Below are the suggested points for the sample examination paper in the study
guide. Please note that this is not the complete, elaborated answers. Students are
expected to elaborate on their answers and draw graphs where applicable, to make
them as clear as possible to the Marker so as to demonstrate your understanding
of the concepts or models tested. The answers below are just suggested pointers
for answering the questions.
Question 1
You have been invited to conduct a workshop for a group of Diploma students at
your school on the topic of money and monetary policy that can be adopted by a
central bank to manage an economy. You are to answer the following questions
raised by the students.
a)
Discuss the monetary policy tools which a central bank can use to stabilise
an economy.
(10 marks)
The objective of monetary policy tools is to adjust the supply of money in the market to
achieve maximum real output in the economy, low unemployment and stable price.
The different monetary tools are as follows (Students are expected to describe how these
tools work).
:
•
Adjustment of required reserve ratio.
•
Adjustment of discount rate.
•
Government buying and selling of bonds and securities.
Students are expected to explain how these tools work such as how Money supply curve
shift to the right during a recession.
•
This leads to a corresponding decrease in the real interest rate.
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•
A decrease in the market interest rate will lead to an increase in planned investment
(I) as well as selected consumption (C).
•
This thus leads to increase in real output in the economy, overcoming the economic
slowdown.
b)
Explain how the monetary policy can keep the economy from becoming
inflationary. Please use the AS/AD model and explain how the effect of the
policy is transmitted to reduce the impact of inflation.
•
(10 marks)
With the reduction in money supply, the interest rate in the market will rise (left chart
below).
•
Numerous expenditures which rely on loans such as private domestic investment (I)
in housing and machineries as well as households’ consumption (C) of items such as
cars, will be reduced substantially due to the higher financing costs of loans from
commercial banks.
•
The AD in the market will reduce and the AD curve will shift left, closing the inflationary
gap.
C)
Identify and discuss two limitations of monetary policy.
(5 marks)
a)
The monetary policy transmission process is long and drawn out and does not
always respond in the same way.
b)
The response of expenditure plans to changes in the real interest rate depends on
many factors that make the response hard to predict.
c)
The response of real long-term interest rate to a change in the nominal rate
depends on how inflation expectations change.
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Question 2
Singapore was adversely affected by the Global Financial Crisis which started in
the United States of America in 2008. As a result, Singapore went into recession
in the middle of 2008. Using the AD-AS model for illustration,
a)
Discuss the view that the Singapore government should use fiscal policy to
eliminate the recessionary gap in order to reduce unemployment. Please
discuss both the supporting and opposing views.
(10 marks)
The aim of this question is to explain how fiscal policy can reduce unemployment and its
limitations.
Effect of expansionary fiscal policy,
•
Increase in government spending or reduction in tax.
•
Leads to increase aggregate demand and equilibrium output.
•
Leads to the fall in unemployment, mainly the cyclical unemployment which arises
from the economic downturn.
Fiscal policy as a demand side policy however is not effective if,
i) Time lags in the implementation of fiscal policy.
ii) Possible crowding out effect.
iii) Irreversibility.
b)
Identify the supply side policies which the government can consider
implementing and discuss the likely effectiveness of implementing such
policies in overcoming the recessionary economy.
•
(15 marks)
Supply side policies are policies designed to strengthen production capability of the firms.
Such supply side policies may include,
o Productivity training of labour.
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o Subsidising by government to encourage adoption of more advanced and
productive capital and technology.
Effectiveness of supply side policies
Through higher productivity, firms will be able to achieve lower per unit cost of production.
This will increase the international competitiveness of the products resulting in greater
exports, hence improving the Balance of Trade.
If implemented successfully, supply side policies will shift LAS and SAS to the right
(Students need to draw for illustration)
Some limitations of supply-side policies
•
Time lag, as supply-side policies are long-term policies with uncertain outcomes.
•
Financing of policies as most of the policies require some government financing which
may have to come from taxes or borrowing.
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Question 3
The simple economy of Zentoland is represented by the following model”
Consumption function:
C = 2,500 + 0.4Yd
Investment function:
I = 1,000
Government spending:
G = 6,000
Net taxes
:
T = 5,000
Export
:
X = 6,000
Import
:
M = 4,000
Disposable income :
Yd = Y - T
a)
What is the equilibrium level of income (Y) of Zentoland? Make sure you present
all your workings.
(4 marks)
Equilibrium output = 15833.33
b)
Draw the aggregate expenditures curve.
(4 marks)
c)
Calculate the multipliers in this economy? Please show your working clearly.
(3 marks)
There are 3 possible multipliers in this economy namely government, tax and balanced budget
multipliers.
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G multiplier
=
1.67
T multiplier
=
-0.67
Balanced budget multiplier
d)
=
1
Discuss the effect of an increase in autonomous Investment of $4,000 on the
equilibrium income.
(4 marks)
With multiplier of 1.67, any increase in autonomous investment will lead to overall
increase of real output by 1.67 times.
Hence, an additional 4000 of autonomous investment leads to 1.67 X 4000 or
approximately 6680 worth of additional output or new equilibrium of $22500.
e)
If $20,000 is the “full employment” level of income, and the government’s goal is
full employment, by how much must government spending (G) increase in order for
the economy to reach the ‘full employment’ level of income?
(3 marks)
If $20,000 is the full employment level of income and the additional autonomous government
spending is A,
20000
=
2500 + 0.4(20000 - 5000) + 1000 + A + 2000
20000
=
A + 11500
A
=
8500
Increase in government spending = 8500 – 6000 = $2500.
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f)
Instead of increasing government spending, the government decides to lower net
taxes (T) to bring the economy to the “full employment” level of income of $20,000.
By how much must net taxes (T) decrease in order for the government to achieve
its goal?
(3 marks)
At full employment level of income,
20000
=
2500 + 0.4(20000 – T) + 1000 + 6000 + 2000
=
2500 + 8000 – 0.4T + 9000
=
19500 – 0.4T
-0.4T
=
500
T
=
-1250 (Give a rebate)
Decrease in net taxes
g)
=
5,000 – (-1250)
=
$6250
Explain why there are differences in the size of the change in G and change
in T in parts (c) and (d) to achieve the same ‘full employment” level of
income.
(4 marks)
The reason for the lower multiplier effect of the reduction in tax is the possibility that part
of the tax reduced will be saved by household instead of being spent.
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Question 4
a)
Many Economists in the United States of America believe that the Chinese
renminbi is undervalued.
The Chinese government however, has
maintained the view that her currency is not undervalued. Explain why the
governments are sometimes concerned about the level of exchange rate of
their country’s currency with their major trade partner.
(10 marks)
Exchange rate can affect,
•
Competitiveness of exports and imports and
•
Investments in and out of the country.
Competitiveness of exports and imports
A fall in the exchange rate may have desirable effects. It makes exports cheaper in other
countries. Hence, it typically leads to increase in exports. Likewise, import payments fall
because the depreciation causes imports to become more expensive.
Investments in and out of the country
It is cheaper for foreign investment to flow in. The country will further benefit from the
transfer of technology and managerial skills.
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Question 5
Explain the effect on the interest rate in the money market of India for each of the
following situations below. Demonstrate your answer with the aid of suitable
diagrams.
a)
The Bank Negara (Central Bank of Malaysia) reduces the required reserve
ratio of commercial banks by 2 percent.
•
(5 marks)
As the Central Bank increases the supply of money, the interest rate in the market will
fall. Students are expected to draw the money market diagram.
b)
The people have decided to hold more money at home as a result of several
commercial banks closing down during the economic crisis.
(5
marks)
•
As people have decided to hold more money, the demand for money will increase.
•
This leads to an increase in the interest rate in the market.
c)
•
The people invest in more bond funds as they expect bond price to rise in
the near future.
(5 marks)
People will demand for less money as people buy bonds in expectation of their price
rising.
•
The money demand curve shifts to the left.
•
The short-term interest rate will fall.
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d)
The economy is experiencing strong economic growth rate of 10% per
annum.
(5 marks)
•
As the economy is doing well, the number of transactions in the economy will increase.
•
The demand for money will increase.
•
This leads to an increase in the interest rate in the market.
e)
Firms are expecting strong economic growth in the next six months.
(5 marks)
•
As firms’ expectation is positive, they are expected to invest more, the demand for
loanable fund will increase.
•
This leads to an increase in the interest rate in the market.
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Question 6
Draw aggregate demand and aggregate supply (AD-AS) diagrams for each of the
following scenarios and identify in each case the impact on the price level and real
GDP on the Singapore economy.
Assume the economy begins with a full
employment level of real GDP and all other factors remains constant.
a)
Export from Singapore has increased substantially following the recession
in 2009.
•
(5 marks)
Increase in export will lead to increase in AD, shifting the AD to the right. Students
are expected to draw the AS-AD diagram.
•
b)
This will lead to a rise in real GDP and price level.
Increase in productivity of the firms.
(5 marks)
•
Greater productivity will lead to increase in LAS and the SAS.
•
The potential GDP and real output will increase while the price level will decrease.
c)
The Singapore population decline by half a million, as many young
Singaporeans emigrate to Australia and Canada in the last two years.
(5 marks)
•
The decrease in population will lead to decrease in aggregate demand for goods
and services. The AD will shift right.
•
The decreased population would also result in decrease in labour force in Singapore
which would reduce the LAS in Singapore. The LAS and SAS will shift left.
•
The real output and potential GDP will decrease.
•
The change in price is uncertain.
d)
The Singapore dollars appreciated against other major currencies.
(5 marks)
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•
Appreciation of the currency will decrease export and increase import. Hence, it will
lead to a decrease in the aggregate demand shifting the AD to the left.
•
e)
Real GDP and price level will decrease.
More successful supply side policies implemented by the Singapore
government to improve the productivity of workers in the last five years.
(5 marks)
•
Improvement in the productivity of workers will lead to increase in LAS and the SAS.
•
The potential GDP and real output will increase while the price level will decrease.
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