Macro

 Balance of trade is a nominal value concept rather than a real concept → BOT
should be referred to as the difference between export revenue and import
expenditure
o The notation (X-M) should not be used as it can refer to the difference
between quantity of exports and quantity of imports (Qx - Qm), like in AD
(aggregate demand is a real value concept)
 Benefit or Cost of a development to a country → Link to the impact on key economic
indicators (BOP, EG, Unemployment, Inflation, Income equality, Efficiency) +
Material and Non-material SOL
 Diversification of economy → Increased spending on education and training in
advanced skills and fund R&D relevant to the manufacturing sector (State the
specific supply-side policy that can be implemented, not just diversification!)
 Improvements in technology leads to more efficient methods of production that
reduces wastage → thus augmenting the level of production for a given amount of
resources → productive capacity increases
 For inclusive growth/sustainable growth → try to link policies to actual and potential
growth!
 Do not suggest expansionary MP via lowering of interest rates as a policy for the
Singaporean government!!
 State that the multiplier process assumes that there is spare capacity in the economy
where firms can increase production to meet the increase in AD!
 Large pool of low cost labour are attractive to FDI for labour intensive industries
whereas highly skilled labour is attractive to FDI for knowledge based industries
 Explaining reasons for attractiveness to FDI/investment
o Rate of returns factors: Economic growth
o Cost factors: High quality labour force and infrastructure
 Effects on AD (short run) and AS (long run) are in different time periods!
(investment)
 Increases in AD which leads to demand-pull inflation does not reduce purchasing
power and mSOL since RNY has increased!
o Specify that mSOL of households earning fixed nominal income or pensioners
will fall as the purchasing power of their earnings/savings are eroded by rising
general price levels

Inflation rate
 If domestic inflation is lower relative to inflation in other countries, this improves the
price competitiveness of the domestic country’s export
 Foreign countries will increase their demand for the relatively cheaper imports
 Domestic households will demand less of the relatively more expensive imports and
substitute them with domestically produced substitutes
 Hence, there is an increase in the amount of Singapore exports and a decrease in
the amount of imports → Increase in the amount of net exports → Increase in AD

BOP effects
 Foreign countries will increase their demand for the relatively cheaper imports, hence
raising export revenue
  Domestic households will demand less of the relatively more expensive imports and
substitute them with domestically produced substitutes, hence reducing import
expenditure
 Balance of trade position in the current account of the BOP of country with relatively
lower inflation rates will improve, ceteris paribus

Depreciation
 Goods and services produced in Singapore will be more competitively prices in world
markets in the short term
o Price of Singapore exports in terms of foreign currency falls
o The amount of Singapore goods and services exported to the rest of the
world increases → extent to which amount of exports increases depends on
PEDx
 Imports becomes more expensive
o Price of imports to Singapore in terms of domestic currency increases
o Amount of goods and services imported into Singapore falls → extent to
which the amount of import falls depends on PEDm
 Overall, there is an increase in the amount of Singapore exports and a decrease in
the amount of imports → Increase in the amount of net exports → Increase in AD

Marshall Lerner’s Condition: If sum of PEDx+PEDm>1, a depreciation of a country’s

currency can lead to an improvement in the balance of trade, and hence BOP, ceteris
paribus
Fiscal Policy
 Increase G, Decrease T (CIP, PIT)
 Targets AD (C,I,G)
 Solves cyclical unemployment
o Unable to solve structural and frictional unemployment
 Limitations:
o Availability of government budget
o Opportunity cost
o Consumer and firms’ confidence in the economy
o Size of multiplier k → if small, then little effect on AD
o State of economy → near or at full employment output level
o C, domestic I and G are small relative to exports and foreign direct investment
as a proportion of GDP → limited impact on AD
o Crowding out effect (rise in i/r, appreciation of currency)
o Time Lag (Recognition/Administrative/Operational)
 Limitations of contractionary
o Hard to decide which G to cut especially for long-term projects
o SG reliant on sound fiscal policies to attract FDI → cannot raise tax rates too
high

Interest Rate Policy

 Targets AD (C,I)
 Solves cyclical unemployment
 Limitations:
o Confidence of consumers and firms
o Liquidity trap
 Explain impact of a fall in interest rates
o Internal effects (C,I) + External effects (depreciation)
o Increase AD + multiplier process
o Impact on BOP (KFA worsen due to hot money outflow, CA improve)
 o Degree of initial spare capacity
o Import-induced inflation due to depreciation (small, resource-poor vs
large,well-endowed nations)
o Confidence in the economy (extent of increase in C and I)
o Economy reliant on FDI (less effect)
o Long-run effects (increase in AS due to I)

Exchange Rate Policy

 Targets AD, mainly net exports (X-M)
 Solves cyclical unemployment
 Limitations of depreciation:
o Cost-push inflation
o Increase in price of raw materials erode increase in price competitiveness of
exports
o Falling demand (YED>1) so increase in price competitiveness does not
increase export volume OR other countries also depreciate currency
o J curve effect → since it takes time for consumers to change their
consumption patterns and seek out alternatives and firms have to fulfil
existing contracts → BOT worsens in the short run
 Limitations of appreciation:
o Causes AD to fall in the short run
o Does not target internal sources of inflation (local pressures on wages, rents
and transportation)
 Does not address supply-side constraints and inflationary pressures
caused by domestic factors such as rising unit labour cost or rising
domestic demand.
o Drawdown on foreign exchange reserves
o In addition, with Singapore moving towards a services-driven economy,
exchange rate appreciation becomes less useful to services industries that do
not benefit significantly from lower imported cost due to their higher
dependence on labour for production. For these service industries, rising
rental and unit labour costs are key factors causing higher production costs.

Supply-side policy
 Targets AS
 Solves structural unemployment
 Limitations:
o Long time lag
o High costs for government
o Opportunity cost
o Labour force is already productive, difficult to achieve further increases in
productivity
o Aptitude of workers
o Receptiveness of workers (potential loss of income) and firms (opportunity
cost of output forgone and workers might change jobs after training)
o Certain industries like F&B and Tourism cannot tap on labour-saving
technologies and machinery due to nature of services provided

Examples of SSPs
 Increase the skills of workers: Courses provided by the Continuing Education and
Training Centres (CET) are accredited by the Singapore Workforce Development
Agency (WDA) to provide Workforce Skills Qualifications (WSQ) training to the
workforce. Subsidies are provided under the Skills Development Fund (SDF) and
 Lifelong Learning Endowment Fund (LLEF) to encourage more workers to take up
training/ upgrade their skills.
 Encourage automation and/or R&D: National Productivity Fund (NPF) provides
grants to help enterprises in all sectors, with special emphasis on sectors where
there is potential for large gains in productivity. ICT for Productivity and Growth (IPG)
Programme seeks to accelerate the adoption of ICT solutions among SMEs and
boost their productivity by providing subsidies for ICT-based productivity solutions.
Productivity Solutions Grant (PSG) helps firms adopt off-the-shelf technology. The
Automation Support Package (ASP) supports firms to deploy impactful, large-scale
automation, such as robotics, Internet of Things solutions, and other Industry 4.0
technologies

Singapore uses ER over IR

 Dependence on FDI that is interest-inelastic
 Susceptible to import-induced inflation
 Total trade is a larger proportion of AD than C,I or G
 Open to capital flows → unable to control IR

Capital Controls
 Finally, if the country decides to impose capital controls so that it can manage both
interest rates and exchange rates, this may deter foreign direct investments (FDI) as
foreign firms are less likely to invest if they are unsure of whether the profits earned
can be repatriated. This will deprive the country of foreign capital, technology and
entrepreneurship, which may reduce both AD and AS, thus lowering actual as well as
potential growth.
 Capital controls are more likely to deter FDI only for small countries. For large and
populous countries, the size of the domestic market is often too big for foreign firms
to ignore so the latter are still likely to attract substantial FDI despite capital controls.
Hence countries with large populations like China, still managed to attract large
inflows of FDI over last few decades despite its lack of free international capital
mobility.

Market Failure
 Subsidies (indirect and direct) → internalise external benefits → target positive
externalities in consumption
 Legislation → Imperfect information
 Education and Campaigns → Imperfect information
 Direct provision → Excessive income inequality

To what extent can small firms survive alongside large firms?

Survive
 Revenue
o Niche market - demand price inelastic
 Cost
o Banding to reap marketing IEOS, reduce unit cost of production
o Firms in industry may reach MES at very low levels of output, saucer shaped
LRAC thus co-exist (IEOS exhausting at low levels of output, followed by
constant EOS over large output)
o Small firms lower total fixed costs, lower MC and AC, thus make sufficient
profits

Cannot survive
 Revenue
o R&D of large firms leads to lower unit costs and higher revenue
  Cost
o Large firms experience IEOS, small firms cannot reap IEOS thus larger firms
can incur lower unit COP, price products below that of smaller firms
 Large firms can use predatory pricing to edge out small firms
o Set low prices as they can rely on past supernormal profits

Strategies to compete:
Price (decrease prices)
 Price war - drive entrants out and increase market share
o Limit pricing or predatory pricing

Non-price
 Product development
o Increase demand and make demand less price elastic
 Process innovation
 Advertising
 Merger and Acquisition
 Diversification
o Venture into new markets → increase demand

Types of entry barriers:

 High R&D cost/high start-up cost deter firms from entering
o Highly specialised and cannot be readily diverted to other markets/industries
thus these are sunken costs
o Risk of making huge losses if firms decide to leave the market
 Presence of significant IEOS
o Existing firms operating at a larger scale can be more cost efficient thus price
more competitively than a potential entrant that would be operating on a
smaller scale
 Limit pricing by existing firms
o Existing firms charge a price that is lower than the profit-maximising price with
the intent of prevent rivals
o New entrants forced to incur losses

Types of IEOS:
 Risk-bearing IEOS
o The returns of R&D are highly variable and uncertain, hence the large firms
are able to spread the uncertainty in COP over a large range of output thus
reducing average costs
 Financial IEOS
o Larger firms have bigger assets that can be used as greater collateral when
they apply for loans with banks
o Thus enhancing the credit worthiness as they are perceived to be low risk
borrowers → secure larger loans at lower interest rates, lowering unit COP

Natural Monopoly
 Another option may be to directly increase competition directly by having more
operators operating on more bus and rail lines. This allows commuters to have more
choice over the route of travel and with which company would they want to travel
with. The introduction of competition could see a fall in the demand, and an increase
in the price elasticity of demand for each firm’s service. Unfortunately, Singapore has
a small market and the scope for building multiple transport lines is limited. If the
 market is shared out across more firms, demand may fall so low for each firm that
none of the firms is able to earn at least normal profit at any level of output.

 Furthermore, the bus and rail industry is likely to have substantial internal economies
of scale. With high set up costs and relatively low additional cost of providing
services to an additional commuter, resources might be better utilised with big firms
that cater to sizeable segments of the markets. At higher levels of output, average
cost of each firm dominating the market is therefore lower.

Strategies to compete:
Price (decrease prices)
 Price war - drive entrants out and increase market share
o Limit pricing or predatory pricing

Non-price
 Product development
o Increase demand and make demand less price elastic
 Process innovation
 Advertising
 Merger and Acquisition
 Diversification
o Venture into new markets → increase demand

Discuss whether this is a case of price discrimination

 Price discrimination
o (only if more marks allocated) Conditions of PD are met
 Market power → ability to set prices
 No arbitrage → no resale of good allowed/possible
 Separable markets (differing PED - profitable)
o No significant cost differences in producing good (difference in prices not due
to differences in cost of production)
 Not price discrimination
o There are differences in cost

Types of policies:
Price ceilings
 Legally established maximum price P to prevent prices from rising above a certain
max

level
 Set below the market eqb price to be effective
 Limitations:
o Persistent shortage, black market

Indirect subsidies
 Granted indirectly to producers of g/s, decreasing COP thus increasing profitability
 Producers more willing and able to produce and supply good at every given price
level, increasing supply

Direct subsidies
 Granted directly to households in the form of cash grants
 Increase the willingness and ability of consumers to purchase, increasing demand
 Limitations:
o High govt expenditure (if price inelastic demand then greater amount needed)
 o Unsustainable in the long run
o High opportunity costs

Ban
 Legal prohibition of a g/s → output = 0
 Limitation:
o Greater deadweight loss might be incurred

Indirect taxation
 Specific tax imposed on producers → increase COP → reduce supply

Factors affecting the size of firms

Nature of the industry

 Cost factors
o Diseconomies occur at low levels of output
o Industries that provide services that require personal attention - if such
specific detail has to be mass produced, any cost advantages to large-scale
production are more than offset by the difficulties in monitoring large scale
quality checks of such customised products → average costs rise sharply as
output increases (optimum size of firms tend to be small)
Full Multiplier Process

A decrease in personal income tax increases households’ disposable income and

their purchasing power, allowing them to purchase more goods and services, hence
resulting in an increase in consumption. A decrease in corporate taxes increases the firm’s
expected post-tax profits from investments. Hence, investments would rise.

Since consumption (C) and investment (I) are both components of aggregate
demand (AD), the combined increase in C and I would lead to an increase in autonomous
AD. This will lead to a more than proportionate increase in real national income via the
multiplier process.

When AD rises and households and firms consume goods and services, they run
down firms’ stocks and inventories. Firms will increase production to replenish their stocks,
thus employing more factors of production, including labour, and thereby increasing
household income. This leads to many rounds of induced consumption via the multiplier
effect as one man’s spending is another man’s income, leading to an overall increase in AD
from AD0 to AD1. The rightward shift in AD becomes smaller in each subsequent round due
to the presence of withdrawals in the forms of savings, taxes and import spending.
Eventually, the multiplier stops when the cumulative increase in induced withdrawals equals
the initial increase in autonomous AD. Ultimately, equilibrium level of real national income
increases more than proportionately from Y0 to Y1 and the economy hence experiences
actual economic growth.

Circular Flow of Income

The circular flow of income is a model of the economy that represents the flow of
money and flow of goods and services between the different sectors of the economy.
Households provide factors of production to firms and in turn receive factor income. Firms
provide goods and services to households and in turn receive payments known as
consumption on domestically produced goods and services. However, not all factor income
received by household returns to domestic firms as revenue. Households also pay taxes to
the government, save a portion of their income in financial institutions, and spend part of the
income on imports. Savings, taxes and imports are hence withdrawals – factor income not
spent on domestically produced goods and services.

Full Reverse Multiplier Process

The rise in income tax by 1% to 3% points will cause the disposable income of
households to fall hence their purchasing power also falls. This will reduce their ability to
consume goods and services. The increase in tax rates represent an increase in the
withdrawals from the circular flow of income. Since the increase in planned withdrawals
exceed planned injections, this will start the reverse multiplier process. As planned
withdrawals exceed planned injections, there is an unplanned increase of inventories.

Alternatively: The rise in income tax by 1% to 3% points will cause the disposable
income of households to fall hence their purchasing power also falls. This will reduce their
ability to consume goods and services, hence causing a fall in autonomous consumption.
The fall in autonomous consumption will start the reverse multiplier process. The fall in
autonomous consumption will lead to a fall in autonomous AD because C is a component of
AD, ceteris paribus, and in turn, AD is less than AS, hence there is an unplanned increase of
inventories.

The increase in unplanned inventories signals to firms to decrease production in the

next time period and to hire fewer factors of production (which include labour, capital, land
and entrepreneurship). Households then receive less factor incomes in the form of wages,
interests, rent and profits, which are payments for factors of production. Lower incomes then
cause a fall in induced consumption. The process continues with many rounds of fall in
induced consumption in the circular flow because according to the multiplier principle, one
man’s fall in spending is another man’s loss in income and loss in income leads to less
spending. However, with each successive round, the decrease in induced consumption falls
because the ability to save, pay taxes and buy imports will fall. This cycle will continue until
the cumulative fall in induced withdrawals is equal to the initial rise in withdrawals [or initial
fall in autonomous consumption]. Equilibrium is once again achieved when planned
withdrawals equals planned injections. Real national income thus decreases more than
proportionately to the initial fall in autonomous consumption.

Barriers to entry

 Control of raw materials

o High quality → less price inelastic, not substitutable, strengthen market power
o Incumbents less affected by shortages, able to maintain lower average COP
  New entrants have to search for raw materials, higher average costs

Competition erode profits

 Demand falls and become more price elastic due to increase in number of substitutes
 Assume firm aims to profit maximise, it will produce where MR=MC and MC rising at
output Q0
 Supernormal profits fall

Strategies to compete
 Acquisition of firms supplying raw material
o Lower AC
 Marketing strategies (brand image, advertising, product differentiation)
o Increase AR and less elastic
Explaining firms and decisions
Oligopoly/Monopoly:
 Restrict output to increase prices
 P>MC hence the value that society places on the last unit of the good is greater than
the opportunity cost in terms of resources used in producing that last unit of the good
 Deadweight loss is thus incurred → hence there is welfare loss → allocative
inefficiency → underproduction

Technological advancement → Profits of firms (Allows supernormal profits to be earned in

the long run)
 Higher technology may install barriers into some markets, and improve profits in the
long run: Large firms which have the capability to conduct R&D on product
development would be able to innovate and introduce significantly better products
and products with advanced features.
o PED: DD becomes more price inelastic firm may increase price to increase
total revenue. Profits increase if the increase in total revenue is greater than
the increase in technological costs.
 Large firms, with better resources, might dominate the market and set up patents
applied to these new technologies
 Barriers to entry will protect supernormal profits of firms, enabling them to continue
earning them in the long-run.

Policies to improve human capital: Human capital refers to the accumulated skill and
knowledge of workers. It is regarded as the most fundamental source of economic growth. It
can be acquired through education, training and work experiences. If knowledge is lacking,
other resources may not be used efficiently. For example, a country may be endowed with
fertile land, but farmers may lack the knowledge of irrigation and fertilization techniques.
 In the case of Singapore, the 2‐year (2008 – 2010) Skills Programme for Upgrading
and Resilience (SPUR) was set up to scale up training efforts in order to build up
stronger capabilities. The government also spends on improving the quality
education in Singapore in order to ensure a workforce that is equipped with
knowledge and skills and is constantly able to upgrade and re‐skill to adapt to the
demands in the future.

Macro Trade-Off Paragraphs

(FP) EG/ Low unemployment vs Low inflation

 To achieve economic growth and lower unemployment rates, a government may
pursue an expansionary FP by increasing government spending (G) and lowering taxes (T).
When income taxes are lowered, consumers have more disposable income and hence
increase consumption expenditure (C). When corporate taxes are lowered, firms have
higher post-tax profits and are more willing and able to invest hence investment (I)
increases. The increase in C, I, and G, all being components of aggregate demand (AD),
leads to an increase in AD. When AD increases, demand for labour, a derived demand,
increases as firms will need to hire more labour so as to increase output. The increase in AD
will eventually lead to a more than proportionate increase in real national income from Y0 to
Y1 via the multiplier effect. Therefore, actual economic growth and lower unemployment is
achieved. However, persistent rises in AD due to the expansionary fiscal policy would cause
continuous shifts of the AD curve to the right. As the economy approaches the full
employment real output level, an increase in demand will lead to a shortage as current
spending exceeds current production levels at the initial general price level P0. Firms will
respond to the rise in demand partly by raising prices and partly by increasing output. This is
because as the economy approaches full employment, factors of production like labour and
raw materials become scarcer. Competition for scarce resources cause firms to bid up factor
prices. As each additional unit of output becomes costlier to produce, prices have to
increase to ensure that production remains profitable. The increase in real income from Y1
to Y2 is thus accompanied by a rise in GPL from P0 to P1. Therefore, attempts to achieve
economic growth and to lower unemployment will inevitably lead to demand-pull inflation
where GPL rises due to persistent increases in AD.

(MP) EG/ Low unemployment/ Favourable BOP vs Inflation

In order to boost growth, countries may adopt an expansionary monetary policy via
depreciation of the domestic currency. When domestic currency depreciates, exports are
now cheaper in foreign currency and thus increases the price competitiveness of the
country’s exports leading to a rise in the amount of exports. Prices of imports in terms of
domestic currency increases and thus the amount of imports decreases. Overall, a
depreciation leads to an increase in the amount of net exports and thus AD increases and
shifts rightwards. When AD increases, demand for labour, a derived demand, increases as
firms will need to hire more labour so as to increase output. The increases in AD also causes
a more than proportionate increase in RNY from Y0 to Y1 via the multiplier effect hence
there is actual economic growth. Additionally, assuming that Marshall-Lerner condition holds
whereby PEDx + PEDm > 1, a depreciation of currency would lead to an improvement in the
balance of trade and hence balance of payments, ceteris paribus. However, the prices of
imported foreign goods and services are now higher in terms of domestic currency, raising
the country’s CPI as the average household has to pay more for imported goods and
services. Additionally, prices of imported raw materials used by firms in the production of
goods and services also increases in terms of domestic currency, leading to a rise in COP
and a fall in AS, represented by an upward shift of the AS curve. Therefore, efforts to spur
economic growth, lower unemployment and achieve favourable BOP through depreciation
will lead to imported inflation as well, increasing GPL.
(IR) EG/ Low unemployment vs Favourable BOP

To increase AD, governments may adopt an expansionary monetary policy via the
lowering of interest rates. A fall in interest rates lowers the cost of financing a loan and
makes it cheaper to borrow. Hence, households are more likely to borrow to purchase big-
ticket items or consumer durables such as cars or furniture. Households are also less
incentivised to save as the rewards from saving has decreased and thus consumer
expenditure increases, For firms, there will be more projects that have a rate of return that is
greater than the cost of borrowing hence becoming profitable since cost of borrowing
decreases. Firms will thus increase their level of investments in plants and machines as well
as inventories. The increase in C and I will lead to an increase in AD from AD0 to AD1.
When AD increases, demand for labour, a derived demand, increases as firms will need to
hire more labour so as to increase output. The increase in AD also results in a more than
proportionate increase in RNY from Y0 to Y1 via the multiplier effect. Therefore, actual
economic growth and lower unemployment is achieved. However, a decrease in interest
rates leads to an outflow of hot money as investors move money out of the country in search
of higher interest rates in other countries. This thus leads to a worsening of the capital and
financial account (KFA). Additionally, an increase in household incomes due to economic
growth leads to higher purchasing power for consumers. Import expenditure thus increases
as consumers increase their demand for foreign imports. This would lead to an increase in
import expenditure and a worsening of BOT. Overall, a worsening of BOT and KFA leads to
a worsening BOP, ceteris paribus. Therefore, attempts to spur economic growth and lower
unemployment via lowering interest rates leads to worsening BOP.

SSPs (Sustained EG) and Structural Unemployment

To achieve sustained growth through achieving actual and potential growth, the
government may adopt a SS side policy of providing R&D grants to encourage technological
developments and automation. By financing ventures to transit from labour intensive to
capital intensive methods of production, this leads to a fall in unit cost of production and
increase in the productive capacity of the country, hence the AS curve shifts outwards
leading to both actual growth and potential growth. However, adopting this policy leads to
structural unemployment, as workers are displaced from their jobs in labour-intensive
industries or are made redundant by labour-substituting methods of production. They do not
possess the relevant skills needed in jobs that require higher skillsets that might require the
operation of machinery and hence they experience occupational immobility and are unable
to find employment, resulting in workers being structurally unemployed. Therefore, efforts to
achieve sustained growth via encouraging technological advancement might lead to a rise in
structural unemployment.