Chapter 9

Question 1

Defn. Economic growth

Answer 1

the increase in real GDP or an expansion in the productive capacity of an economy

Question 2

Economic growth formula

Answer 2

(change in real GDP) / (real GDP in year 1) x 100%

Question 3

Technical recession happens when

Answer 3

an economy exhibits 2 consecutive quarters of negative growth rates

Question 4

Terms to describe the economy

Answer 4

+ :
- economic expansion
- economic boom

• :
• contraction in the economy
• economic bust
• economic recession

Question 5

Defn. Actual growth

Answer 5

increase in equilibrium level RNY of the country

Question 6

Defn. Potential growth

Answer 6

increase in productive capacity of the country

• shifts the AS curve rightwards and downwards

Question 7

Defn. Sustained EG

Answer 7

occurs when an economy experiences non-inflationary rate of growth that can be maintained over time

Question 8

How to achieve sustained EG

Answer 8

• increase in AD must be matched by increase in productive capacity or LRAS.
• hence, sustained EG can only be achieved with both actual and potential growth

Question 9

Benefits of EG on households and the economy

Answer 9

1. Rising mat SOL
   -> EG -> increase in real GDP -> economy producing more goods and services -> increase in mat SOL
   -> households consume more g&s -> enable ppl to consume basic necessities
   -> higher GDPpc reflects that each person in the country has more g&s avail to them -> higher mat SOL
2. Rising employment and wages
   -> increase in RNY -> more g&s produced -> increase LD since the DD for labour is a derived demand -> increase in equi lvl of labour employed -> lower crime rates -> increase non-mat SOL as residents in the country may feel more secure with falling crime rates
   -> increase LD -> higher wages -> raises purchasing power of labour -> raises mat SOL

Question 10

Benefits of EG on firms and the economy

Answer 10

1. Increase profits
   -> EG -> greater purchasing power -> greater DD for g&s -> boost in sales revenue -> higher profit
2. Increased expenditure on R&D
   -> EG -> higher business profitability -> greater investment in R&D -> firms can engage in process and product R&D
   -> increased expend. on R&D result in technological innovations -> raise productivity and lowers COP -> potential growth
   -> environmentally friendly technology that reduces pollution -> sustainable -> reduce market failure
   -> R&D -> newer and better products that can improve the lives of ppl -> eg. -> mat and non-mat SOL increase
3. Sustained EG
   -> EG -> encourages firms to invest -> in order to meet future DD -> higher investment -> creates a virtuous cycle of EG/investment -> increase in actual and potential growth -> sustained EG

Question 11

Benefits of EG on govt. and the economy

Answer 11

1. Improvement in govt budget
   -> increase real GDP -> rising employment, wages, profits, expend. -> enables govt to collect more tax rev via direct and indirect taxes
   -> simultaneously, spending less on transfers (unemployment benefit etc.)
   -> reduction in govt expend. -> rise in tax revenues -> improves govt budget balance
2. Making growth more inclusive
   -> govt can used these increased rev to reduce level of govt borrowing and provide transfer payments to lower income group -> make growth more inclusive -> helps to alleviate poverty
3. Achieving sustained EG
   -> rising tax rev -> enable govt to spend on developing and building country’s infras (transportation system, communication networks, airports, sewage, water, electrical systems etc.)

Question 12

Defn. Slow growth

Answer 12

period where RNY or RNoutput is rising but rising at a slower rate

Question 13

Defn. Recession (negative growth)

Answer 13

period where RNY or RNoutput falls over a period of a year

Question 14

Disadvantages of economic growth

Answer 14

1. Inflation
   -> EG -> households and firms optimistic about the future -> increased consumption and investments
   -> if econ operating on intermediate or classical range, AS will not be able to meet rise in AD -> shortages of g&s -> inflation -> reduces purchasing power of ppl -> worsening of mat SOL -> households now unable to purchase the same amount of g&s due to rising prices
2. Environmental degradation
   -> EG -> greater use of resources to produce goods -> use of resources cld lead to env dmg -> eg. -> threaten human health & safety -> worsen non-mat SOL
   -> rising temp. -> affect mat SOL through agriculture -> monsoon/ drought reduces crop and grain production -> falling AS reduces real GDP and raises GPL
3. Increased income inequality and non-inclusive growth
   -> diff sector of economy expand at diff pace -> LD in diff sector rises disproportionally -> social tensions (protests for more equal wages), disincentive to work for low income group when hard work is not remunerated with higher wages
   -> groups left behind (sick, retired, disabled, housewives, elderly, unskilled)
4. Increased unemployment of low skilled labour
   -> EG -> enables firms to increase profits and spend more on R&D -> increase investment on AI and automation -> job loss for low skilled labour (who are involved in admin tasks as well as manual labour)

Question 15

Policies to address recession and slow rate of EG

Answer 15

Demand-side policies:
1. fiscal policy
2. Expansionary monetary policy
3. Exchange rate policy: depreciation
4. Income and price policy

Short-run supply-side policies:
1. Fiscal policy
2. ERP: appreciation
3. Income and price policy

Long-run supply-side policies:
1. increase quantity of FOPs
2. improve quality of FOPs; technological progress
3. Improve mobility of FOP

Question 16

Defn. Fiscal policy

Answer 16

involves the altering of govt expenditure and/or tax revenue to affect the level of economic activity in the economy

Question 17

Expansionary FP (AD)

Answer 17

1. Raising govt. expenditure
   - Raising govt expend on g&s -> increase G -> increase AD -> increase RNY
   - Increase in transfer payments to households -> raise disposable income -> raise pp -> increased consumption of g&s -> increase C -> increase AD -> increase RNY
   - increase in transfer payments to firms -> subsidies on R&D and investments -> encourage firms to invest more -> increase I -> increase AD -> increase RNY

*increase in transfer payments increase C and I, not G

2. Reducing tax rates
   - reduce direct tax -> personal income tax reduced -> disposable income and purchasing power of households will increase -> increase in C -> increase AD -> increase RNY
   - reduce direct tax -> corporate tax reduced -> increase in after-tax profits -> increase expected profitability -> increase I - increase AD -> increase RNY
   - reduce indirect tax -> reduce export tax -> enhance competitiveness of the country’s exports -> encourages exports -> increase in X
   - higher import tariffs -> makes imports more ex than domestic goods -> discourage purchase of imports -> increase consumption on domestic goods -> decrease M, increase C

Question 18

Taxes

Answer 18

Direct tax is levied on income

Indirect tax is levied on g&s

Question 19

Explanation when AD increases, with multiplier process (Essay)

Answer 19

can lead to a rise in C, I, G, (x-M), leading to a rise in AD. The initial rise in AD will cause an unplanned fall in the firm’s inventory. To maintain their inventory, firms will need to employ more resources such as labour. As more labour are hired, they receive more in wages. The purchasing power of the labour force rises. This leads to multiple rise in the induced consumption. Each subsequent rise in induced consumption will be increasingly smaller due to withdrawals/ leakages. This results in multiple rightward shift in the AD curve, where AD is rising at a decreasing rate. The overall rise in AD has resulted in a multiple rise in RNY. The larger the size of the multiplier, the larger the rise in AD and hence RNY.

Question 20

Limitations of Expansionary FP (AD)

Answer 20

1. Size of multiplier
   -> if size of multiplier small, multiple increase in induced consumption will also be relatively smaller -> smaller overall increase in AD -> RNY increase less -> limiting the effect of the FP
2. Possibility of crowding-out effect
   -> increase G leads to budget deficit -> use govt reserves to finance -> with borrowing, govt will be competing with private sector for loans and resources -> drives up interest rates in financial market, higher DD for resources -> higher factor prices in factor market -> lower profits for firms -> decrease I
3. Time lag (AD & AS)
   -> decision lag -> execution lag -> time lag -> conditions in economy cld have worsened so much that remedies no longer adequate or slow growth/ recession subsided so policy create inflation instead
4. Govt. budget deficit (AD & AS)
   -> Govt expend. greater than rev -> govt have less reserves in the future to pay for the resulting debt and the interest incurred -> less funds to spend on social and developmental needs in the future -> intergenerational transfer of welfare from future genS to current ones

Question 21

Limitations of Expansionary FP examples

Answer 21

1. SG has high MPS due to high rate of mandatory CPF social security savings. high MPM as it lacks land and other natural resources -> highly dependent on imported goods. leads to SG having high MPW and consequently a low multiplier since k=1/MPW. strong culture of saving in Asian countries would mean they have a small multiplier. European countries have low multiplier because they have high MPT.

Question 22

Defn. monetary policy

Answer 22

(centered on interest rates) is the adjustment of interest rates via the regulation of the money supply in a country

Question 23

Tools central bank uses to adjust money supply

Answer 23

1. Open market operations (OMO)
   -> Central bank can buy/sell securities on the open market to influence money supply. -> open market purchase of bonds by CB raises the money supply in the economy
2. Varying the cash reserve ratio
   -> is the percentage of a commercial bank’s deposits that the central bank must keep in cash as a reserve in case of mass customer withdrawals
   -> reduce cash reserve ratio -> commercial bank able to provide more loans to the public -> raises money supply -> reduce interest rates
3. Varying the bank rate
   -> is the interest rate charged by the CB for loans made to commercial banks. -> when CB raises bank rate, commercial banks are less willing to provide loans to the public -> reduces money supply -> raise i/r

Question 24

i/r against qty of money GRAPHHHH
and
i/r against investment GRAPHHHHH

Answer 24

DRAW

Question 25

Monetary policy (MP)

Answer 25

Fall in interest rates will:

1. Increase C
   -> relatively cheaper to borrow from banks. -> lower cost of borrowing would encourage households to purchase more g&s -> raises C
2. Increase I
   -> relatively cheaper to borrow from banks -> lower cost of borrowing increase rate of returns on investments -> raises I

Question 26

Limitations of MP

Answer 26

1. Ability to control money supply
2. size of the multiplier
3. Interest elasticity of investments and consumption (MEI)
4. Liquidity trap
   -> when i/r are close to zero and consumers are very pessimistic abt future growth -> households not willing to spend -> save cash instead -> MP does not change the i/r (GRAPH) and hence does not stimulate EG

Question 27

Quantitative easing (QE)

Answer 27

Credit squeeze /crunch is a sudden reduction in the avail of loans (credit) from banks. usually emerge as banks reduce lending to households and firms in times of recession. Bank wld rather buy govt bonds, which are loans made to the govt instead.

QE is a form of monetary policy where CB purchase govt bonds from banks to increase liquidity in financial system. Banks are left with more cash rather than bonds. High level of liquidity compels banks to increase lending to households and firms -> rising C and I

QE usually implemented when there is a liquidity trap where interest rates are already near zero. CB have fewer tools to influence EG

Question 28

Limitations of quantitative easing

Answer 28

1. Risk appetite of banks and pessimism of households and firms
2. Inflation

Question 29

Defn. Exchange rate policy

Answer 29

the deliberate attempt by the central bank to manipulate the exchange rate of the country’s currency in order to influence the economy

Question 30

How does the CB adjust their country’s exchange rate

Answer 30

Appreciating the domestic currency:
- when buying domestic currency in the ER market, increase in DD of country’s currency in the ER market. causes domestic currency to appreciate -> exports to be more expensive in terms of foreign currency, imports cheaper in terms of domestic currency

Question 31

Exchange rate policy (ERP) - Depreciation (AD)

Answer 31

1. Reduce import expenditure
   -> cause imports to be more expensive in terms of the domestic currency -> if the DD for imports is price elastic, this would lead to a fall in its M
2. Raise export revenue
   -> price of exports in terms of domestic currency remains unchanged, DD for export would increase -> rise in X (export revenue)
   (DD graph showing price in domestic currency against quantity of M and X)

Question 32

Limitation of depreciation (AD)

Answer 32

1. size of the multiplier
   -> if size of multiplier small, multiple increase in induced consumption will also be relatively smaller -> smaller overall increase in AD -> RNY increase less -> limiting the effect of depreciation
2. Rising cost of imported raw material
   -> small, resource-poor and highly dependent on imported raw materials countries like SG, depreciation will lead to a rise in production costs -> upwards shift in the AS curve (draw graph)

Question 33

Defn. Income and price policy (IPP)

Answer 33

economy-wide wage and price controls. eg. wage cuts and maximum prices

Question 34

Income and price policy

Answer 34

to increase economic activity -> employee’s CPF contribution can be reduced to increase the workers’ disposable income -> increase purchasing power -> increase C -> raises AD

Question 35

Limitation of IPP

Answer 35

1. Size of the multiplier
2. Unintended consequences
   -> CPF is a key pillar of SG’s social security system and serve to meet retirement, housing and healthcare needs -> reduction in employee’s contribution adversely affect the aim of the CPF since less money is channeled into the CPF account -> affect ability of singaporeans to fund their housing, retirement and healthcare needs
3. Pessimism of households
   -> degree of responsiveness of C to higher disposable income due to cut in employee’s contribution depends on consumer’s confidence about future economic growth.
   -> if households have weak sentiments about the future, the policy not very effective in raising RNY

Question 36

Expansionary FP (SRAS)

Answer 36

1. Reducing tariff
   -> reduction in import tariff will reduce the cost of imported raw materials -> lower COP -> increase SRAS
2. Reducing govt fees and rentals
   -> reduce firm’s costs and raise SRAS
3. govt subsidies
   -> COP can be reduced by providing subsidies to producers -> eg. factors of production like labour and land and resources like oil (SRAS curve shift downwards)

Question 37

ERP - Appreciation (SRAS)

Answer 37

• with a stronger currency, country is able to purchase imported raw materials at a lower price in terms of the domestic currency -> lowers COP -> encourages production and hence increase RNY

Question 38

Limitations of appreciation (SRAS)

Answer 38

1. Proportion of imported input
   -> effectiveness of measure would depend on proportion of input that is imported.
   -> if a high proportion of inputs for a product is imported, its cost may be reduced significantly with an appreciating domestic currency
2. ER appreciation can result in a fall in AD
   - Raise import expenditure -> imports wld now be cheaper in terms of the domestic currency -> if DD for imports is price elastic -> rise in M
   - Reduce export revenue -> domestic goods more expensive in foreign currency -> although price of exports in terms of domestic currency remains unchanged, DD for exports fall -> fall in X
3. Availability foreign exchange
   -> in order to appreciate the domestic ER, CB will need to buy the domestic currency by supplying foreign currency in the foreign exchange market (CB must first have sufficient foreign currency reserves)

Question 39

Income and price policy (SRAS)

Answer 39

1. Controlling factor cost
   -> Price ceiling (price controls) are used to prevent excessive rises in cost of FOPs.
   -Eg. rental market -> price ceiling prevents rental of shops and factories from rising uncontrollably
2. Lowering wages
   -> CPF used as a tool that enables the adjustment of wages. -> govt can lower the employer’s CPF contribution rate -> cost savings for firms -> reduce COP -> raises SRAS

Question 40

Limitations of IPP (SRAS)

Answer 40

1. Imposition of price ceilings on rentals, results in shortages in the market. In order to continue with their production, producers need to secure the factory space.

They may turn to the black market and pay higher prices for factory space. Higher cost incurred may then be passed on to consumers in the form of higher prices

2. Lowering of employer’s CPF contribution rate wld mean lower contribution to the employee’s CPF account -> lower savings -> undermine future consumption

Question 41

Increasing quantity and quality of labour - fiscal policy (LRAS)

Answer 41

1. Providing tax incentives
   -> cut personal income tax to increase the incentive to work -> increase labour participation rate
   -> those who are not employed would now be drawn into the labour market as a result of the higher after-tax wages, raising the quantity of labour
2. Increasing govt expenditure on workforce training and healthcare
   -> encourage training of labour by subsidising training costs and providing training institutes -> raise productivity of labour -> raise quality of labour -> raising productive capacity
   -> encouraging population increase by taking steps to reduce death rate through better health facilities and health awareness programmes may also raise the quantity of labour in the country

Question 42

Limitations of Increasing quantity and quality of labour - fiscal policy (LRAS)

Answer 42

1. Tax cuts have uncertain effects on the incentive to work -> people may decide to work less as they have more income now and choose to have more leisure time

Question 43

Increasing quantity and quality of labour - other policies (LRAS)

Answer 43

1. Compulsory education
   -> literacy rate and skill level of the workforce can increase -> ensures more educated workforce -> raise quality of labour
2. raising retirement age
   -> less people will leave the labour force -> increase quantity of labour
3. Loosening immigration policy
   -> help to ensure a continuous flow of labour into the economy -> raises quantity of labour -> encouraging inflow of highly skilled foreign talent also improves the quality of labour as the transfer of skills and knowledge to local labour will increase their productivity

Question 44

Increasing quantity and quality of capital - fiscal policy (LRAS)

Answer 44

1. Providing tax incentives
   -> lower corporate tax and tax holidays raises the incomes of firms -> encourages greater investment -> increase amount of capital goods, improves technology -> firms may engage in more risk-taking -> increase output to larger profit margins
2. Increasing govt expenditure on infrastructure
   -> eg. communications and road networks -> so that production more efficient, encouraging investments

Question 45

Limitations of Increasing quantity and quality of capital - fiscal policy (LRAS)

Answer 45

1. may lead to increase in inflation rates -> as AD increase, GPL also rises. -> hence, measures aimed at increasing AS in the long-run may lead to inflationary pressures in the short-run

Question 46

Increasing quantity and quality of capital - other policies (LRAS)

Answer 46

1. increasing savings
   -> process of building up necessary stock of capital require funds -> comes from domestic savings or borrowing
   -> country can develop and credit mechanisms to channel savings to investors and provide incentives for capital investments

Question 47

Improving technology (LRAS)

Answer 47

1. govt. can increase expenditure on R&D projects and facilities.
   - Eg. SG has developed twin hubs of biomedical and engineering research at the Biopolis and Fusionopolis
2. govt. can develop institutes of higher learning (including uni and poly), which also doubles as hotbeds of technological innovation. and provide seed funding for research to attract more locals and foreigners to undertake technological research

Question 48

Defn. Sustainable economic growth

Answer 48

Achieved when the economy grows at a strong and stable rate without resulting in significant environmental degradation, and hence resource depletion for future generations.

2 criterias:
- Economy to grow at strong and stable rate
- preservation of environment and resources for future generations

Question 49

Advantages of pursuing sustainable EG

Answer 49

1. *refer to “advantages of EG”
2. Improvement in quality of life (SOL)
3. Securing the future

Question 50

Disadvantages of pursuing sustainable EG

Answer 50

1. *refer to “disadvantages of EG”
2. Economic cost of sustainable growth (link to increase COP and effects on economy)
3. Contraction of several industries and rising unemployment

Question 51

Policies to achieve actual and potential growth (sustainable EG)

Answer 51

• policies to increase equilibrium level of RNY
• policies to increase productive capacity

Question 52

Policies to reduce environmental damage (sustainable EG)

Answer 52

1. Tax on goods that create pollution during production
2. Campaigns to encourage recycling and minimise waste

Advantages and disadvantages like market failure and prev cards

Question 53

Policies to reduce resource depletion (sustainable EG)

Answer 53

1. Subsidies on R&D in green technology
2. Legislation to prevent the over-usage of renewable resources

Advantages and disadvantages like market failure and prev cards

Question 54

Defn. Inclusive growth

Answer 54

Achieved when the economy grows at a strong and stable rate without resulting in significant worsening of income or wealth inequality

2 criteria:
- Economy to grow at strong and stable rate
- income and wealth inequality should not worsen

Question 55

Advantages of pursuing inclusive EG

Answer 55

1. *refer to “advantages of EG”
2. Reduction in social friction an improvement in the SOL
3. Improved social mobility and rising productivity
4. Improvement in the govt budget
5. Increased AD leading to EG and employment
6. Increased AS leading to EG, employment and low inflation

Question 56

Disadvantages of pursuing inclusive EG

Answer 56

1. Reduced incentive to innovate and work

Question 57

Policies to achieve actual and potential growth (inclusive EG)

Answer 57

• policies to increase equilibrium level of RNY
• policies to increase productive capacity

Question 58

Policies to reduce income inequality (inclusive EG)

Answer 58

1. Redistribution of income via a progressive tax system
2. Direct subsidies for lower-income households
3. Upgrading of skills and retraining
4. Imposing a minimum wage

Advantages and disadvantages like market failure and prev cards