National Income

Question 1

How can the performance of an economy be assessed?

Answer 1

1) Explain the 4 indicators, with a brief description of each goal
2) Explain how to use each indicator
3) Explain impacts of each goal on economy’s performance

Question 2

Name the benefits of achieving economic growth

Answer 2

1) Raises material standard of living as household purchasing power increases
2) Leads to a fall in cyclical unemployment as the derived demand for labour to produce goods and services rises
3) Higher income, sales and corporate tax revenue for the government , which can be deployed towards spending on social amenities or capital goods.
4) Improves business confidence. Higher investment levels further generate potential growth in the economy. FDI inflows also improve the capital/financial account and contributes towards a country’s foreign reserves.
5) Further fuels economic growth with high consumption and investment activities

Question 3

How would you interpret falling growth rates?

Answer 3

Rate is not the same as level. Decreasing growth rates suggest that the economy is growing at a slower pace, but GDP is not decreasing. Hence, unemployment is not likely to rise also.

Question 4

Name the benefits of achieving price stability

Answer 4

1) Ensures that exports are price-competitive, which boosts net export sales.
2) Increases investor confidence as investors can accurately predict their future streams of revenue and costs. Investments generate actual and potential growth
3) Ensures minimal distortion to the workings of the price mechanism, which maintains efficiency in resource allocation.
4) Reduces shoe leather and menu costs (wastage of time and resources in managing costs of inflation).
5) Avoids redistributive effects of inflation (i.e. borrowers benefiting at expense of lenders; asset owners benefiting while pension earners suffer).

Question 5

Name the consequences of high unemployment

Answer 5

1) High unemployment is usually associated with low consumption and investment spending, which further lowers the economic growth prospects of the country.
2) Unemployment also suggests that the country is not using its resources efficiently, and any potential gains that these resources could have brought about (e.g. increase in amount of goods produced for export which increases the country’s foreign earnings) are lost.
3) Aside from the fall in tax revenue, there is also greater strain on government resources to provide unemployment benefits. Such payments carry opportunity costs, as the funds could be directed into infrastructural projects to increase the economy’s growth performance.
4) In addition, if unemployment is prolonged, workers may lose their skills and motivation to work, which results in a fall in the economy’s productive capacity (leftward shift in LRAS / PPC).
5) Crime rates may also rise with unemployment, which compromises social stability.

Question 6

Define the term “labour force”

Answer 6

Members of the population who are willing and able to work.

Question 7

Why is full employment not the same as zero unemployment?

Answer 7

At the full employment level of output, cyclical unemployment is zero. However, structural and frictional unemployment can still exist (i.e. natural unemployment).

Question 8

When is rising unemployment not a cause for alarm?

Answer 8

When unemployment is due to discouraged workers rejoining the workforce. This adds on to 1) no. of unemployed (numerator), as well as 2) the size of the labour force (denominator), causing unemployment rates to rise. This is usually a sign of improving economic prospects.

E.g. unemployment rate rises from 20/100 to 25/105 when 5 discouraged workers rejoin the workforce.

Question 9

Name at least 3 consequences of a BOP disequilibrium?

Usually associated with a persistent BOP deficit as a persistent BOP surplus may be less harmful

Answer 9

1) A persistent current account deficit may suggest that the country’s exports are not price competitive, while a persistent financial account deficit suggests that investor confidence is weak. Both result in a fall in AD (either through net exports or FDI) which leads to slower growth.
2) Persistent BOP deficit may lead to lower demand for a country’s currency to purchase its exports, leading to depreciation of the currency, which can cause imported inflation
3) Persistent BOP deficit drains the country’s reserves, which can further erode investor confidence.

Question 10

When is a BOP deficit not a cause for alarm?

Answer 10

When deficit is due to :

1) Higher import spending (worsens current account, but improves material SOL)
2) Higher FDI outflow (worsens capital/financial account in short-run, but profits earned flow back as income, which improves current account)

Question 11

Given information on economic growth, unemployment and inflation rates, what other information is needed to measure the living standards in a country?

Answer 11

Think: DIRCO framework. Note that information on all 4 KEIs are not strictly needed (unless you are trying to measure the performance of an economy).

Define SOL (includes material and non-material) ,
Indicator to measure SOL (GDP),
Refinement for indicator (to obtain real GDP per capita), Complementary info needed (distribution and composition of GDP)
Other limitations related to using GDP

Refer to subsequent questions on links between an economy’s PERFORMANCE and SOL.

Question 12

If given information on economic growth, how can the link to SOL be established?

Answer 12

Growth is usually quoted in real terms, which indicates improving material SOL, since households can consume more goods and services with higher incomes.

Higher growth leads to higher govt revenue which can be deployed towards healthcare and education spending; but higher stress and pollution levels make impact on non-material SOL unclear.

Question 13

Name at least 2 other indicators that can be used to measure SOL.

Answer 13

1) Human Development Index (includes GDP per capita (based on PPP), life expectancy and adult literacy rate.)
2) Measure of Economic Welfare ( includes leisure and non-marketed activities)
3) Gross National Happiness index ( takes into account level of sustainable development and holistic well-being of citizens)

Question 14

What are the limitations with using economic growth to measure SOL?

Answer 14

• GDP level should be used instead of growth rates
• per capita terms needed to establish that an individual’s share of NI is increasing
• composition of NI (impacts current vs future SOL)
• distribution of NI (Gini coefficient)
• PPP (cross-country comparison)
• other limitations, e.g. unrecorded transactions

Question 15

If given information on inflation rates, how can the link to SOL be established?

Answer 15

Higher inflation generally leads to lower real purchasing power, hence material SOL worsens. For small and open countries, inflation damages price competitiveness, leading to slower growth and further fall in material SOL

Question 16

If given information on unemployment rates, how can the link to SOL be established?

Answer 16

• Higher unemployment is associated with falling household incomes, which worsens material SOL.
• Govt spending on welfare benefits carries opportunity cost, since the funds could be directed to healthcare and education instead (can link to material or non-material SOL).
• Higher unemployment leads to family tensions and crime rates, which compromise non-material SOL.

Question 17

If given information on BOP, how can the link to SOL be established?

Answer 17

• Higher M benefits material SOL directly, while higher X benefits material SOL through growth in NI.
• Need to consider composition of imports (capital vs consumer goods; merit vs demerit goods).

Question 18

If given information on C, G, I and (X-M), how can the link to SOL be established?

Answer 18

C: Benefits current material SOL directly. But need to check distribution of income and per capita spending.

G: Spending on healthcare/education benefits non-material SOL while spending on national defence has no direct impact on SOL. Spending on welfare benefits improves current material SOL, while spending on infrastructure and capital goods improves future material SOL.

I: Benefits future material SOL.

(X-M): Higher M benefits material SOL directly, while higher X benefits material SOL through economic growth.

Question 19

Name one limitation of using GDP to compare SOL across SPACE, which is not relevant when comparing SOL across TIME.

Answer 19

GDP numbers are denominated in different currencies, hence PPP exchange rates need to be used.

Question 20

What aspects should we note when looking at the composition of NI?

Answer 20

1) Consumer vs capital goods
2) Goods for domestic consumption vs export destinations
3) Military spending vs healthcare spending

Question 21

What is the difference between GDP and GNP indicators?

Answer 21

GNP is the total value of final goods and services produced by factors of production owned by residents of a country, regardless where the factors reside.

GDP is the total value of final goods and services produced within the geographical boundaries of a country over a period of time.

GNP may be more relevant for Singapore, given the number of MNCs operating within the country (factor income to abroad), and the number of investment projects made overseas by Singaporean firms, including sovereign wealth funds like Temasek and GIC(factor income from abroad).

Question 22

Define real GDP (or GDP denominated in base year prices)

Answer 22

Total value of final goods and services produced within the geographical boundaries of a country over a period of time, measured at constant prices (effects of price changes have been removed).

Question 23

Explain the Human Development Index (HDI)

Answer 23

Measure of economic development which takes into consideration material and non-material aspects of living standards. These include GDP per capita (based on PPP exchange rates), life expectancy and adult literacy rate.

Question 24

Why is the Purchasing Power Parity (PPP) more useful than exchange rates when comparing SOL across countries?

Answer 24

1) The exchange rate may fluctuate due to speculative activities relating to currencies.
2) The PPP takes into account differences in cost of living and purchasing power across different countries.

Question 25

Explain how to derive real GDP growth rate from nominal GDP growth rate

Answer 25

Nominal GDP growth rate – inflation rate = real GDP growth rate

Question 26

Explain how to derive real GDP per capita growth rate from real GDP growth rate

Answer 26

Real GDP growth rate – population growth rate = real GDP per capita growth rate

Question 27

Explain why the COMPOSITION of GDP matters, when considering impact of GDP figures on material SOL (knowing how to explain this is important to avoid point-dropping).

Answer 27

Increased military spending or investment in capital goods may boost GDP, but does not contribute to improving material living standards in the short run. Similarly, export-led growth may not mean that the amount of goods and services available for domestic consumption has increased. Hence, there is a need to consider the composition of GDP.

Question 28

Explain why the DISTRIBUTION of GDP matters, when considering impact of GDP figures on material SOL (knowing how to explain this is important to avoid point-dropping).

Answer 28

The distribution of income (or income gap, as measured by the Gini coefficient) indicates whether the increase in GDP is shared equally among residents in the country. In Singapore, the rising income gap means that the gains from Singapore’s economic growth may not have improved material standard of living for all Singaporeans.

Question 29

How can actual growth be depicted on a PPC?

Answer 29

Movement from a point within the PPC to a point closer to it. (note that this may also occur due to greater efficiency in the utilisation of resources)

Question 30

How can potential growth be depicted on a PPC?

Answer 30

Outward shift of the PPC

Question 31

When does the PPC shift inwards?

Answer 31

Usually due to destruction of existing factors of production, e.g. due to war or natural disasters. Note that a fall in potential growth should result in a SMALLER outward shift of the PPC instead.

Question 32

How is a technical recession defined?

Answer 32

2 consecutive quarters of negative GDP growth.

Question 33

For case study questions on the impact on current and future SOL, what should students generally consider?

Answer 33

Spending on capital (augments future SOL) vs consumer goods (augments current SOL). A PPC approach can be used too.

Question 34

When comparing balance accounts (e.g. BOP), what should constitute the general/refinement (anomaly) trends?

Answer 34

General: compare surpluses vs deficits
Refinement: compare worsening/improving trends

Question 35

What is wrong with the statement below?

“The balance of payments has become more positive.”

Answer 35

It should read:

“The balance of payments surplus has increased.”

Explaining that the balance has become more positive is a mere numeric description, that does not capture an understanding of what a balance account entails (same applies to budget balance).

Question 36

What are the limitations of using PPP-denominated exchange rates?

Answer 36

1) It is hard to establish a common basket of goods as consumption patterns may vary across countries.
2) Data may be less available and reliable in developing countries.

Question 37

What is wrong with the following term?

• “real GDP per capita at PPP exchange rates”

Answer 37

When PPP exchange rates are used, the PURCHASING POWER of income in different countries (measured against a common basket of goods and services) is considered. Hence, conversion to REAL terms is no longer required. I.e. the indicator should read: “GDP per capita at PPP exchange rates”.

Question 38

Name at least 3 aspects of non-material SOL.

Answer 38

1) Level of stress
2) Congestion and pollution (especially pertinent for developed countries such as China and Singapore)
3) Life expectancy
4) Healthcare
5) Level of happiness

Question 39

For case study questions requiring students to use data to assess whether SOL have improved, what are the 3 steps to note?

Answer 39

1) How data supports an improvement in SOL
2) How data suggests a worsening of SOL (always 2 sides to look at)
3) More evidence is required (data can never be exhaustive)

Use DIRCO for above.

Question 40

What are some aspects of SOL that are pertinent to the SG context?

Answer 40

1) Rising income gap - Gini coefficient = 0.463 in 2014 (gains from growth may not benefit everyone equally)
2) Congestion due to high population density (worsens non-material SOL)
3) Rising stress levels (worsens non-material SOL)
4) Good healthcare and education due to allocation of government budget.
5) Having achieved a certain level of material living standards, Singaporeans are more concerned about non-material aspects, including whether there are enough green spaces in Singapore.

Question 41

Explain what is meant by the equilibrium level of national income

Answer 41

Level of national income (NI) where there is no tendency for further change.

Question 42

When asked to explain NI equilibrium using the circular flow, what are the steps involved?

Answer 42

1) Explain diagram
2) Define equilibrium NI
3) Explain adjustment to equilibrium process

Question 43

Name the various types of injections and withdrawals.

Answer 43

Injections (I, G, X)

Withdrawals (S, T, M)

Question 44

Explain the adjustment process under the circular flow when J>W

Answer 44

When injections exceed withdrawals (e.g. rise in government expenditure or fall in savings),

the excess spending will increase firm output,

which leads to firms hiring more factors of production.

In return, households receive more factor income in the form of wages, rent, interest and profits. Hence, national income (national output rises).

As household income rises, withdrawals also increase through households saving more, paying more in taxes and buying more imports.

Meanwhile, households will also spend more which generates further rounds of income.

Withdrawals will continue to rise until they are equal to injections. This is the adjustment to equilibrium process.

Question 45

Explain the adjustment process under the circular flow when W>J

Answer 45

When withdrawals exceed injections (e.g. fall in government expenditure or rise in savings),

the fall in spending will reduce firm output,

which leads to firms hiring fewer factors of production.

In return, households receive less factor income in the form of wages, rent, interest and profits. Hence, national income (national output falls).

As household income falls, withdrawals also fall through households saving less, paying less in taxes and buying fewer imports.

Meanwhile, households will also spend less which generates further rounds of decreases in income.

Withdrawals will continue to fall until they are equal to injections. This is the adjustment to equilibrium process.

Question 46

What is the crowding-out effect?

Answer 46

Government spending financed by borrowing, which results in higher interest rates, hence reducing (“crowding out”) investment and consumption expenditure.

Question 47

Explain the Marshall-Lerner condition

Answer 47

MLC states that an exchange-rate depreciation will only improve the balance of trade if the sum of the price-elasticities of demand for import and export exceeds one.

NOTE: MLC is only relevant when assessing (X-M) for the country changing its exchange rates.

Question 48

How would you describe the multiplier process succinctly?

• Applicable for CSQs or when question is on the impact on an economy (not national income)

Answer 48

The rise in AD triggers a multiplied increase in national income (NI) through the multiplier process.

For example, assuming that the government spends on the construction of a new highway, the increase in autonomous spending generates an increase in income for households hired by firms to build the highway. The increase in household income induces more spending which results in subsequent rounds of income generation. The multiplier process stops when the initial increase in autonomous expenditure has been fully accounted for through the rise in withdrawals. Hence, overall, NI increases by a multiple of the original increase in spending.

Question 49

What are the factors affecting MPS, MPM and MPT?

Answer 49

MPS

1) Government policies (e.g. CPF)
2) Culture of thrift

MPM

1) Level of resource endowment
2) Income level of residents

MPT

1) Whether country is a welfare state
2) Efforts to attract investments and talent may result in lower tax rates

Question 50

Does a cut in income tax by $100m have the same effect on national income as a direct rise in government expenditure by $100m?

Answer 50

No.

A rise in G by $100m starts the multiplier process immediately (i.e. initial spending is $100m), while a cut in taxes does not trigger the multiplier process directly. For the latter, it is only when households spend from their greater pool of disposable income, that the multiplier process starts (i.e. initial spending is MPC x $100m).

Question 51

Name the ICE ICE PIQ acronym

Answer 51

Consumption:

1) Income (disposable)
2) Credit (cost and availability)
3) Expectations (economic outlook)

Investments:

1) Interest rates (MEI)
2) Cost of operations (corporate tax)
3) Expectations (steepness of MEI)

Net exports:

1) Price-competitiveness (inflation; x/r)
2) Income levels (YED)
3) Quality-competitiveness

Question 52

What is the difference between domestic investments and FDI?

Answer 52

Both have the same impact on actual/potential growth. However, domestic investments are affected by domestic interest rates, while FDI is independent of interest rates (do not mix up with hot money flows).

Question 53

Differentiate between induced and autonomous consumption

Answer 53

Autonomous consumption is consumption independent of the level of income and is affected by NON income factors (e.g. cost of credit, economic outlook).

Induced consumption is consumption that changes when the level of household income changes (related to the level of economic activity).

Question 54

How do we calculate the size of the multiplier?

Answer 54

1/MPW or 1/(1-MPC)

Question 55

When should we include the full multiplier process in an essay?

Answer 55

When the question asks for the impact of an event on:

• National income
• GDP (or output)
• Economic growth

Question 56

What affects SRAS?

Answer 56

Cost-push inflation

Question 57

What affects LRAS?

Answer 57

Quality and quantity of FOPs

Question 58

What essay framework should we use when explaining the impact of an event on NI?

Answer 58

MISC framework

1) Multiplier process in full
2) Influence of factors on the size of the multiplier (brief para)
3) Analyse the state of the economy (Keynesian, Classical, Intermediate range)
4) Ceteris Paribus condition holds? (brief evaluative para)

Question 59

Explain the impact of a fall in income taxes on the consumption function.

Answer 59

Upwards shift of the consumption function (affects autonomous consumption).

Question 60

Recap the impact of a fall in investment levels on the LRAS curve

Answer 60

Smaller outward shift due to lower potential growth (note: not inward shift)

Question 61

Recap the diagram to illustrate slower economic growth in an economy

Answer 61

Smaller rightward shift of AD curve (not leftward shift)

Question 62

State the two factors that determine the impact on national income of increased AD.

Answer 62

1) Size of k (can break down into factors affecting MPS, MPM, MPT)
2) Size of increase in AD

Question 63

What is meant by a hard landing in an economy?

Answer 63

Sudden fall in real output, usually due to contractionary policies implemented by the government in an attempt to bring down inflationary pressures.