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Answers to 2021 GCE A Level H2 Economics Exam

Paper 1
Question 1
Using a demand and supply diagram, explain why the rise in the price [2]
(a)
of salmon has led to the change in the price of cod in Norway.
Cod is a substitute for cod as both are species of fish consumed. A rise in
the price of salmon would lead to a rise in the demand for cod. This is
represented by a rightward shift of the demand curve from D0 to D1,
causing prices to increase from P0 to P1. [1]

0
[1m for diagram]

(b) With reference to Extract 1 and Figure 1

(i) Using a diagram, explain the likely impact of the disagreement [2]
between fishing workers and boat owners in Iceland on the market
for cod in 2017.
The disagreement between fishing workers and boat owners would lead to
a fall in supply as workers would not be working. The fall in supply,
represented by a leftward shift of the supply curve from S0 to S1 would
result in a rise in price of cod from P0 to P1 and quantity to fall from Q0 to
Q1. [1]
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0
[1m for diagram]

(ii) Suppose a maximum price of Iceland cod of €2.25 per kg has been [2]
operating since March 2016.

Explain the impact such a maximum price would have had on the
market for Iceland cod.
When the maximum price is set above the market equilibrium price, there
would have been no effect on the market. [1] This would have been seen
in March to July 2016, as prices were below €2.25. From August 2016
onwards, the maximum price would have caused a shortage in the market
for Iceland cod as the market equilibrium price was above the maximum
price. [1]

(iii) Explain how ‘large stockpile of frozen cod in Iceland’ can be used to [4]
keep cod prices stable, and identify two difficulties in operating such
a scheme
The stockpile of frozen cod could be released when needed to increase
the supply of cod in the market. [1] With this rise in supply, the rise in the
price of cod could be reduced. With a rise in supply, it would lead to a
surplus and cause a downward pressure on price.[1]

One difficulty in operating in such a scheme is to make sure that the

stockpile is sufficient as the stockpile has been reducing (Extract 1), as
peak cod-fishing season is typically only during February to April. This
would reduce the ability of the government in increasing supply. [1]

Another difficulty would be how consumers may regard frozen cod as a

poor substitute for fresh cod. Hence, the release of the stockpile of frozen
cod may not be effective in keeping the prices of cod stable. [1]
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Explain why many small-scale shrimp farmers in India took the [2]
(c) decision to shut down production in the short run and leave the
market in 2020.
Due to Covid-19, shrimp farmers in India were facing a fall in demand for
their shrimps as their largest buyers – hotels and restaurants have been
losing customers. [1] Due to this fall in demand, these shrimp farmers were
not generating enough revenue to cover variable cost. Hence, the firms
would have been better off shutting down as they would make less than
normal profits (i.e. subnormal profits). [1]

Discuss whether Barramundi Asia’s plan to increase its scale of fish [8]
(d)
production is likely to benefit consumers.
When Barramundi Asia expands, consumers can benefit due to potentially
lower prices as well as increased consumer choice due to R&D conducted
by the firm.

Thesis 1: Consumers may enjoy lower prices and greater output

[P] When the firm expands, it can enjoy internal economies of scale, which
can be translated to lower prices for consumers.
[E/E] Due to an increase in output, Barramundi Asia can ‘own and operate
its entire supply chain’. This could result in an improvement in the
production process as the firm would have greater control of the entire
process from breeding fishes to sales and marketing. This would lead to a
fall in marginal cost, and thus average cost of production. With a fall in
marginal cost of production from MC0 to MC1, the firm can increase output
from [L] Q0 to Q1 and charge consumers a lower price, as seen by a fall
in price [L] from P0 to P1.
P, R, C
($)

MC0

P0 a
b MC1
P1

DD
MR

0 Q0 Q1 Qty / t

With the fall in price, consumers enjoy a rise in consumer surplus.

Consumer surplus rises by area P0abP1.
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Thesis 2: Consumers may enjoy greater product variety due to R&D

carried out by the firm
[P] When the firm expands, there is greater potential to conduct R&D.
[E/E] Increasing the size of their fish farm would also mean that there could
be more innovation and R&D, which could bring about greater product
variety or better quality of fishes.
[L] This would benefit consumers as consumer welfare would increase.

Anti-thesis: Consumers may end up paying higher prices

[P] Barramundi Asia may end up charging higher prices due to stronger
market power
[E/E] With higher output, Barramundi Asia’s market power will increase. In
theory, when Barramundi Asia expands and enjoys internal economies of
scale, it can charge cheaper prices (as explained earlier). Other smaller
fisheries that are not able to match the lower prices will face loss of sales
and may earn losses, causing them to exit in the long run.
[L]Thus, over time, Barramundi Asia captures a bigger market share and
with greater market power, Barramundi Asia is able to charge higher
prices, which disadvantages consumers.

Furthermore, if Barramundi Asia ends up dominating the market, it could

result in lower consumer welfare as there will be a reduction in consumer
choice.

Conclusion
[Stand] It is likely that consumers would benefit from the expansion of
Barramundi Asia to a large extent.
[Substantiation] In the short run, it is unlikely that Barramundi Asia would
be able to end up dominating the market, as it is still making subnormal
profit now (Ext 3). Furthermore, they are only specialising in one kind of
fish, which has substitutes available in the form of other fishes like salmon
and cod. Moreover, even though increasing the scale of production will
enable Barramundi Asia to enjoy internal economies of scale, consumers
typically value variety in their fish diet and so small fisheries without
economies of scale and charge higher prices can still survive as
consumers are prepared to pay more for differentiation.

Level Descriptor Marks

L1 Underdeveloped two-sided answer on how consumers 1-3
could be affected by the expansion of Barramundi Asia
OR

Well-developed one-sided answer on either how

consumers could be positively or negatively affected by
the expansion of Barramundi Asia
L2 Well-developed two-sided answer on how consumers 4-6
could be affected by the expansion of Barramundi Asia

Up to 2 marks can be awarded for an evaluative conclusion on the impact

of Barramundi Asia’s expansion on consumers.
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Due to fears over climate change and a growing demand for plant- [10]
based diets, many consumers are changing from animal protein to
vegan alternatives.
(e)
Discuss whether demand factors or supply factors have a greater
impact on the market for fish in the long run.
The market for fish can be affected by both demand and supply factors.
We will need to look at how the factors can affect the market for fish before
weighing the factors.

Demand factor 1 – Change in taste and preference

[P] A change in consumers’ taste and preference would lead to a fall in
demand for fish.
[E/E] As consumers become more environmentally conscious and opt for
sustainable food choices (Ext 4], they will switch from animal protein such
as fish to plant-based proteins that are made from seaweed and algae.
They become less willing to pay for fish and this will lead to a fall in the
demand for fish.

Evaluation: The extent of fall in demand would depend on the consumers’

perception of how good of a substitute plant-based proteins are in place of
animal protein. The current products by Novish have received good
feedback (Ext 4), and the company also expects that growth in
consumption of plant-based proteins will be substantial. However, the
company acknowledges that developing plant-based products which has
the “right taste and texture” it is challenging. (Ext 4).

Demand factor 2 – Change in price and availability of substitute

(plant-based protein)
[P] With greater availability of substitutes in the form of plant-based
proteins, consumers will switch away from animal proteins such as fish.
[E/E] Companies like Novish are gradually increasing their product range,
which will include uncoated salmon burgers and tuna steaks (Ext 4). With
increased market supply as more firms enter the plant-based protein
market in response to the trend of consumers opting for sustainable and
healthy food choices, there may be fall in the price of plant-based proteins.
Thus, this would cause a fall in the demand for fish.

Evaluation: Whether price of plant-based protein can fall or not will depend
on whether the rise in supply could exceed the rise in demand. The rise in
supply could be limited in the short term because although ‘Plant-based
foods are trending’ (extract 4), it is not clear what percentage of the
population have caught on and are like-minded in wanting to switch to
sustainable food choices.

Supply factor – Change in government policy

[P] Changes in governments’ stand towards consumption of fish would
have an effect on the supply of fish.
[E/E]
The fishing industry faces the problem of dwindling fish stocks over time
because fishermen, in pursuit of profits, typically ignore the external cost
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of fishing (e.g. less fish for future generation) leading to over-fishing from
society’s view point.
If governments decide to discourage the over-consumption/production of
fish by imposing a tax on the market for fish (e.g. taxes are imposed on the
fishing industry in taxes (extract 1)), it will cause supply of fish to fall. This
would then cause the price of fish to rise, and the output of fish to fall.

Evaluation: This would depend on the governments’ perception of the

severity of the impact on the environment when fish is consumed. With
rising concerns about sustainability of the fishing industry, the
governments might impose a very high tax on the market for fish.

Conclusion
[Stand] It is likely that the demand factors would be more significant than
the supply factors in affecting the market for fish.
[Substantiation] Given how there is increasing consumer awareness of
the negative impacts on the environment due to consumption of fish, it is
very likely that the fall in demand for fish would be quite significant.
Coupled with the increased availability of plant substitutes, there is no
doubt that the demand for fish would decrease significantly. This would be
even more pronounced in the very long run, as the increase in availability
of substitutes would be even more significant with the advancement of
technology. On the other hand, although governments might increasingly
tax the production of fish, this tax serves to discourage over-fishing and
hence has the effect of helping to maintain the stock of fish in the ocean,
such that the natural supply of fish will not fall drastically over time and
adversely impact the fish market.

Level Descriptor Marks

L1 Underdeveloped two-sided answer on how the 1-4
market for fish could be affected by various
demand and supply factors OR

Well-developed one-sided answer on how the

market for fish could be affected by either demand
or supply factors
L2 Well-developed two-sided answer on how the 5-7
market for fish could be affected by both demand
or supply factors

Up to 3 marks can be awarded for an evaluative comment on the

significance of the demand and supply factors, and an overall conclusion
as to which is relatively more significant
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Question 2
(a) State what is meant by foreign direct investment (FDI) and identify the component
of the balance of payments account in which FDI is recorded [2]

Foreign direct investment is investment by a multinational company in establishing

production, distribution or marketing facilities abroad. [1]
It is recorded in the Capital and Financial Account of a country’s balance of payment
accounts. [1]

(b) (i) Explain the opportunity cost of investment expenditure that uses domestic funds
[2]
The opportunity cost of investment expenditure that uses domestic funds is the sacrifice
of the benefit of the next best use of the domestic funds [1] which is the satisfaction that
could have been obtained by citizens of a country from spending on healthcare consumer
goods.
(ii) Using a production possibility diagram curve, show the impact of infrastructure
improvements in a country such as Singapore and Vietnam.

As infrastructure is a capital good, improving the improvement infrastructure means

diverting resources away from consumer goods to capital goods (i.e. movement from point
a to b). This could increase the country’s capital stock (or lead to rise in factor productivity)
such that the country’s productive capacity rises, causing the PPC curve to shifts outwards.
[1]

Diagram [1]
Consumer
goods
(Units)

a
b

Capital goods
0 (Units)

(c) Explain how the current account of the balance of payments of Singapore or
Vietnam is likely to be affected in the long-run by increased FDI. [6]
FDIs that flow into Vietnam are directed towards the exports sector, as suggested by
Extract 6 para 3 “multinational enterprises divert operations from China”, whereby
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multinationals use Vietnam as a production base to export to countries including the US

instead of China as a way to bypass tariffs imposed by the US on goods being exported
from China into the US.
As multi-nationals bring with them the latest technology, goods being produced in Vietnam
incur a lower cost of production and there is a gain in export competitiveness. Assuming
demand for exports from Vietnam is price elastic, there is a more than proportionate
increase in quantity demanded for exports and an increase in export revenues (X). At the
same time, with price of domestically produced goods now being relatively cheaper, there
is a fall in demand for imports and hence import expenditure (M) falls as domestic
consumers switch away from exports to domestically produced goods. With rise in X and
fall in M there is an increase in the current account of the balance of payments.
However, multinational enterprises remit their profits back to their home countries which
is recorded as an outflow in the current account of a country’s balance of payments. As
such, in the long run, there may be a worsening of the current account if such outflows in
the form of factor income paid abroad are greater than the inflows from increase in net
export revenue.
(d) Discuss whether broad export diversity or specialisation in a narrow range of
exports is more likely to be beneficial for an economy engaged in international trade.
[8]
Thesis: Explain benefits of specialization in a narrow range of exports
[P] Specialisation in a narrow range on exports enables a country to fully reap the
benefits of specialisation and trade based on comparative advantage.
A country is said to have a comparative advantage in the production of a good if it can
produce the good at a lower opportunity cost than another country. Using the example of
Singapore and Vietnam, Vietnam has a comparative advantage in the manufacturing of
garments due to its relative abundance of low skilled labour, whereas Singapore has a
comparative advantage in the manufacturing of semiconductors due to its largely pool of
skilled labour. Vietnam should specialise in the manufacturing of garments and export it
to Singapore in exchange for semiconductors while Singapore should specialise in the
manufacturing of semiconductors and export it to Vietnam in exchange for garments. In
this way, resources are being allocated in the most efficient way - in the case of Vietnam,
it incurs a lower opportunity cost in producing garments i.e. Vietnam has to give up less
units of semiconductors to produce one unit of garment; in the case of Singapore it
Singapore has a lower opportunity cost in producing semiconductors i.e. Singapore has
to give up less units of garment to produce on unit of semiconductors. Assuming trade
takes place using a mutually beneficial terms of trade, consumption levels of both country
increases, leading to welfare gains for consumers.
Anti-thesis: Explain drawbacks of specialization in a narrow range of exports/argument for
broad export diversity
However, by specialising in the production of a narrow range of goods and hence only
exporting those goods, the country’s economy is more exposed to external shocks. This
may come in the form of falling demand for the product a country exports. If Singapore
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were to specialise only in the production of semiconductors, it would be extremely

vulnerable to a downturn to the global electronics sectors. Firms abroad which demand
semiconductor for electronic components would experience rising inventories of
semiconductors and reduce demand for semiconductors for Singapore, leading a fall in
Singapore export revenue and ceteris paribus, net export revenues. Firms in Singapore
will face rise excess inventories and reduce factors of production, including labour and
hence there will be a fall in wages, triggering a fall in induced consumption. There will be
a fall in Aggregate Demand, and via the reverse multiplier effect, fall in National Income
which is greater than the initial fall in net export revenue. There would also be a worsening
of the current account of the balance of payments account and a rise in demand-deficient
unemployment.
Synthesis/Evaluation:
[STAND] On balance, it would be more likely for countries who engage in international
trade to benefit over the long term if they had broad export diversity.
[SUBSTANTIATION] As explained above narrow specialization would make an economy
vulnerable to external shocks. This is especially so as nowadays as external shocks can
result from structural shifts, which take place more rapidly than before due to the rapid
rate of technological transformation, i.e. good or services which are in demand now may
not be in demand in future. That said, countries should take into account their comparative
advantage and not venture into sectors they have no comparative advantage in as this
would entail very large opp. costs. For e.g. countries with an abundance of labour would
still want to venture into labour intensive industries or parts of the supply chain of a product
which require a lot of labour. That way, the benefits of specialization based on
comparative advantage can be reaped while insulating the economy from external shocks.
(e) Discuss whether a government should encourage domestic investment rather than
investment from external sources to improve the standard of living. [10]
Both domestic and external sources of investments, which affect an economy’s Aggregate
Demand (AD) and Aggregate Supply (AS), thereby affecting an economy’s actual and
potential growth, and thereby living standards over time.
Explain how an increase in investments leads to an improvement in living standards
[P] Both domestic investment and investment from foreign sources, i.e. FDIs can
bring about improvements in living standards.
An increase in Investments(I), whether from domestic or foreign sources, will increase a
country’s Aggregate Demand (AD) as they are a component of AD. When I increase,
planned expenditure will exceed planned output leading to a unplanned rise in inventories.
Firms will respond by increasing factors of production, resulting in an increase in factor
payments, including wages paid to labour. This will in turn lead to a rise in induced
consumption, giving rise to the multiplier effect. This results in a rise in AD and National
Income which is greater than the initial increase in I. With the increase in NY, households
can purchase more goods and services, resulting in a rise in the satisfaction they derive
from consuming goods and services and hence a rise in material living standards.
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In the context of Vietnam and Singapore, which are countries reliant on exports, the
investments flow into the export sector, i.e. which fuels an increase in AD and real NY via
an increase in net export expenditure (X-M) as well.
Assuming the rate of capital accumulation stemming from the rise in I is greater than the
of capital depreciation, there will be a rise in the capital stock in the economy. This results
in a rise in the productive capacity of the economy, which allows more goods and services
to be produced over time. In other word, the economy can accommodate future increases
in AD. This allows the rise in material living standards to be sustained over time.
Explain why having investments from foreign sources may be more beneficial
[P] Where the investments are from foreign sources, there is likely to be a greater
improvement in living standards
FDIs often flow from countries whose firms are leaders in their fields; and hence bring with
them the latest technology. This allows for a reduction in the unit labour cost of production
and overall unit cost of production. For countries dependent on exports, this leads to an
increase in the competitiveness of the export sector, and via an increase the net export
revenue, a rise in real NY. This is reflected by a downward shift of the AS curve, i.e., there
is a rightward movement along the AD curve via the real balance effect, wealth effect and
international substitution effect. With this additional effect resulting in an increase in real,
NY there will be an even greater increase in living standards.
The increase in the level of technology also results in rise in productive capacity in the
economy, allowing for the economy to experience further increases in the overall
productive capacity, i.e., there is an increase not just in the quantity of capital but also
quality of capital/level of technology. Hence there can be a more sustained increase in
living standards.
In addition, more efficient processes and technologies brought in through FDIs allows
workers working in these firms to be more efficient in their tasks and hence allow for a
given amount of output to be produced in a shorter time period than before. This allows
for there to be shorter working hours and more time to be spent on leisure activities or rest,
bringing about an increase in non-material living standards as well.
Explain disadvantages of having investments from foreign sources
[P] However, there are drawbacks of relying on investments from foreign sources
If a country over-relies on investments from abroad, especially to drive its export sector,
there could be a fall in investments and exports should foreign firms find other countries
more advantageous due for e.g., them becoming more price competitive in the production
of certain goods. While Vietnam for e.g., is currently attracting a lot of FDIs, a part of
which flow into the export sector, the emergence of Indonesia as a competitor for e.g.
could lead to Vietnam experiencing a fall in I and X-M, and hence fall in economic growth
and living standards.
Furthermore, there will be profit repatriation in future, i.e profits earned by foreign firms get
send back to their home countries, which leads to an outflow of income in the current
account of the balance of payment.
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Synthesis/Evaluation
[STAND] Despite the drawbacks that come with relying on investments from foreign
sources, a government should encourage investments from foreign sources over domestic
investments to increase the SOL of its citizens
[SUBSTANTIATION] Even though reliance of FDI means that a portion of GDP accrues
to foreigners as factor Y paid abroad and FDI causes the country to be vulnerable to the
shocks created by sudden relocation of FDI, the faster rate of EG that can be obtained
from FDI and employment generated are significant plus factors that can boost their
material SOL of developing countries. By just relying on domestic I, the overall level of I
will be much lower since poor countries have low saving which leads to low investment,
limiting job creation and the rate of economic growth. That said, countries which rely on
foreign investments need to constantly pursue effective supply side policies such as
ensuring high quality of education and skills training to ensure wage and hence price
competitiveness, in order to remain attractive to foreign firms to continue to have rising
living standards.
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Paper 2
Question 1
The market for bicycles is often said to generate external benefits such as reduced traffic
congestion and reduced air pollution.

a) Explain how economic theory suggests that consumers act rationally to decide
whether or not to buy bicycle, and how producers of bicycles act rationally to determine
their level of output. [10m]

b) Discuss how government intervention in the market for bicycles could be used to
maximise social welfare and consider how likely is it that such intervention will be
successful in achieving this aim. [15]

Approach

Part a)

Students are expected to explain how consumers apply the marginalist principle to determine
whether or not to buy a bicycle and the output level that will maximise their net total private benefit.
The application marginalist principle will also be relevant for producers to determine their
production levels that will maximise their profits. Students should include well-drawn diagrams as
tools of analysis to explain the workings of the marginalist principle for each economic agent and
relevant examples of related costs, benefits and constraints.

Suggested answer:

Introduction:

Consumers and producers make rational decisions where they aim to maximise their self-interest.
Marginal benefit (MB) is the additional benefit derived from doing one more unit of an activity.
Incremental cost/marginal cost (MC) is the additional cost derived from performing one more unit
of an activity. To maximise their self-interest, consumers and firms apply the marginalist principle,
which states that the optimal level of an activity is attained when MB = MC. In the pursuit of self-
interest, consumers and producers consider only their private costs and private benefits.

Rational decision-making for consumers

[P] Consumers seek to maximise net total private benefit from consuming goods and services. [E]
Consumers derived utility or satisfaction from consuming/using a bicycle. Consumers are willing
to buy an additional unit of a bicycle so long as the additional benefit they derived from
consuming/using it (marginal private benefit, MPB) exceeds the additional cost they incur from
buying, which is the price of the bicycle. When this occurs, the consumer maximises his net total
private benefit from it.

[E] The MPB can come in the form of additional benefit from using the bicycle as a mode of
transport or cycling. This can be the extra convenience to travel or as a form of exercise which
results in additional health benefits. For consumers working in the food delivery industry, buying
a bicycle allows them to make more food deliveries and earns them additional income. MPC is
the price of the bicycle.
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[P] According to the marginalist principle, as long as MPB is greater than MPC, the consumer
derives a net private benefit from consuming it and should consume it since doing so would
increase his net total private benefit. [E, E] With reference to Figure 1, MPB curve is downwards
sloping due to the law of diminishing marginal utility. The law states that after a certain level of
consumption, the consumer’s additional benefit derived from the good declines as successive
units of the good is consumed. If the price of the bicycle is P, the consumer will consume up to
Qe units which is the point where his MPB=MPC.

At any units below Qe, for example at Q1, MPB is greater than MPC. The rational consumer will
purchase the bicycle since the addition to private benefit exceeds the addition to private cost
which means net total private benefit is rising. On the other hand, a rational consumer will not
proceed with buying the bicycle if MPB is less than MPC, for example at Q2, as the addition to
private benefit is lower than the addition to private cost which means that net total private benefit
is falling. [L] Consumers will aim to consume up to Qe, where MPB intersects with MPC because
at this quantity, the consumer maximises net total private benefits area AEP as given by the
difference in total private benefit (area 0AEQe) and total private cost (area 0PEQe).

The consumer will also have to consider his income constraint before deciding whether or not to
buy the bicycle – if his income is insufficient, he would then not be able to do so.

Rational decision-making for a firm

[P] A rational firm will make use of the marginalist principle in order to maximise total profits when
deciding whether to produce one more bicycle. [E, E] MB is the addition to total revenue from
selling an additional bicycle while MC is the addition to total cost, from producing an additional
bicycle. This can be in the form of additional labour cost and the cost of materials to produce one
more unit of a bicycle. Total private cost rises as output rises.
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Assuming that the MB of producing an additional unit of a good is MR. In a perfectly competitive
(PC) market, MR equals the price of the good since the firm is a price taker. With reference to
Figure 2, a profit-driven producer will produce up to the point where MC intersects MR and charge
Pe. Profits are maximized at Qe. Any production below Qe, for example, at Q1, the firms can
increase profits by producing more. This is because the addition to total revenue exceeds the
addition to total cost from an extra unit of bicycle produced. On the other hand, any production
level above Qe, for example at Q2, the firm can increase its profits by producing less. The addition
to total revenue is lower than the addition to total cost, and profits will fall, if it sells beyond Qe. [L]
Hence profits are maximized at output level Qe, where MR equals MC.

In addition to the decision making based on the marginalist principle, rational producers will have
to consider resource constraints such as the availability of resources, for example, the availability
of aluminium for bicycle parts and manpower to produce an additional unit of bicycle.

Approach:

Part b)

Students are expected to explain how the market for bicycles may fail due to the presence of
positive externalities. Students should also explain how policies of indirect subsidies and direct
provision of cycling facilities or cycling paths may help to improve society's welfare. Students are
also expected to provide evaluative judgements on whether the measures will be successful, e.g.
whether the measures address the root causes of the market failure problem,
limitations/constraints that may limit the measures' effectiveness and unintended consequences.

Note: Although the preamble stated that the market failure problem arises from positive
externalities in consumption, the main stem question does not specify the source of market failure
in the market for bicycles. Therefore students may also consider that the market fails due to the
problem of imperfect information on the private benefits of cycling, and this should be matched
with relevant measures such as public campaigns to encourage more commuters to cycle.
 15

Suggested answer:

Market failure occurs when the free market fails to allocate resources efficiently. Government
intervention in the bicycle market can maximise society’s welfare by tackling market failure arising
from positive externalities and the problem of imperfect information on the private benefits of
cycling. However, such intervention is not without limitations or its unintended consequences.

[P] Market failure occurs in the market for bicycles due to the presence of positive externalities.
[E, E] Positive externalities exist due to spillover benefits on third parties who are not involved in
the economic transaction. When more people use bicycles instead of cars, this will reduce the
congestion on the roads. Workers do not need to be stuck on the roads, and the reduction in
travelling time will increase the workers' productivity. Third parties, such as employers, will benefit
as there will be higher output per worker due to the increase in productivity. Employers are able
to generate more earnings without the need to pay for such benefits. In addition, when more
people travel via bicycles, there will be less emissions. Residents near major roads, who are third
parties, will be able to enjoy better health, which will help them be more productive and increase
their wages. [L] The generation of positive externalities in consumption results in allocative
inefficiency in the market for bicycles.

Qty of bicycles/ t

Figure 3: Under-consumption in the market for bicycles

[P] The positive externality causes the marginal social benefit (MSB) to be greater than the
marginal private benefit (MPB) from cycling since the additional benefits to society (MSB) include
both the additional private benefits to consumers (MPB) as well as the additional benefits to third
parties not involved in the consumption (MEB). [E] MSB curve to be higher than the MPB curve,
where MEB is the vertical distance between the MSB and MPB curves. [E] Under the free market,
consumers will base their decisions on their MPB and disregard the external benefits. Assuming
there are no negative externalities, MPC = MSC. When left to market forces, the market
equilibrium output will be at Q where demand equals supply (which is also where MPB = MPC).

However, the socially optimal output is at Q*, where MSB = MSC and society’s welfare is
maximised. Hence, under the free market, there is underconsumption of bicycles by Q* - Q units,
resulting in welfare loss to society. This is because, for Q to Q*, the MSB is greater than the MSC.
The deadweight loss of consuming at the market equilibrium output Q is represented by area A,
given that the total social benefits of consuming Q to Q* units (areas A+B) are greater than the
total social costs (area B). [L] Therefore, the free market has failed to achieve allocative efficiency
as society’s welfare is not maximised.
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[Note: Students may also consider that consumers may be ignorant about long-term health
benefits they may enjoy when they cycle frequently and underestimate the true benefits of cycling.
In this case, the market failure occurs because the perceived MPB is lower than the true MPB,
resulting in under-consumption of bicycles]

[P] Government intervention through subsidies can address the market failure that arises from
positive externalities. An indirect subsidy given to bicycle producers would lower their marginal
cost of production and enables the producers to pass on the cost savings to consumers by
reducing the price.

Figure 4: Subsidy to address positive externality

[E] From Figure 4, granting a subsidy equal to MEB at the socially optimal output Q*, incentivising
the producers to internalise the MEB to society. [E] The per unit output production subsidy will
lower the producers’ MPC, causing an increase in supply. The SS curve (MPC) will shift vertically
downwards to SS1 (MPC1) by the amount of MEB at Q*. Assuming the government has perfect
information and is able to estimate the MEB accurately, the subsidy results in a rise in output from
Q to Q*. This is because the rise in supply causes price of bicycles to fall and this incentivizes
consumers to increase quantity demanded for bicycles to Q*. [L] The new market equilibrium
output (where SS’ = DD coincides with socially optimal output Q* (where MSB = MSC), causing
the welfare loss of area A to be eliminated and allocative efficiency is restored. The subsidy
represents a market- based approach which does not interfere excessively with market forces,
hence, consumers will preserve their sovereignty and can decide whether to buy a bicycle.

Evaluation: [P] However, the subsidy needs to be calibrated carefully to reduce the risk of
worsening the market outcome as the government may not be able to measure MEB accurately.
[E] For example, an over generous subsidy (value of subsidy is greater than MEB) may result in
too many consumers using bicycles on pedestrian walkways or on the roads which may pose a
risk to pedestrians and other road users. When there is over consumption of bicycles, it may also
result in unintended consequences when bicycles are parked indiscriminately in public spaces,
causing inconvenience to other uses of these spaces.
 17

[E] From Figure 4, the over subsidization occurs when a subsidy of S2 instead of S1. This shifts
MPC down to MPC2 and this results in equilibrium quantity of bicycles consumed to be at Q2
(where MPC2 intersects with MPB). At Q2, the addition to social cost exceeds the addition to social
benefit, leading to overconsumption of Q* - Q2 units. [L] If the welfare loss from this over
consumption is greater than the welfare loss that comes about from the positive externalities in
the free market, then government failure occurs.

Also, the strain on government’s budget which arises from the subsidy expenditure may lead to
lead to opportunity costs incurred in the form of less reserves available for spending in other
economic sectors.

[P] Besides indirect subsidies, the government can consider direct provision of bicycle facilities
and the implementation of cycling lanes to tackle the market failure problem. [E, E] Facilities such
as lockers and sheltered bike stands at workplaces or near MRT or train stations may encourage
more people to cycle to work. In addition, the government may also build cycling routes and
dedicated cycling lanes on roads to allow cyclists to travel at their preferred speed without
interference from traffic conditions. When more people using bicycles instead of their cars to
commute to work, this will help society to reap the external benefit from cycling and maximise
society’s welfare. If the policy is successful, this will enhance the experience of cycling and raises
the demand for bicycles, where MPB will now shift towards MSB. [L] The new market equilibrium
output moves closer to the socially optimal output Q* (where MSB = MSC), causing welfare loss
of area A to be reduced and improvement in allocative efficiency.

Evaluation: [P] The above policy may be limited in the sense that some may regard bicycles as
poor substitutes to driving. [E] This is because there are dangers when cyclists share the roads
with motorists, on top of the physical exertion from cycling. [E] Also, consumers may not respond
to the price incentives as intended by the government. [L] Therefore, the new market equilibrium
may not be at the socially optimal level, and the allocative inefficiency in the market persists.

Conclusion:

[Stand] Overall, subsidies by the government to reap the external benefits from cycling is an
effective way to maximise society’s welfare.
[Substantiation] The success of the policy is more apparent for land scarce countries that face
severe congestion and pollution problems from the usage of cars, such as Singapore. In this case,
cycling may help to alleviate the congestion problem and the degree of positive externality from
cycling may be significant. Although it is difficult to quantify the exact value of external benefit
which may then result in the ‘wrong’ level of subsidy given, the problem of over-consumption that
ensued from this wrong level of subsidy may be minimal as the external benefit from the
consumption of bicycles will be relatively large. Overall, the subsidy will improve society’s welfare.

However, subsidies alone may not be sufficient to tackle the market failure problem. In the longer
term, the government should focus on making cycling comfortable and attractive through street
planting and sheltered walkways, as well as providing end-of-trip amenities such as bike parking
around bus stops and train stations on top of dedicated cycling lanes to encourage more
commuters to cycle. Additionally, to encourage more commuters to give up driving and increase
the substitutability between cycling and driving, the government should improve public transport
connectivity and expand its network. Regulations should also be enacted to allow foldable bikes
in certain MRT carriages and buses. Integrating cycling infrastructure with public transit will give
cyclists the flexibility to combine public transport and cycling in their travel options. This will further
decrease the problem of congestion and pollution.
 18

Question 2
In recent years the United States (US) government has increased tariffs (import taxes) on
a wide range of imported goods from China.

(a) With the aid of a diagram, explain what is meant by consumer surplus and producer
surplus
(b) Discuss the view that all economic agents in the US economy will lose from the
introduction of tariffs on imported goods from China

Approach
Part (a)
Students are required to use diagrammatical analysis to explain the derivation of both consumer
surplus and producer surplus. In the case of consumer surplus, the marginalist principle must be
applied to explain the maximum amount that a consumer is willing to pay above the amount
actually paid. The consumer surplus is derived from the Law of Diminishing Marginal Utility.
Similarly, the explanation of producer surplus is based on the marginalist principle and derived
from the Law of Diminishing Returns.

Answer outline:
[P] Consumer surplus refers to the difference between what consumers are willing and able to
pay for a good or service (indicated by the demand curve) and the amount that they actually pay
(i.e. the market price). [E] It is shown by the area under the demand curve and above the
market price. It is a measure of consumer welfare that people gain from consuming goods and
services.

[E] The demand curve is downward sloping due to the Law of Diminishing Marginal Utility (LDMU).
Consumers value each good based on the satisfaction that they derive from the consumption of
an additional unit of the good. For example, marginal utility is the additional satisfaction that a
 19

consumer derives from consuming a plate of chicken rice. LDMU states that beyond a certain
level of consumption, as more and more of a good is consumed, the additional utility gained from
the consumption of the good decreases. For example, the consumer feels less satiated as he/she
consumes an additional plate of chicken rice. The amount that a consumer is willing to pay above
the amount actually paid diminishes. The price (MC) is the addition to the total cost from
consuming 1 more unit of the good, and this is assumed to be constant. This is because
consumers are assumed to be price takers in a market and cannot influence the market price of
chicken rice with their individual consumption levels. MC corresponds to the market equilibrium
price, Pe The market equilibrium price, Pe and quantity, Qe is determined by the intersection of
market demand and supply at the equilibrium point, E.
With reference to the diagram, at Q1 units, MB (MU) =P1. The additional consumer surplus gained
from consuming an additional unit of the good at Q1 is given by P1-Pe. When Q2 units of the
good is consumed, MB (MU) falls to P2. The additional consumer surplus gained from consuming
an additional unit of the good at Q2 is P2-Pe. Consumers will continue to consume as long as MB
> MC (or MU>Pe), since there is a net gain in consumer surplus. However, at Q3, consumers will
cut back given MB of P3 is lower than Pe, thus causing a net loss in consumer surplus. As a
result, consumers will maximise the consumer surplus at Qe, where the MB from consuming the
last unit of the good equates to equilibrium price, Pe. The total consumer surplus is given by the
area below the demand curve and above the price line at Pe, which correspond to area aEPe.
Producer surplus is the difference between what producers are willing and able to supply a good
for and the price they actually receive. It is shown by the area above the supply curve and
below the market price. It is a measure of producer welfare.
The supply curve is upward sloping due to the Law of Diminishing Marginal Returns (LDMR),
where MC refers to the addition to total cost from producing one more unit of the good. In order
to produce higher levels of output, a firm will need to employ more factors of production. In the
short run, some factors of production e.g. capital is fixed. As more variable factors e.g. labour are
added, each variable factor will have increasingly less of the fixed factor to work with and hence,
the addition to total cost i.e. marginal cost (MC) increases as output increases. Producers must
minimally be able to charge a price equal to the MC in order for it to be willing and able to produce
and sell the good. The supply curve is thus upward sloping to reflect the increasingly higher prices
that producers must receive in order for them to be willing and able to produce and supply the
good at each output level. MB for producers is the marginal revenue derived from the production
and sales of additional units of the good, which corresponds to the market equilibrium price, Pe.
With reference to the diagram, when Q1 units of the good is produced, MC=P3. The additional
producer surplus gained from producing an additional unit of the good at Q1 is given by Pe – P3.
When Q2 units of the good is produced, MC rises to P4. The additional producer surplus gained
from producing and selling an additional unit of the good at Q2 is Pe – P4. Producers will continue
to produce as along as Price > MC (MB > MC) since there is a net gain in producer surplus.
However, at Q3, producers will cut back on production since MC of P2 exceeds Pe, thus causing
a net loss in producer surplus. As a result, producers will maximise producer surplus at Qe, where
MC from producing the last unit of the good equals to the equilibrium price, Pe. The total producer
surplus is given by the area below the price line at Pe and above the supply curve, which
correspond to area bEPe.
 20

Part b
Approach
Students are required to give a good analytical explanation of the impact of tariffs on at least two
economic agents of producers, consumers or the government. Students should highlight that
amongst the producers there could be different impact on producer surplus depending on whether
they are importers of raw materials from China or whether they are producers in the protected
domestic sectors in US. Similarly, the impact on consumer surplus also differs for consumers as
some consumers are also workers in the protected sectors. Evaluative judgements must be made
on the overall impact on consumers and producers surplus and this will depend on the objective
of the policy, issues pertaining to producers’ competitiveness in the long term and the unintended
consequences on government’s macro goals.

Introduction
A tariff is a tax imposed by one country on the good and services imported from another country.
It serves to raise the price of imports to make domestic goods more attractive to domestic
consumers and thus help to boost domestic production. The tariffs in question were first
implemented in 2018, when the Trump administration slapped steep levies on over $200 billion
worth of Chinese goods such as solar panels, washing machines, steel, and aluminum, to combat
what then US President Trump described as unfair practices. Trump accused China of forcing
foreign companies to exchange technology for access to the Chinese market, and reportedly
dumping cheap goods in the U.S.

Body
Let us consider the effect of a protective tariffs imposed by the US government on Chinese imports
We will assume that the US is too small a buyer of the product in the world market to affect the
world price if it varies its demand for imports. It is thus a price taker at the world price. China is
willing to supply as large a quantity as US would want to buy at the world price, i.e. world supply
curve is horizontal as supply is perfectly price elastic.

Figure 1: Impact of tariffs on imports and consumer surplus

 21

Before the imposition of the tariff, at the world price of Pf, consumption was 0D units, of which 0A
is from domestic production source (price taker country producing 0A on domestic SS curve Sd)
and remaining quantity supplied of AD is from imports. Consumer surplus = PfXZ. Domestic
producers’ surplus= Area (5).
Impact on consumer/ Households
After the imposition of the tariff, the market price rises by the full amount of the tariff to Pt since
US alone cannot influence world price. They are therefore facing a horizontal supply line. At price
Pt, domestic production increases to 0B. Imports are reduced to BC.
Thus, domestic consumers lose as they now pay higher prices (Pt > Pf) and consumer surplus
shrinks from area PfXZ to area PtXY. There is a reduction in consumer surplus equivalent to area
PfPtYZ (Areas 1 + 2 + 3 + 4).
However, domestic workers employed in the industries in which tariffs are imposed could benefit
from the introduction of tariffs. When domestic firms expand production from 0A to 0B, they will
hire more workers and unemployment in these sectors will fall. Workers employed in these sectors
will experience a rise in their incomes. This would protect increase their ability to consume goods
and services and hence increase their welfare.
Additionally, households may also experience a rise in prices for goods that are heavily reliant on
imported factor inputs (explained below).
Impact on producers
Domestic producers supplying the goods in which the tariffs are applied on foreign imports will
benefit from the introduction of tariffs. The imposition of the tariff raised the price of imports,
resulting in a reduction in imports and an increase in domestic production, thus protecting the
domestic industry from foreign competition.
Domestic producers’ surplus increases from Area (5) to Areas (1) + (5). The increase in domestic
producer surplus is represented by Area 1 due to the redistribution effect. Domestic producers in
industries where tariffs are imposed on foreign imports are likely to benefit in the short run due to
protective effect of tariff.
However, for producers that rely heavily on the foreign imports as a factor input for production will
experience a rise in their marginal costs of production, For example, the tariffs imposed on steel
imports would raise the marginal cost of production for car makers that use steel as one of its key
factor inputs. With reference to the Figure 2 below, a rise in price of steel would cause a fall in
supply of US cars from S1 to S2, which results in a fall in producer surplus from ABP1 to DCP2.
 22

Figure 2: Impact of tariffs on producer surplus

Furthermore, the rise in price of factors inputs will cause a rise in MC and AC, resulting in a fall in
profits of producers. This could lead to a contraction of downstream industries, for example, the
rise in price of China’s steel may also affect the construction and machinery manufacturing
industries as output falls and there will be a rise in unemployment in these sectors. Moreover,
households will also lose out in the long run when the higher costs of production experienced by
downstream producers is passed down to consumers in the form of higher prices.
[EV] The extent of the impact on downstream producers depends on the strategies undertaken
by firms in these industries. For example, downstream producers may undertake strategies such
as finding alternatives and reduce reliance on factor inputs from US, undertake more efficient
methods of production so as to offset the higher AC from the tariffs, or move their production to
other countries (i.e. offshoring) so as to bypass the import tariffs.
[EV] In the LR, whether firms that are protected by tariffs are more likely to benefit/lose depends
on their ability to become more efficient and competitive. If these firms take steps to improve
productivity (through process innovation) or the quality of the product (through product
innovation), this can help to boost competitiveness in a sustainable manner, without need for
further govt protection. However, if firms becomes complacent and their good are less price-
competitive compared to foreign imports even with the imposition of tariffs, they will eventually
face a loss in profitability. Moreover, high import tariffs may also force downstream producers to
undertake strategies such as offshoring (as explained above), which would cause firms in the
protected industries to experience a fall in demand for their goods and eventually, a loss in
profitability.

Impact on government
Government will also benefit from the increase in tax revenue collected. With reference to Figure
1, the revenue collected by government from the tariff is equal to Area 3 (revenue effect), which
is calculated by taking the per unit tax multiplied by the number of units imported.
However, the imposition of tariffs would result in overall welfare loss for society and worsens
allocative inefficiency. Area 2 measures the welfare loss due to the increase in domestic
 23

production (production effect). This is because the domestic producers are relatively more
inefficient than the foreign producers, leading to wastage of resources. Area 4 measures the
surplus that is lost by consumers due to the reduction in overall consumption (consumption effect).
Units C to D could be acquired at low cost and generate high value (between Pt to Pf in diagram)
of consumer surplus but they are not bought. The tariff imposed has denied consumers the
opportunity to consume these quantities. The welfare loss is thus represented by Areas 2 and 4.
The tariff has led to domestic over-production and domestic under-consumption of the good.
Conclusion
[Stand] Most consumers, some producers (especially downstream producers) and the
government is likely to lose from the introduction of tariffs on imported goods from China. Whether
economic agents lose or benefit from the import tariffs depends on various factors such as the
purpose of the tariffs, the length and extent of the tariffs, as well as the efficacy of the US
government in channeling the tariff revenue earned to retraining programmes and/or mitigate the
negative consequences associated with the imposition of tariffs on the other economic agents.
[Substantiation]
Depends on purpose and length of the tariffs – If the tariffs had been adopted as a populist
measure and the government has no proper plan or intention to remove the protection over time,
then workers, consumers and firms are more likely to lose in the long run as consumers have to
pay higher prices and downstream producers also face higher cost of production. Additionally,
while the imposition of tariffs helps to protect the jobs in the inefficient industries, this comes at
the expense slowing down the reallocation of scarce resources to higher value-added areas,
which would slow down the pace of economic growth.
If the tariffs are implemented on a sunset industry in which the country no longer has comparative
advantage in and the intent is to prevent massive structural unemployment, then whether workers
ultimately benefit or lose out in the long run, depends on how actively the government undertakes
R&D to develop new areas of comparative advantage as well as the quality of retraining
programmes to enhance factor mobility of workers.
Depends on how government uses the tariff revenue – if the government redistributes the
tariff revenue earned to supplement the incomes of the poor and/or offset the spending on
essential goods and services through the use of grants and vouchers, then it may contribute to
alleviating inequity and households may not necessarily lose as a result of the higher prices.
 24

Question 3

Singapore’s telecommunications (telco) market is dominated by four firms - Singtel (32%),

StarHub (25%), M1 (22%) and new entrant MyRepublic (15%), Commentators argue that
Singapore’s telco market might be considered an oligopoly.

(a) Explain why Singapore’s telco market might be considered to be an oligopoly and how
economic theory suggests this market structure would affect the firms’ pricing and
output decisions. [10]

(b) Discuss how government intervention in Singapore’s telco market could protect
consumers and consider the extent to which such intervention will be successful.[15]

Approach

Part (a)

To address this question, students must explain the characteristics of an oligopoly and why these
characteristics could fit the Singapore telco context. Linking to the characteristics of an oligopoly,
students must explain how prices and output are determined (e.g. for oligopoly, rival
consciousness may result in price rigidity or collusion such as price leadership).

Suggested Answer:

Introduction

The structure of the market can be described in terms of the following characteristics: level of
barriers to entry, number and size of sellers (i.e. firms / producers), nature of product, level of
market information / knowledge from the perspective of consumers and producers. Telco
companies in Singapore operates in an oligopolistic market structure. An oligopoly is a market
where there are only a few firms or there could be many firms, but a small number of firms control
a high percentage of the market’s sales.

Body

[P] In the telco market in Singapore, barriers to entry are high. [E] To set up telecommunications
services, firms will need to incur high set-up costs (fixed cost) in terms of setting up underlying
network infrastructure like satellites, fiber cables and broadband servers. Potential entrants may
not be able to afford the expensive infrastructure or capital required or may find investing in the
expensive capital risky if the business is not successful.

[E] The firm also needs to be large enough to reap internal economies of scale, where the lower
unit cost enjoyed by the large telco firms also pose an entry barrier since new firms will face higher
unit cost due to a smaller scale of production and thus may not be able to compete by matching
the lower costs of the incumbents. For example, SingTel is able to enjoy technical EOS through
gains from specialization e.g. dedicated IT workers or gains form indivisibilities of capital. e.g the
network infrastructure cannot be divided into smaller units, the Singtel needs to serve a very large
number of customers to lower its cost. A new entrant whose initial output level may be relatively
small will have difficulties competing with an establish brand. Besides natural entry barriers, there
are also artificial entry barriers. Telco firms need to apply license from the Infocomm Media
 25

Development Authority to operate. In Singapore the government limits the number of

licenses in this industry, and this in turn prevents new firms from entering the market. [L]
The high barriers to entry results in a limited number of firms.

[P] For a telco firm to be profitable, there can only be a small number of large firms. [E, E] The
telco market is dominated by a few large firms such as SingTel, StarHub, M1 and MyRepublic.
Moreover, the telco market can be considered an oligopoly as the 4-firm market concentration
ratio is 93%. Hence, telco firms need to take the actions and reactions of their rivals into account
when they make their own production or marketing decisions. [L] The small number of dominant
firms result in rival consciousness.

[P] The telco firms also sell differentiated products in the products that they offer. [E] Telco firms
would offer a variety of services such as mobile data plans, TV and internet subscription services.
[E] For example the market for TV licensing, StarHub has exclusive licensed broadcasting rights
for the live matches for the English Premier League, whereas other telcos only offer other football
leagues such as the Bundesliga in Germany. In the market for mobile phone data plans, SingTel
boasts the fastest 5G mobile plan, as compared to their rivals. [L] With these characteristics
(barriers to entry, small number of firms, product differentiation), telco firms are likely to operate
in an oligopoly market structure.

[P] Firms in the telco industry possess high market power, enabling each firm to be a price setter.
[E,E] Due to the high barriers to entry resulting in a smaller number of telco chains competing in
the telco industry, the firms have a higher level of market power. This is further reinforced by the
high degree of product differentiation in this market. Hence, when a large firm raises the price of
its services, it will still be able to retain some customers as there is a lack of close substitutes for
the customers to turn to. [L] The high market power enables telco firms to be price-setters, thus
they face a relatively price-inelastic demand for its products. Although they are price-setters, the
firms are still subjected to the law of demand and can determine either the price or the output but
not both. To sell an additional unit, firms have to lower its price.

[P] Firms in the telco industry aim to maximise profits, thus will produce Qe and charge price Pe.
[E, E] Firms in the telco industry are assumed to aim to maximise profits, hence they will produce
at Qe according to the marginalist principle where MR = MC, with the MC curve cutting the MR
 26

curve from below. In Fig 1, at Q1, when MR > MC, an additional unit of output adds more to TR
than to TC, causing profit to rise, thus the firm should increase its output to increase profits. On
the other hand, at Q2, where MR<MC, an additional unit of output adds less to TR than to TC,
thus a loss is made on this additional unit, hence the firm should decrease its output to maximise
profits. Hence, at Qe, when MR=MC, profits is maximized, and there is no tendency to change
output any further. [L] At this output level, Qe, firms in the telco industry will fully exploit its market
power by charging price Pe since this is the highest price consumers are willing and able to pay
for Qe units of telco services as indicated by the firm’s demand curve.

[P] In addition, due to rival consciousness, firms in the telco industry prefer to keep prices stable.
[E,E] As explained earlier, firms in the telco industry operate in an oligopoly and there is rival
consciousness when firms in this industry make decisions. For example, when StarHub cut prices,
this may cause its rivals M1 or SingTel to follow suit to prevent loss of customers. Hence, the fall
in price is likely to result in a proportionately smaller increase in quantity demanded, resulting in
a fall in total revenue for StarHub which started the price cut. On the other hand, if StarHub instead
raises prices, its rivals may not follow suit, resulting in a more than proportionate fall in quantity
demanded for its products and a fall in its total revenue. [L] Hence, telco chains prefer to keep
prices unchanged once they have set it at Pe, unless faced with significant changes in market
conditions.

[P] Moreover, rival consciousness may also cause firms in the telco industry to collude implicitly
in the form of price leadership. [E, E] The smaller telco firms such as Circles.Life and MyRepublic
will tend to charge a price close to the price Pe that is set by the big telco firms (price leader) as
they fear triggering a price war and sustaining losses. The smaller telco firms may not have
reserves from past supernormal profits to sustain a price war with the big telco firms. [L] Hence,
they will follow the prices charged by the large telco firms.

Approach

Part (b)
To address the first requirement, students must address how the government interventions work
(focus is on the policy mechanism for deregulation, MC/AC pricing and fines) to protect
consumers’ welfare, namely the use of consumer surplus and lowered prices, and increasing
variety of choice. The choice of deregulation to lower barriers to entry and MC/AC pricing is
preferred as students can use diagrammatic analysis as a tool of analysis.

For the second requirement, students must evaluate the success of each government intervention
in the context of the telco market in Singapore. The level of success for each policy can vary,
depending on the appropriateness of the policy in improving consumers’ welfare, considering the
intended outcomes and unintended consequences for each policy.

Suggested answer:

Introduction

As mentioned in (a), the telco market in Singapore is considered an oligopoly. Firms with high
market power tend to restrict output and charge a price higher than MC. Government intervention
is needed protect consumers’ welfare. Government intervention would include deregulation to
remove barriers to entry, impose MC pricing and fines to punish telco firms for anti-competitive
 27

behaviour. To measure how government intervention (by the IMDA) can protect consumers, we
will consider outcomes for consumers, which can be improved if the price charged is lower as this
increases the affordability of the goods and the consumer surplus. In addition, providing greater
choices will improve consumers’ satisfaction and hence consumers’ welfare. The extent of the
policies may differ, depending on the success of the policies in the context of the telco market.

Intervention 1: Deregulation to remove barriers to entry is largely successful in protecting

consumers by lowering prices and increasing variety of consumer choices.

[P] Impact of deregulation on the outcomes for consumers in the telco market

[E, E] The government can deregulate and allow new entrants into the telco markets by reducing
the barriers to entry. For example, the government had granted TPG a network license to operate
in Singapore to compete in the telco market. Also, existing telecommunications giants such as
M1 and SingTel have more recently shared the use of their existing network infrastructure with
new Mobile Virtual Network Operators (MVNOs) such as Circles.Life and GOMO. The entry of
more firms into the telco industry encourages greater competition and reduces market dominance
by the incumbents. In addition, allowing the entry of new firms helps abolish exclusivity
arrangements with popular bundles such as new release iPhones help consumers gain greater
access to these products.

Assuming cost remains unchanged, with new entrants into the industry, incumbent firms are likely
to face a falling demand, i.e. DD falls from DD1 to DD2. Demand also becomes more price elastic
with more substitutes available. The prices that incumbents can charge have fallen from P1 (where
MC=MR) to P2 (where MC=MR2) making it more affordable for consumers to purchase the service.
[L] The lower price charged by the incumbent firms coupled with a rise in the whole industry’s
output improve consumer surplus.

[E, E] This policy has largely been successful in lowering prices in the telco industry, where
mobile data plans have mostly fallen with greater competition. For example, TPG offers $10 for
 28

100GB of data per month, which is much lower than the prices of SingTel and StarHub plans in
the past. There has also been a greater variety of choice for consumers, with the (re-)emergence
of SIM only plans, for consumers to choose the amount of mobile data they need from month to
month, as opposed to being locked into a fixed amount of mobile data every month. [L] Thus,
these have shown that deregulation to reduce barriers to entry can be considered a large
successful intervention by the government to protect consumers’ interest of lower prices.

[Ev] However, with more firms entering into the 2 markets, each firm will now produce at a lower
output (Q1 to Q2). This can mean the loss of potential internal economies of scale (EoS), especially
for the telco license owners (but less so for the MVNOs). The costs of maintaining the telco
network and performing any upgrades to the network fibre cabling are now spread over a lower
range of output. Higher average cost may translate into higher prices for households if the firms
become less able to pass on cost savings to consumers. The reduced supernormal profits earned
by firms may also have adverse impact on the quality of service or product innovation. This will
have a negative impact on the consumers.

Intervention 2: Price controls such as MC pricing might protect consumers by lowering

prices

[P] Impact of MC pricing on the outcomes for consumers in the telco market

[E,E] The government (IMDA) can also regulate the telco markets’ pricing. With market
dominance, firms tend to restrict output, resulting in higher prices. This is observed in the telco
market where a large market share and 4 firm concentration ratio of 93% grants these firms
significant power. For example, the price of exclusive programs such as English Premier League
broadcasts cost $49.90 per month on SingTel.

Assume that a telco is initially charging P1 and earning supernormal profits. The government can
regulate the prices in the telco market using MC pricing. By compelling the firms to charge
P=MC, price is reduced from P to PMC, with output rising from Q to QMC. Here, firms will be making
supernormal profits as PMC > ATC, but of a smaller amount. This output QMC, on the other hand,
is allocative efficient, and allows for improvements for consumers with higher output and lower
price. Here, consumer surplus has increased from abP1 to adPMC.

P, R, C
($) a

MC
b ATC
P1
d
PMC

DD
MR

0 Q1 QMC Qty / t
 29

[Ev] Due to imperfect information, this means that the government will have to rely on the firms to
provide their demand and cost curves for price regulation in order to carry out MC pricing
accurately. However, profit-maximising firms will not be incentivised to provide such accurate
information MC pricing will likely hurt their profits.
Another disadvantage is that with reduce profits, the telcos will have less incentive to engage in
innovation. This will be detrimental to consumers’ welfare.

Intervention 3: Fines on incumbent telco firms might protect consumers if firms are found
guilty of anti-competitive behaviour.

[P] Impact of fines on the telco market to lower prices via deterrence of anti-competitive
behaviour.
[E, E] If incumbent telco firms are found to have engaged in anti-competitive behaviour such as
price fixing and collusion, the government can apply anti-trust laws to penalise these firms, or
used as a deterrent. If firms are fined, the firms’ supernormal profits are likely to be significantly
reduced if the fines are large enough. This may be effective when the incumbent firms such as
SingTel and StarHub are likely to be more incentivised to be more productive efficient, and
eventually charge competitive prices in order to avoid hefty fines. [L] Consumers will benefit from
the fall in price of telco services, granting greater consumer surplus and choices. Thus,
consumers will be protected with these improved outcomes.

Conclusion:

[Stand]
In the telco market, the use of deregulation to remove barriers to entry is likely the most successful
intervention to protect consumers, whereas other policies such as MC (or AC) pricing and fines
might be less successful to protect consumers.

[Substantiation]
Policies to allow for new entrants such as deregulation is likely the most successful and in line
with the Singapore governments’ initiatives. With the removal of barriers to entry, new entrant
firms can only enter the telco market to lower prices, it also offers a greater variety of products
that cater to different consumers’ needs. For example, for consumers who want a fuss free
product, they can opt for cheaper mobiles such as the above-mentioned TPG mobile plan for $10
for 100GBs. However, for consumers that require more services such as global roaming data or
greater amount of talktime, opting for the mobile plans from the incumbent telcos SingTel or
StarHub might be a better choice, with better connectivity for travelers at a relatively lower
additional cost. However, the extent of the success of the deregulation depends on the number
of new Telco firms that the Singapore government allows to enter. There should not be too many
players operating in Singapore’s small domestic market (there are currently 4 telcos and 7
MVNOs in Singapore) which may erode the cost savings from large scale production. On the
other hand, policies to directly depress supernormal profits such as MC pricing, or fines might
come with unintended consequences of firms to reduce incentive to innovate. Innovation is
extremely crucial in the telecommunications industry as it directly affects the speed of
digitalisation of services, an important factor to consider to develop Smart Nation initiatives from
the government.

In the telco space, next steps in development come in the form of 5G networks and
implementation of Internet of Things (IoT) to digitalise in examples such as SingPass. Thus, to
promote innovation the government (IMDA) has granted a license for a joint venture between M1
and StarHub to develop 5G networks. The joint venture can reap economies of scale for this
 30

particular project. Overall, this can help give consumers better consumer surplus in the long run,
as such product innovation of 5G networks not only give consumers a greater variety of choice, it
also improves consumers’ internet speeds, which positively impacts consumers’ utility in any
internet-related service (e.g. NetFlix video streaming, Spotify music streaming) they consume.

Question 4

The rate of unemployment in more than 50 of the world’s countries, including several
European countries, exceeds 10%. Governments face a difficult decision about whether
income tax rate cuts are the most effective policy measure to reduce unemployment to
more acceptable levels.

a) Explain how a reduction in the rate of income taxes paid by workers and firms might
have consequences on an economy’s aggregate demand and aggregate supply. [10]
b) Discuss whether a reduction in the rate of income taxes is likely to be the best policy
measure to reduce high unemployment in a country. [15]

a)
Approach
Answers should demonstrate analysis of how a fall in both income and corporate tax will result in
a rise in both AD and AS.

R1: Explain how a fall in taxes will impact the AD, via C and I components
R2: Explain how the fall in taxes will impact the AS, both the horizontal as well as the vertical
portions of the curve. Candidates should be able to recognize that it affects the UCOP and the
productive capacity of the economy.

Introduction
Reducing the rate of income tax rates paid by workers and firms is a form of an expansionary
fiscal policy, to address the problems of negative real/actual growth (recession) and demand-
deficient unemployment. In the AD-AS model, a country’s real GDP level is determined by the
intersection between aggregate demand and aggregate supply of domestic output.

Body

Aggregate Demand refers to the total demand of domestically produced goods and services that
buyers collectively desire to purchase at each general price level (GPL) in a given time period.
These buyers include domestic households, domestic firms, the government and foreigners. The
AD for domestic output can thus be obtained by summing planned consumption expenditure (C),
investment expenditure (I), government expenditure (G) and net exports expenditure on goods
and services (X - M).

The aggregate supply (AS) curve shows the level of domestic output that firms collectively desire
to produce at different general price levels. Aggregate supply depends on the decisions of firms
to use workers and other factor inputs to produce goods and services to sell to households,
government, other firms and for exports.
 31

[P] A cut in both the income as well as corporate taxes will increase the AD.

[E,E] Lower income tax means that households will have higher disposable income. This then
leads to an increase in purchasing power, raising ability of households to spend on consumer
goods/services to satisfy their wants increases, raising consumption (C) levels. On the other hand,
lower corporate tax raises the expected after- tax profits for firms. This increases the post profits;
and with higher returns on investment, firms are likely to demand more capital goods (e.g.
machinery), leading to an increase in investment expenditure (I). With the rise in both C and I, AD
rises, represented by a rightward shift form AD1 to AD2 shown below.

[P] A cut in corporate taxes will also increase the AS, thereby increasing the country’s
productive capacity.

[E, E] A rise in productive capacity means a rise the ability of the economy to produce goods and
services. For example, the increased investment spending by firms will increase the quantity of
capital, such that the productive capacity of the economy rises. Foreign direct investments will be
drawn too, as the post-tax returns are relatively higher than elsewhere in the world, further
increasing the capital stock accumulated. Therefore, assuming the rate of capital depreciation is
lower than the rate of capital accumulation, this will result in a rightward shift of the vertical portion
of the AS curve from AS1 to AS2 to reflect an increase in potential growth, as shown above.

[P] A cut in corporate taxes will also lower the unit COP, thereby increasing the AS.

[E, E] As explained above, post-tax profits will increase when corporate tax rate falls. With the
rise in profits, firms are incentivised to increase their investment expenditure, which includes
machinery. With greater use of technology, this allows firms in various sectors of the economy to
be more efficient in using resources and hence labour productivity increases. While this will lead
to increases in the country’s productive capacity because the same quantity of labour can now
produce more, there will also be a reduction in unit cost of production. Assuming wages do not
rise, UCOP will fall and hence AS increases (horizontal AS shifts down as shown above). Through
the movement along AD and via the international substitution, net wealth and real interest effect,
RNY will increase hence there is actual growth.
 32

[L] Therefore, a cut in both income and corporate tax can enable AD and AS to increase in tandem,
likely to lead to a sustained growth of an economy.

b)
R1: Candidates should explain how expansionary fiscal policy (via rise in G and/or reduction in
income taxes) would likely reduce cyclical unemployment rate in an economy.
R2: Candidates should discuss one other policy and how it would likely result in cyclical
unemployment rate.

Approach
Answers should demonstrate knowledge of the various policy tools to reduce high unemployment
rates. An answer should therefore first explain how an expansionary FP (via taxes) can help to
reduce unemployment levels, followed by a discussion of at least one other policy tool. Finally,
answers should conclude by making a substantiated judgement on whether expansionary FP
should remain the most important policy to control the different types of unemployment present in
an economy.

Intro
Unemployment is a condition where some factors of production are not being used in the
production of goods and services. Unemployment rate is the number of unemployed expressed
as a percentage of the labour force. In a globalised world with increase integration between
economies via trade flows, investment and labour flows, many economies end up with at least
one of the three main types of unemployment: cyclical, structural unemployment. In deciding
which policy to adopt to maintain a low rate of unemployment, it is necessary to consider the
nature of the economy and the type of unemployment faced.

Body
[P] As explained in part (a), reducing both income and corporate tax will cause the AD to
rise, reducing cyclical unemployment levels in the country.

[E, E] An expansionary fiscal policy would increase AD and lead to a rightward shift of AD from
AD1 to AD2 as C and I increase. With AD exceeding AS at the current general price level, there
will be an unplanned fall in inventories. This will lead to firms increasing production and hiring
more factors of production, such as labour. As a result, households’ income will increase and this
increase in purchasing power will induce higher consumption of other domestic goods and
services. This leads to further increases in production and more FOPs hired resulting in another
cycle of spending. The national income will be higher as output increases further. This multiplier
process would lead to an increase in real GDP to Y3 that is a multiple of the initial injection. As a
result, there will be actual growth and a fall in cyclical unemployment.

[L] Since the demand for labour is a derived demand, the increased production of the economy
leads to increased employment, from Y1 to Y3, reducing the unemployment rates.
 33

[Ev] However, expansionary fiscal policy via a reduction in taxes has its limitations. In light
of the current global economic condition where consumer and business sentiments are bleak, a
cut in taxes may not be as effective in addressing cyclical unemployment. Tax cuts may not
stimulate consumption especially during a recession if consumers and investors feel pessimistic
about the future. With poor consumer sentiments and expected fall in sales, firms may see little
incentive in expanding their productive capacity. As such, low confidence in the would often make
consumption and investment indifferent to tax cuts, limiting a government’s ability to stimulate
AD. With a limited increase in AD, the economy will not be stimulated enough and cyclical
unemployment may persist.

[P] The government can utilise supply-side policy to reduce structural, cyclical and
frictional unemployment.

[E, E] Supply-side policy to retrain workers can reduce structural unemployment. Structural
unemployment occurs when workers are unable to find jobs that require their particular skills.
These workers are unable to take up available jobs in growing sectors because they lack the
necessary skillsets. This means that time is needed for these workers to pick up new skills, leading
to occupational immobility. As such, the government can intervene either through subsidising
education or by directly providing the education services. It can set up vocational and tertiary
institutions focusing on technical education in order to train the workforce with the necessary skills
demanded by the industry. Alternatively, the government can also provide training facilities or
subsides to encourage workers to go for further training and upgrade themselves. For example,
to cope with the climbing unemployment levels in the UK, the government had sought to help
those structurally unemployed with their Plan for Jobs scheme, which aims to help people back
into work by developing their skills. This would lead to a more skilled workforce who will be able
to take on available jobs once the UK emerges from the pandemic.

[E, E] Supply-side policy to reduce the unit cost of production can reduce demand-deficient
unemployment. For example, the UK government had also provided wage subsidies to reduce
labour costs, in response to the crisis borne by the pandemic. By reducing firms’ labour costs,
they would be better able to retain employment in times of falling demand and revenue, thus
reducing cyclical unemployment. As shown below, the rise in AS from AS1 to AS2 due to 4a fall
in firms’ unit COP increases the employment levels from Y1 to Y2 in the economy.
 34

YF
A highly skilled workforce is also more productive, flexible and occupationally mobile which in turn
also attracts more FDIs. Investment expenditure which is a component of AD rises which will
result in a rise in AD. This leads to a multiple rise in national income which boosts actual growth
and further reduces cyclical unemployment.

[L] Hence, with the implementation of SS-side policies, both structural and demand deficient
unemployment can be reduced.

[Ev] However, education requires a very long gestation period and may take many years
for the SS-side policy to take effect. Hence the positive impact of education on the economy
will be experienced years after the policy is implemented. Although skills re-training has a shorter
gestation, there is usually great resistance in acquiring new skills, especially among older workers
with low education who might either be reluctant to train (attitude problem) or are unable to be
trained (ability problem).

Conclusion
Stand: The decision on which policy to use should be based on the nature of the economy, the
source of unemployment and the nature of the economy.

Substantiation: When it comes to cyclical unemployment, a reduction in taxes may have the
edge in terms of addressing the problem quicker. However, if there is a persistent bleak global
economic outlook, it is likely that households will withhold consumption and increase
precautionary savings, thus they may not spend the increase in disposable income arising from
the tax cut, as they may be worried about job security and expectations of future income. Thus,
fiscal policy in the form of increased in government expenditure will be more effective. In the case
of structural and frictional unemployment, supply-side policies are necessary to target the root
issues as opposed to a demand-management policy. In addition, if the country has a small
multiplier as is the case for Japan, supply-side policies such as wage subsidies act as important
complementary policies for addressing demand-deficient unemployment. Nevertheless, in Japan
where ageing population persists, the elderly workers may not be as keen to explore and retrain
to work in a different sector. The nature of such training programmes is also such that attending
these courses does not guarantee successful acquisition of the required skills to gain employment
in a new sector. Furthermore, the cost of providing such training and subsiding wages can impose
a burden on the government budget especially in the current global environment where many
countries do suffer from budget deficit. Nevertheless, it is still superior to tax cuts to address
 35

structural unemployment, since it addresses one of the causes of the problem by improving
occupational mobility.

Additionally, globalisation has increased the volatility of many economies especially the export-
driven ones. As they become more integrated, domestic economic performance of one country
will quickly impact the other through trade. The smaller and more open a country is, the more
volatile she becomes to cyclical unemployment.

When the economies are growing, structural unemployment is likely to be the main type of
unemployment in many countries. Hence, policies aimed at enhancing human capital through
education and training seems to be the more fundamental solution to ensuring long term
employability.
 36

Question 5
Singapore currently has a low rate of inflation and a persistent surplus on the current
account of its balance of payments. However, unexpected external developments such as
the outbreak of disease, natural disasters or increases in global raw material prices always
represent potential risks to Singapore’s economy.

a) Explain how a modest and gradual appreciation in Singapore’s exchange rate might
affect Singapore’s rate of inflation and its current account balance. [10]

b) Discuss whether the modest and gradual appreciation in Singapore’s exchange rate is
likely to be the best policy to manage the effects of unexpected external developments.
[15]

Part (a):
Introduction
Singapore is a small and open economy that relies heavily on external demand as well as imports
of raw materials. As such the causes of inflation for Singapore is likely to be cost-push due to
rising import prices and demand-pull that comes from strong external demand.
The current account balance is the sum of the value of next exports (also known as
balance of trade), net property income from abroad and met unilateral transfers. The
biggest component is the balance of trade.
Relying on its exchange rate-centred monetary policy of a modest and gradual appreciation to
manage its economy, Singapore is able to manage its inflation rate and its current account
balance.

Body
[P] A modest and gradual appreciation in Singapore’s exchange rate can reduce a balance
of trade surplus in the current account.
[E, E] An appreciation in Singapore’s exchange rate will result in a fall in the prices of imports in
local currency (Singapore dollars) and a rise in the prices of exports in foreign currency. The rise
in the price of exports in foreign currency will result in a fall in demand for Singapore’s exports,
leading to a fall in export revenue. Assuming the demand for imports is price elastic, the fall in the
price of imports in Singapore dollars will lead to a more than proportionate rise in quantity
demanded of imports. Hence, import expenditure will rise.
[L] Thus, the fall in export revenue and the rise in import expenditure will reduce any balance of
trade surplus in Singapore’s current account.

[P] A modest and gradual appreciation in Singapore’s exchange rate will help reduce its
inflation rate.
[E, E] Inflation in Singapore can come from demand-pull and/or cost-push factors. For example,
Singapore could have been facing both cost-push and DD-pull inflation such that the GPL has
risen from P0 to P3 already.
An appreciation in Singapore’s exchange rate will result in a fall in the prices of imports in local
currency (Singapore dollars). When the S$ appreciates, raw material prices in the local currency
would fall; ceteris paribus, leading to an overall fall in the unit cost of production (UCOP) in the
 37

economy. This results in a rise in AS which is illustrated by a downward shift in the horizontal
portion of the AS curve from AS2 to AS1. The GPL falls from P3 to P2, as illustrated in the diagram
below, where the equilibrium point changes from point A to point B. This reduces cost-push
inflation.
At the same time, the value of net exports fall (as explained in the preceding paragraph). Ceteris
paribus, such a fall in net exports will lead to a fall in the AD for Singapore, illustrated by the
diagram below as AD shifts leftwards from AD0 to AD1 (point B to point C); thus alleviating
demand-pull inflation.
[L] Thus, with concurrent appreciation of SGD when SG is facing DD-pull and cost-push inflation
pressures, the appreciation of Singapore’s exchange rate can help alleviate both demand-pull
and cost-push inflation pressure for the economy.

Diagram to illustrate leftward shift in AD and downward shift in horizontal portion of AS

GPL

AS2 A
P3

P2 AS1  B
P1 C
AD2
P0 
AD1
AS0 AD0

0 Yf Real GDP/t

Conclusion
Hence, based on the above explanation, the appreciation in Singapore’s exchange rate helps to
alleviate the pressures of rise in the general price level from demand-pull and cost-push factors.
At the same time, the appreciation of the exchange rate that worsens her balance of trade which
can mitigate the persistent surplus in the current account of its balance of payments.
 38

Part (b):
Discuss whether the modest and gradual appreciation in Singapore’s exchange rate is
likely to be the best policy to manage the effects of unexpected external developments.
[15]

Introduction
Outbreak of diseases can have a contractionary impact on the aggregate demand for Singapore
(SG)’s final output. For example, the outbreak of the COVID-19 pandemic besides causing a
sharp drop in tourist arrivals in SG, also led to recession in the economies of SG’s trade partners,
leading to fall in demand for Singapore’s exports. This in turn caused SG’s GDP to contract, i.e.
negative actual growth. Natural disasters or increases in global raw material prices cause SG to
face rise in prices of imported inputs which leads to decrease in the aggregate supply which in
turn leads to cost-push inflation and contraction of SG’s GDP.
In deciding which policy is the best policy, the criteria to consider in the judgment will include
effectiveness in mitigating the effects of the external shocks, fiscal sustainability of the measure
and solving them with minimal conflict with other macroeconomic goals.

Body
THESIS – A modest and gradual appreciation of the SGD can be useful to manage the
effects of unexpected external developments

[P] A modest and gradual appreciation in Singapore’s exchange rate helps to mitigate
imported cost-push inflation that was caused by rise in global prices of raw materials
[E, E] The outbreak of disease and natural disasters can disrupt global supply chains and lead to
an increase in global raw material prices. For a small country with a lack of natural resources,
Singapore needs to import all its raw materials for production. As such, it is very susceptible to
imported cost-push inflation. A modest and gradual rise in the Singapore exchange rate would
help mitigate this rise in raw material costs. This is because the appreciation of the S$ would
reduce the rise in the foreign price of imports, leading to a smaller increase in the S$ price of raw
materials.
[L] Hence, the modest and gradual appreciation in the Singapore’s exchange rate is able to
mitigate the negative impact of rising raw material cost.

[EV] While an appreciation of the SGD can lower imported cost-push inflation in SG, as explained
in part (a), an appreciation of the SGD leads to a worsening of SG’s BOT and this in turn has a
contractionary impact on the AD for SG’s final output. Thus, this policy could lower imported
inflation but conflicts with the goal of sustained economic growth.

ANTI-THESIS – There are other policies that SG could use to manage the effects of external
developments

[P] Singapore could use supply-side policies to manage the effects of external
development on the economy
[E, E] When SG faces rise in prices of imported inputs which leads to cost-push inflation, one way
to lower inflation is to apply supply-side policies like policies to increase labour productivity - e.g.
 39

subsidies to incentivise firms to take up automation and provision of skills upgrading opportunities
to workers. With increases in labour productivity, less units of labour will be needed to produce 1
unit of output. This will lower unit cost of production and hence serve to increase AS, thereby
offsetting the contractionary impact that rising prices of imported inputs would have on SG’s AS
and [L] hence lower cost-push inflation in SG.
[EV] A limitation of this policy is that it can take a long time for such SS-side policies to take effect.
Workers might be reluctant to go for skills upgrading or it might take a long time to train the older
workers in SG who tend to have lower level of education qualifications

[E.E] When Singapore faces external shocks that lead to falling AD and recession in Singapore,
Short-term supply-side policies like wage subsidies may be implemented to keep workers in
employment and help firms offset part of their wage cost. This would ensure that firms are able to
tide over any short-term challenges whilst households’ consumption is maintained. Doing so will
help to mitigate the negative sentiments that cause firms’ investment expenditure and household
consumption to fall.
In terms of AD-AS analysis, the fall in AD would have caused SG’s real national output to fall from
Y2 to Y1. Through the wage subsidies, unit COP falls which causes AS to rise form AS0 to AS1.
This leads to do downward pressure on SG’s GPL which leads to movement along AD1. One
reason is the international substitution effect where the fall in GPL causes gain in price
competitiveness of SG’s exports. This leads to rise in quantity demanded for SG’s exports and
reduction in import spending by SG residents. SG’s national output rises from Y2 to Y1.

GPL

P2
P1 AS0
P0
AD0

AS1
AD1

0
Y
1
Y Y Yf
2
Real GDP / t
3

[EV] A limitation of this policy is that it is costly and is difficult to sustain over time.
 40

Evaluation/Conclusion
[Stand] The modest and gradual appreciation of the SGD is not necessarily likely to be the best
policy to manage the effects of unexpected external developments.
[Substantiation]
This is because it depends on the nature of the unexpected external developments that SG faces.
• If the external shock is due to rise in price of imported raw materials which causes SG to
suffer cost-push inflation, appreciation of the SGD will be the best policy to address the
problem. This is because it can solve the problem more quickly compared to SS-side policy
like policy to increase productivity to drive down cost and solve the problem more cheaply
compared to wage subsidies.

A policy of appreciation of SGD to address imported inflation could conflict with the goal of
EG, due to its contractionary effect on (X-M) and hence AD. But this conflict can be reduced
by supplementing a policy of appreciation of SGD with SS-side polices that can boost AS
such that MAS does not need to appreciate the SGD by too much.

• If the external shock is in the form of fall in export demand from one of SG’s key trade partners
(e.g. USA during the pandemic) which caused SG to suffer a recession, appreciation of SGD
will be the worst policy, among the 3 considered, to address the problem. It would worsen SG’s
recession. Although the appreciation pf SGD can help lower unit COP and increase AS, the
fall in AD would likely be greater than the rise in AS, given that X takes up a big % of SG’s AD,
such that SG’s national output falls. A better policy would SS-side policy like wage subsidy.

Hence, whether a gradual appreciation of the S$ is the best policy depends on the nature of the
external shock.
 41

Question 6
The annual rate of real GDP growth in Singapore dropped from 4.6% at the start of 2018 to
1.2% at the start of 2019. However, the Gini coefficient remains stable at around 0.46.
a) Explain one potential demand-side cause and one potential supply-side cause of real
GDP growth. [10]
b) Discuss whether a reduction in the rate of real GDP growth makes it harder for
Singapore to achieve both inclusive growth and sustainable growth. [15]
Suggested answer (a)
Approach: Suggest and explain one reason for a rise in AD and one reason for a rise in AS that
will bring about real GDP growth (i.e., increase in RNY). A stronger response will use the multiplier
process to explain how increase in RNY comes about.

Body:
GDP refers to the value of all final goods and services produced by factors of production located
within a country’s geographical boundaries, during a given period (usually a year). Real GDP
growth is when there is a rise in national income considering the changes of general price level.
One possible reason for real GDP growth is an increase in government expenditure (G) on large
scale projects such as airport (expansion of Changi Airport with Terminal 5), MRTs (Thomson-
East Coast Line) and roads (North-South Corridor) can increase a country’s aggregate demand
(AD).

[P] Government expenditure (G) will increase AD and create actual economic growth.

[E, E] Building more large-scale infrastructure will increase the demand for domestically produced
goods and services such as cement and steel, causing AD to rise. As AD increases from AD1 to
AD2, firms that produce construction material face an unplanned fall in inventories and will hire
more factors of production such as labour and resources in order to increase production.
Assuming that there is spare capacity in the economy, this will lead to an increase in the national
income from Y1 to Y2. This increase in national income increases the purchasing power of
households, which in part leads to an increase in consumption of domestically produced
goods/services. Part of the increase in income will also be saved, taxed and spent on imports.
AD continues to increase from AD2 to AD3 from the increase in consumption, which causes
 42

further unplanned falls in inventories. Firms again hire more factors of production to increase
production which leads to further increases in national income from Y2 to Y3. AD continues to
increase as each round of spending creates further increases in income. This process results in
a multiplied increase in real national income and will continue until the initial increase in
government expenditure (injections) equals to the increase in withdrawals due to savings, taxes
and imports.

[L] There is real GDP growth as the real national income of the county increases from Y1 to Y4.

[P] A possible supply-side reason that brings about real GDP growth is the improvement of labour
productivity within the economy. This can be due to a governmental effort to increase productivity
or might be brough about by better education and skills training.

[E,E] To raise productivity of labour, the government can improve the skill levels of the workforce
as well as increase capital accumulation for firms. Under SkillsFuture Singapore, schemes such
as learning credits (grant) are provided to citizens to pay for work related courses to increase their
labour productivity. Also, under the Productivity Solutions Grant, firms are encouraged to invest
in labour saving IT capital to improve productivity. This increase in quality of labour available
increases the productive capacity of the economy because the same quantity of labour can now
produce more, leading to a rise in AS shown by a rightward shift of the AS curve from AS to AS1 2

With the rise of AS, there will be a movement along the AD curve and via the real balance, net
export and interest rate effects. For example, with regards to the international substitution effect,
when the GPL falls as a result of the rise in AS from AS1 to AS2, foreigners will increase quantity
demanded for SG’s exports which leads to rise in SG’s export revenue if PED for X >1. At the
same time, SG residents will substitute local goods/services for imports, leading to fall in import
spending. The rise in net exports leads to movement along AD2. [L] National income equilibrium
is restored at a higher real national income which rises from Y1 to Y2.
Conclusion
Both the rise in AD and AS can bring about sustained economic growth as real GDP continues
to rise without inflationary pressure. This will form the basis for further growth such as sustainable
and inclusive economic growth.
 43

Suggested answer (b)

Approach: Explain how a slowing economic growth will hamper the achievement of inclusive and
sustainable growth. This might come from the reduced ability to finance government expenditure
with environmental focus and how slowing growth might disproportionately affect the distribution
of income for the lower income households. A complete answer should also explain how slowing
economic growth might not make it harder to achieve the 2 macro goals.
Intro:
Sustainable economic growth refers to a rate of growth that is sustained without creating other
significant socio-economic issues (such as depleted resources and environmental problems or
debt), especially for future generations.
Similarly, inclusive growth is based on sustained growth, but it allows for the benefits of economic
growth to be distributed to a larger proportion of the population. We can see that to attain inclusive
and sustainable growth, the economy will need to first attain sustained economic growth.
Body:
Thesis: Slowing economic growth will make it harder for Singapore to achieve inclusive
and sustainable growth
[P] Slowing economic growth will limit Singapore’s ability to enjoy sustained economic growth,
which is a precursor for sustainable and inclusive economic growth.
[E,E] Slowing rates of economic growth will affect both domestic and multinational firms’
perception of Singapore’s economic health. This will lower the expected rate of returns (EROR)
of investment decision for firms in Singapore. Hence, previously profitable investment projects
are now deemed unprofitable, if MC of investment remains the same, leading to a fall in
Investment expenditure (I).
This fall in I will result in a fall in AD and cause AD to shift from AD to AD . The fall in I would also
1 2

lead to a decrease in the quantity of capital stock, assuming the rate of accumulation of capital is
below the rate of depreciation. This decrease in quantity of capital available decreases the
productive capacity of the economy, leading to a fall in AS shown by a leftward shift of the AS
curve from AS to AS
1 2
 44

As AD decreases from AD1 to AD2, firms face an unplanned rise in inventories and will hire less
factors of production such as labour and resources. Assuming that there is spare capacity in the
economy, this will lead to a decrease in the national income from Y1 to Y2. This decrease in
national income decreases the purchasing power of households, which in part leads to a decrease
in consumption of domestically produced goods/services. Part of the decrease in income will also
be saved, taxed and spent on imports. AD continues to decrease from the decrease in
consumption, which causes further unplanned rise in inventories. Firms again hire more factors
of production to increase production which leads to further decreases in national income. AD
continues to decrease as each round of withdrawal creates further decreases in income. This
process results in a multiplied decrease in real national income and will continue until the initial
decrease in investment expenditure (injections) equals to the decrease in withdrawals due to
savings, taxes and imports.

Without the expansion of potential national output, increase in equilibrium real national output
must eventually come to an end. This is because once spare capacity has been used up, i.e. full
employment of labour and other factors of production is reached; growth of equilibrium real
national output will be restricted by the growth of potential national output. This means that without
the rise in potential output and the accompanying fall in real national output, Singapore’s ability
to achieve sustained economic growth is hampered. [L] Hence, as economic growth slows down
in Singapore, its ability to attain sustainable and inclusive growth will be made harder.
[Ev] Given Singapore’s open and trade dependent nature, it is likely that its slowing growth might
be due to weakened global sentiments and a weakened global demand. Naturally, the global
economy undergoes business cycles of economic booms and recessions. Countries which can
achieve their desired trend growth rate in the long term could face the problem of unstable actual
growth rate in the short-term (where its real GDP fluctuates around its long-term trend path). [L]
Even with slowing economic growth, if Singapore’s long run economic growth follows its long-
term trend, its ability to attain sustainable and inclusive growth will not be affected.
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[P] Slowing economic growth will hamper inclusive and sustainable economic growth as there will
be a slower rise in tax revenue collected for redistribution purposes and to implement measures
to limit environmental damage.
[E,E] With slowing economic growth, the tax revenue collected by the Singapore government is
likely to rise at a slower rate. In addition to the rising government expenditure to manage effects
of an ageing population, the government might find it more difficult to have sufficient resources to
spend on policies that can bring about inclusive and sustainable economic growth. One example
is the GST vouchers provided by the government since 2012 to defray some of the rising cost of
living especially for lower income household. It cost the government $850 million in 2020 and
expected to cost $1.2 billion in 2022.
[L] Hence, with slowing economic growth, it will limit the government’s ability to provide such
support to lower-income households, limiting the distribution of growth to said households,
affecting inclusive growth.

Anti-thesis: Slowing economic growth might not make it harder for Singapore to achieve
inclusive and sustainable growth
[P] Slowing growth might reduce the environmental pollution within Singapore bringing about
sustainable economic growth.
[E,E] Given that Singapore is a major petrochemical and oil refining hub, there is a high level of
environmental pollution through carbon emission. The slowdown of economic growth can reduce
the production activities of these refineries, leading to lesser carbon emissions in Singapore. This
will also weaken the demand for clean water as it is a necessary resource to refine crude oil,
already a scarce resource in Singapore, and energy. In turn, this can improve the non-material
standard of living for Singaporeans, [L] bringing about the attainment of sustainable economic
growth.
[P] Slowing economic might bring about less structural changes within the economy, hence
making it easier for Singapore to achieve inclusive growth.
[E,E] Much of Singapore’s growth is based on trade and to maintain relevance within certain
technological fields (i.e. bio-medical and wafer fabrication). However, this reliance of these two
areas can bring about significant structural changes within Singapore’s economy. This in turn will
contribute to rising income inequality as only the export-oriented industries benefit while other
industries might not from the increase globalisation. In addition, some workers might lack the skill
sets to be part of these industries. Hence, although the recent trend of deglobalisation might slow
Singapore’s economic growth, it can also slow the widening of income gaps between high and
low-skilled workers. This will provide more time for the government to put up re-training programs
that enable more workers to acquire the necessary skill sets and participate in growth industries,
[L] achieving inclusive growth.
[Ev] However, over the long run, it is likely that such trends will limit Singapore growth trajectory
and the attainment of inclusive and sustainable growth as mentioned in the first paragraph.
Therefore, the Singapore government should not depend on slowing structural changes to
achieve its macro goals make growth inclusive. Rather, it should enact policies to achieve the
inclusive and sustainable growth.
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Stand: Slowing economic growth will affect Singapore ability to achieve sustainable and inclusive
growth
Substantiation: As discussed, sustained economic growth is the precursor of sustainable and
inclusive growth. With slowing economic growth, Singapore’s ability to attain sustained economic
growth will be limited, hindering the attainment of inclusive and sustainable growth.
While the stable Gini coefficient might suggest that income distribution remains constant, slowing
economic growth tend to affect lower income households to a larger extent given that these
households are most at risk of retrenchment and lack the opportunities and ability to seek
employment in other industries. This limits the ability of lower-income households to reap the
benefits from economic growth. Without further financial assistance, the benefits of economic
growth will be concentrated amongst households that are able to remain employed and have the
ability to maintain relevance in the changing needs of the economy. Hence, Singapore’s ability to
attain inclusive growth will be hampered.
Lastly, Singapore has an ageing population, this will limit its future ability, assuming if birth rate
and population growth rates remains constant or becomes negative, there is a need to
continuously increase its AS to ensure sustained economic growth. Overall, we will argue that
slowing economic growth with existing structural changes such as ageing population in the
Singapore’s economy will severely limit Singapore ability to achieve sustainable and inclusive
growth.