, response Small – shorter time lag

Taxes – unpredictable effect on C/I – k works only on the extra disposable income that is spent Expectations: pessimism / optimism Fall in direct taxes – rely more on indirect taxes (GST) (increase COL) –

regressive – increase income gap B) Summation: FP in Singapore – limited role If economy weakens (fall in GDP) – usually due to external factors like fall in X eg.

911 US recession – policies should target X Policy exchange rate management – sustainable growth

Gradual and modest appreciation of S$ Price of imports fall in S$ - check imported inflation (low inflation) +

Singapore depends a lot on imported raw materials – lower COP – LT able to price competitively – stable growth – BOT increase (PED)

Price of X increases in immediate period Gradual: Singapore firms to find other ways to reduce cost Modest: not to totally erode export competitiveness

Supply-side policy: education and training, welfare benefits, taxation incentives Conclusion FP in Singapore limited effect on Ad, serves as supply-side measure to increase NY

over long term + exchange rate management – to boost long term export competitiveness

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In the fourth quarter of 2004, Singapore’s unemployment rate rose to 3.7%. Discuss whether supply-side policies are the best way of achieving full employment in Singapore. [25m] Introduction Full employment: natural (frictional) rate of unemployment (some structural) Cause for concern (very briefly): if structural severe, if cyclical Development A) Supply-side Education and training – Budget 08

Schools and vocational institutes gear Singapore workers for the challenges of new economy – grants, scholarships, places in university – focus: biomedical – increase employability

Subsidise firms for workers training – Skills Development Fund – upgrade skills – reduce structural unemployment

Life-long learning – knowledge can become obselete – constant upgrading of skills – reduces prospect of being structurally unemployed

Long term and may not yield results Increase employability and attracts MNCs

Welfare benefits Singapore no unemployment benefits – reduce frictional unemployment Forced to upgrade skills – reduce structural unemployment

Reduce power of trade unions NTUC: government body – harmonious relations – no labour unrest: attracts

investment (FDI) NWC: wage recommendations – wage increase < productivity increase –

keep COP low Increase employability of workers

B) Policies to deal with cyclical unemployment: fall in AD Supply-side – structural, cannot solve cyclical FP: increase G, decrease T but small k, external factors Exchange rate management

Recession due to fall in X: depreciation / appreciation Depreciation: price of exports fall – immediate solution but Singapore cannot

afford to – price of imports increase – COP increase – later price of exports increase (growth cannot sustain)

Singapore’s choice: gradual and modest appreciation (long term solution) Conclusion Increase G on education and training + taxation incentives – supply-side policies –

effect on AD and some effect on cyclical unemployment – limited role in Singapore due to small k

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Why Singapore does not use interest rate policy Very dependent on overseas funds – small Eg. if Singapore’s interest rate falls to curb recession – ‘hot’ money outflow - $ in

Singapore banks fall – MS falls – interest rate increase – no control Discuss interest rate only if not Singapore Problems with exchange rate instability Exchange rates determined by Trade and investment between trading partners Speculation Government management / manipulation of exchange rate eg. buy US bonds to

keep USD up 1) Trade Affects business planning: need for certainty to forecast profits Eg. If S$ depreciates

Price of Singapore exports fall in foreign currency – volume of exports increase

Price of imports increase in S$: dependent on raw materials (same for developing countries which need capital goods)

Eg. If S$ appreciates – price of exports increase in foreign currency – affects export earnings

2) Investment Persistent depreciation – loss of confidence in economy – fall in investment 3) Developing countries Foreign loans in US$ denomination – if your currency depreciates – pay back more in

your country’s $