3. Explain the possible impact of an Increase in wealth and consumer confidence on aggregate demand. Answers may include: • definitions of wealth, consumer confidence, aggregate demand (AD) • diagram(s) to show AD shifting to the right • explanation of the possible impact of an increase in wealth and consumer confidence on AD Wealth is the value of financial assets of a person (and wealth is a stock concept), whereas income is the amount received by a person for his factors of production (income is a flow concept). Consumer confidence refers to the sentiments that consumers have about the future of the economy. The Aggregate Demand (AD) is the totality of the demand of the four sectors namely, H ouseholds, Businesses, Government, and Foreign Sector,for the final goods and services in an economy which are at d ifferent price levels. AD = C+I+G+X-M. When the wealth in the economy increases, consumers will have a greater ability to purchase goods and services. This increase in purchasing power increases the ability of consumers to consume goods and services in the economy. Hence, as the wealth of a country increases, the Consumption in the economy increases. Furthermore, as consumer confidence increases, consumers have a better outlook on the economic performance of a country. Due to the better economic outlook, consumers are more willing and able to consume goods and services within the economy, thus increasing C. Since Aggregate demand (AD) = C+I+G+X-M, as Consumption increases, the Aggregate Demand (AD) in the economy increases. As the Aggregate demand increases, AD shifts from AD0 to AD 1 as seen in the figure below. As this occurs, the real national output increases from Y0 to Y1, and the general price level increases from P0 to P1. This thus results in Economic growth, and demand-pull inflation. 4. Explain the impact that a fall in the world price of oil might have on aggregate supply and gross domestic product (GDP) in an economy. [10] Answers may include: • definitions of aggregate supply and GDP • diagram to show AS/SRAS shifting to right and GDP increasing • explanation that in an oil importing country a fall in the price of oil reduces production costs to industry and causes the aggregate supply to increase and GDP to rise • example of economies where fall in oil prices has increased aggregate supply and GDP in an economy. AS:The Aggregate Supply (AS) is the totality of output goods and services firms are willing to produce and sell at different price levels.It represents the ability to produceby an economy considering the available resources. Gross Domestic Product (GDP)- refers to the total money value of all final goods and services produced within the country’s geographical boundary during a given period of time. Oil is a key factor input in many industries and is used for the production of goods and services as it is used to generate energy and electricity. For an oil importing country such as Singapore, the fall in prices of oil will lead to a cheaper cost of production. This is because firms are able to obtain factor input at a cheaper price. As a result, this will lead to a drop in the unitary cost of production, causing the aggregate supply in the short run to increase. This is because firms are able to supply a higher total output of goods and services as the costs of factor input decreases. As such, the AS increases from AS 0 to AS 1, as seen in the figure below. Ceteris paribus, when AS increases from AS 0 to AS 1, the economy will experience an increase in the real national output from Y0 to Y1, and the general price level will decrease from P0 to P1, as firms pass on cost savings to consumers. One example is the fall in oil prices from 2014-2015, which led to an increase in the world GDP by 0.8-.1.0% on a whole. 4 Macroeconomic goals In general, students should be able to: 1) Define the terms 2) Explain: a. How to measure b. [imitations of measurements c. Types d. Causes e. Consequences f. Solutions and their pros and cons A. Economic Growth (EG): It may be Actual or Potential Growth. Actual Growth is the economic growth in real terms while Potential Growth is the growth of economic capacity in production. Actual growth occurs when the total output of the economy increases (and hence REAL NATIONAL INCOME increases in the economy). How to measure: GDP is an indicator used to measure actual economic growth. To account for inflation and change in population size, a better indicator used is REAL GDP per capita. Limitations: Does not take into account the non-material standard of living, and any externalities that may arise from the economic growth. GDP alone is also not a good indicator of the average person’s SOL, since the DISTRIBUTION OF INCOME IS NOT TAKEN INTO CONSIDERATION. B. Low and stable inflation rates → achieve price stability: Low and Predictable inflation rate, in the range of 1-3% also known as Mild Inflation, is the reason why prices are targeted to be stable, thus avoiding higher inflation, and hyperinflation at worst. How to measure: The Consumer Price Index (CPI) is used to measure the inflation in a country. The CPI comprises a basket of goods and services that a typical household in the nation consumes. The CPI is used to measure the average price changes over time. Limitations: Does not take into account the different costs of living in different countries.. C. Full Employment (FE): Employment is fully employed when there is no Cyclical Unemployment. (There will still be structural and frictional unemployment) It is not totally at zero unemployment rate, but within the range of 4-6% of the working population. 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 = 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝑝𝑒𝑜𝑝𝑙𝑒 𝑇𝑜𝑡𝑎𝑙 𝑙𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 𝑃𝑎𝑟𝑡𝑖𝑐𝑖𝑝𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = * 100% 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑎𝑏𝑜𝑣𝑒 𝑎𝑔𝑒𝑑 15 The Labour force includes all individuals aged 15 and above who are WILLING AND ABLE to work. This includes both Employed and unemployed individuals. How to measure: Unemployment rate Limitations: Does not take into account non-market activities, black market transactions NOR discouraged workers D. Balance of Payment (BOP): It is the summation, in monetary terms, of all the economic transactions between residents of a country and the rest of the world in a specific period. BOP is recorded, most often, annually. The BOP consists of 3 main accounts: i. The Current account which includes balance of trade in goods and services, and the transfer payments to and from other countries ii. The Capital and Financial account that takes into account Foreign direct investments (long term) and Hot money (short term). iii. The official foreign reserves. Any imbalance in the 2 accounts is cleared off from this account. 1. Explain why structural unemployment may occur in an economy. [10] Answers may include: • definitions of unemployment and structural unemployment • diagram to show the decline in employment caused by structural factors such as a fall in demand for labour in a particular market • explanation of how the structural changes in the economy, such as capital replacing labour in a market, lead to unemployment because workers do not have the skills or geographical mobility to get a new job quickly • examples of where structural changes in the economy lead to structural unemployment Unemployment occurs when individuals who are able and willing to work are unable to find employment. Structural unemployment occurs when workers are unable to obtain employment since they lack the skills needed to obtain employment in booming industries. Structural unemployment occurs because of both geographical and occupational immobility. Geographical immobility occurs when workers are unable to find employment as they stay in areas that are far away from regions where there is a high demand for labour. This is a problem for bigger countries without good transport networks. Occupational immobility occurs when employees lack skills for obtaining employment in booming industries, despite being willing and able to seek employment. One other factor that causes structural unemployment in an economy is when consumers have a change in taste and preference for goods and services, and reduce consumption for a particular type of good and service. When this occurs, firms lay off workers in one industry as they have a decrease in Total revenue and total profits. However, due to a lack of skills, these employees do not have the skills needed to obtain employment in other booming industries. <one example is the automobile industry. Consumer taste is changing and there is an increasing preference for Electric vehicles. Thus, there is a rising demand for labour in the electric vehicle market, since labour is a derived demand. In addition, labour is laid off in gasoline vehicle market → structural unemployment occurs because workers cannot transit from the gasoline vehicle market to the electric vehicle market, as they lack skills>. Another possible factor leading to structural unemployment in the economy is when firms switch from labour intensive means of production to capital intensive means of production. When this occurs, labour is laid off, as more cost efficient methods of production that involve technology are utilised instead. 2. Using real-life examples, discuss the view that the most significant consequence of unemployment is the loss of tax revenue for the government. [15] Answers may include: • definitions of unemployment and tax revenue • diagram to show possible consequence on AD of decreases in government tax revenue and therefore government spending • explanation of how increased unemployment will decrease tax revenue and may lead to a budget deficit and/or a reduction in government spending • examples of consequences of unemployment • synthesis or evaluation (discuss). Discussion may include: the other economic and personal and social consequences of unemployment, e.g. loss of GDP, increased cost of unemployment benefits, greater disparities in the distribution of income or an increase in government spending due to falling tax revenues and increased unemployment benefits acting as an automatic stabilizer. Intro: Unemployment occurs when individuals who are able and willing to work are unable to find employment. Tax revenue is defined as the total revenue collected by the government from the tax imposed on goods and services. Unemployment leads to many significant negative impacts on the economy, including a fall in the standard of living in the economy, a decrease in Tax revenue and an increase in Government expenditure, and a fall in the general price level (deflation). As unemployment worsens in a country, fewer labour will be employed, leading to a fall in the incomes earned by workers, and thus a fall in tax revenue earned by workers. When this occurs, the government will collect a smaller sum of money, and thus have a lower ability to conduct fiscal expenditure. In addition, due to lower disposable incomes, households reduce consumption, and thus reduce indirect tax collected from GST. Hence, the government spending (G) decreases. Since G is a component in AD, where AD =C+I+G+X-M, a fall in G will lead to a fall in AD. Thus, one negative impact due to unemployment is a fall in tax revenue collected. One example for which this occurs is when unemployment surged in 2020 all across the globe. This resulted in a reduction in personal income tax collected and also corporate tax, thereby reducing the total amount of tax revenue for governments globally. However, there may be other more significant impacts of a fall in unemployment. One other significant impact is the DECREASE in living standards. As seen in the graph above, when AD decreases due to a fall in G, AD falls from AD 0 to AD 1, and thus there is a decrease in real national income from Y1 to Y0, leading to a fall in GPL from P1 to Po. This will cause the disposable income and purchasing power of households to decrease, leading to a fall in the material standard of living as consumers are less able to afford goods and services. Furthermore, with a fall in real national income, consumers may not be able to enjoy and afford the same quantity and quality of education and healthcare, leading to a fall in non-material standards of living. Ultimately, this leads to an overall decrease in living standards. → Examples: As unemployment increased due to covid in 2020, in Singapore, where Employment levels fell by 5%. This decreased the RNY, and also decreased standards of living of consumers. As seen in the figure above, deflation can also result. Deflation may be very harmful if it leads to a deflationary spiral. This occurs as consumers expect a fall in prices in the future and then they thus WITHHOLD present consumption. When this occurs, there is a further fall in (C) which causes firms to receive a lower Total revenue and total profits. This ultimately further leads to further decrease in employment levels, as firms lay off workers to cope with the fall in demand for their goods and services. Ultimately, the worsening unemployment will lead to many negative impacts on the economy. Arguably, the most significant impact is not the fall in tax revenue, but rather the fall in living standards of an economy. This is further exacerbated by a possible deflationary spiral that could further worsen the state of the economy. Thus, the government must intervene to improve the economic performance of the nation. 3. Using real-life examples, discuss government policies to deal with the different types of unemployment. [15] Answers may include: • definitions of government policies and frictional, structural, seasonal and cyclical (demand-deficient) unemployment • diagrams might include AD/AS showing how government policies can increase AD and lead to an increase in GDP, and increase in employment. A diagram to show how the increase in AS can led to a decrease in structural unemployment and the natural rate of unemployment • explanation that fiscal, monetary or supply-side policies can all be used to reduce the different types of unemployment. Outlining the transmission mechanism involved • examples of situations where a country has reduced a type of unemployment • synthesis or evaluation. Examination may include: the effectiveness of fiscal, monetary and supply-side policies in terms of dealing with the different types of unemployment including the limitations of using demand management to deal with anything other than cyclical unemployment and the suitability of various supply-side policies. In addition, the short-run/long-run implications of using demand management and supply-side policies may be evaluated. Intro: Structural unemployment arises from changes in the pattern of demand or supply of goods and services in the economy which results in the mismatch of skills between the unemployed and the skills required by producers seeking labour. It is typically long-term and chronic, and exists even when the economy is not in recession. Demand-deficient or cyclical unemployment is caused by a fall in AD. it is associated with economic recessions, where national income falls for at least two consecutive quarters. Cyclical unemployment exists fundamentally as a result of a lack of production activities, therefore a lack of job vacancies. Frictional unemployment refers to the unemployment of workers when they take time to search for jobs and remain unemployed in the meantime. Frictional unemployment occurs for new entrants to the labour force (e.g. fresh graduates starting to work) and also for people transitioning between jobs. It is inevitable and always exists. Seasonal unemployment refers to the unemployment of workers in industries where demand is seasonal (e.g: Skiing/travelling etc). When the economy is experiencing demand deficient unemployment, the government can make use of policies such as Expansionary Fiscal Policy and expansionary monetary policy. One way for the government to improve the employment levels in the economy is by implementing these policies to increase Aggregate Demand. Expansionary Fiscal policy can be used to increase AD as the government increases government expenditure, and decreases tax revenue. When this occurs, G, I and C increase. G increases as the government increases spending on the economy by developing new infrastructure. It increases as firms reduce tax revenues collected, stimulating the firms to increase the amount of Investments in the economy as certain projects become more profitable, allowing firms to reap better returns from investments. Furthermore, with lower taxes collected, households have a higher disposable income, and this leads to an increase in disposable income, which then increases the total amount of goods and services that households can consume. This ultimately increases AD. Alternatively, the government can make use of expansionary monetary policy. This is done by decreasing the interest rates as the government increases the supply of money. When this occurs, the cost of borrowing decreases, and thus firms are more likely to invest a larger amount and expand business operations due to the lower costs. Households will also increase consumption (C) since they are able to obtain loans at a cheaper cost, and will thus increase spending on big ticket items. As a result, since I and C are components of AD, AD increases from AD 0 to AD 1. This naturally increases the real national income from Y0 to Y1. As firms experience a larger demand, they will hire more labour to cope and deal with the increase in demand, leading to a rise in employment levels, as seen in the graph below. To solve structural unemployment, Supply side policies that are aimed at increasing the skills of the workers can be implemented. This can be done by the government to INCREASE the productivity and skill levels of workers, thereby decreasing the occupational immobility experienced by labour. For instance, in 2020, the Singapore government used the Digital Resilience bonus to TRAIN and upgrade the skills of workers, especially increasing their TECHNOLOGICAL PROFICIENCY. As a result, workers are more able to obtain employment in newer booming industries REDUCING OCCUPATIONAL IMMOBILITY 6a. Explain the factors that cause demand pull inflation and Cost push inflation Factors affecting DD pull inflation: Demand pull inflation refers to the increase in the general price levels due to an increase in Aggregate Demand. AD = C+I+G+X-M. Any factor that increase AD → increase in GPL if there is decreasing spare capacity in the economy. As AD approaches FULL EMPLOYMENT, a further increase in AD will cause firms to drive up factor prices. This will thus cause price levels to rise, as firms pass on the higher costs in the form of higher prices for goods and services. - Govt policies that may cause DD pull inflation → Expansionary FP and Expansionary MP may lead to higher G, I, C, and thus higher AD → Higher GPL as demand pull inflation occurs - As AD increases, GPL increase, this is thus demand pull inflation Cost push inflation refers to an increase in the GENERAL PRICE LEVEL due to a decrease in Aggregate Supply. In 2011, when Singapore was experience economic growth as she recovered from the global financial crisis, AD rose close to full employment, causing the general price level to increase, and thus causing demand pull inflation. Factors affecting COST PUSH INFLATION: When aggregate supply DECREASES, there will be a cost-push inflationary effect on the economy. This occurs when the PRODUCTIVITY of the economy decreases, and hence the unitary cost of production RISES. For instance → If factor inputs imported from other countries increase in price → then the cost of production would rise → AS decreases → increasing the general price levels. Singapore experiences COST PUSH inflation as she imports factor input and raw materials from other countries to produce final goods and services. Hence, as other countries experience inflation, Singapore experiences IMPORTED inflation arising from the more costly imports. 6b. Using real-life examples, discuss the view that the use of fiscal policy is the most effective way of reducing the rate of inflation in an economy. Intro: Contractionary fiscal policy is an effective means to decrease Demand pull inflation. However, other means may be more effective in the long run, such as Supply side policies, and monetary policies. Bp1: Contractionary Fiscal policy can reduce inflation in the economy by Increasing Tax (T) collected and decreasing Government expenditure (G). As this occurs, G decreases, I and C decreases as well. This is because firms have lower profits as more tax is collected, decreasing their ability to invest in the economy. Furthermore, due to higher taxes, Households have a lower disposable income, thus they are less able to consume goods and services, decreasing (C) . Since G,I and C are all parts of AD, where AD = C+I+G+X-M. Thus, AD falls. Hence, the general price level also decreases, reducing the demand pull inflation in the economy. However, there may be more effective ways of reducing inflation in the economy. One measure is through the use of Contractionary monetary policy. This occurs when the government DECREASES the supply of money, and increases interest rate. As interest rates rise, there is a higher COB → lower I, Lower C .Thus decreasing AD. Interest rate policies like these MAY BE MORE EFFECTIVE for countries that are heavily dependent on LOANS and FINANCING to run business operations Finally, in the long run, the best policy to reduce inflation is SUPPLY SIDE POLICIES. Supply side policies are aimed at increasing the productivity of factor input in an economy. Some policies adopted by the Singaporean government include policies to RETRAIN AND UPGRADE workers, and to stimulate technological improvement in the nation. When this occurs, the economy is able to produce a larger amount of goods and services for a lower unitary cost, hence the cost of production falls, and the economy is able to produce a higher amount of goods and services. As seen in the graph below, SSP will increase the AS in the economy, and therefore decrease levels from P0 to P1. Supply side policies are arguably more effective than demand management policies like fiscal and monetary policies → since they are able to decrease general price levels without decreasing income and real national output. However, supply side policies usually take a LONG TIME. For instance, Singapore adopts the use of SKILLS FUTURE training programmes, that increase the productivity of workers BUT this takes a long time for training. Furthermore, it is heavily dependent on the receptiveness of the people. Conclusion: Ultimately, both demand management and supply side policies MUST BE USED together to manage prices in the short and long run. In the long run, supply side policies are MORE EFFECTIVE than demand side policies as they are able to concurrently achieve economic growth.
