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
i​ncome i​s 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) i​s the t​otality 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) i​s the totality of output goods and services firms are
willing to produce and sell at ​different price levels.​It represents the ability to produce​by 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.