Economics H2 Economics

Macroeconomics

Microeconomic Goals Showing Economic Growth via PPC

• Equity / Equality
• Measured by Gini Coefficient
• Economic Efficiency
• Includes both allocative and productive efficiency
• Production on a point on the PPC
• SMC = SMB
• Goals of Firms
• Maximize Profit
• Goals of Government
• Maximize Social Welfare

Macroeconomic Goals
• Sustainable Economic Growth
• Both Actual and Potential Growth
• Low Inflation Rates (2% - 5%) Showing Economic Growth via AD/AS
• Full Employment
• Zero Cyclical and Structural Unemployment
• Stable Exchange Rate
• Healthy Balance of Payments

ECONOMIC GROWTH
Actual EG: Annual % Increase in National Output
Potential Eg: Annual % Increase in Productive Capacity
Key Indicator: GDP / GNP
Singapore: 1.5% in 2008

Determinants
AE = C + G + I + (X-M)

Benefits of High and Sustained Economic Growth National Income Accounting [ INDICATORS ]

• Increased Levels of Consumption GDP: Total market value of all final goods and services
• Higher real income produced within the geographical boundaries of a country
• Increase in Purchasing Power during a specified period
• C will increase
• Promotes Social Welfare GNP: Total market value of all final goods and services
• More Equitable Income Redistribution produced by factors of production owned by residents,
• Under a progressive tax system, tax revenue will during a specified period.
increase when income increase
• Government can spend more on social welfare Market Price Factor Cost
programs
• Reduces Unemployment Price purchasers have to pay Refers to what the factors of
• Increase in AD will help reduce cyclical for the goods and services production received for the
unemployment sold on the market goods and services
• Potential growth due to increase in productivity Includes indirect tax Includes subsidies
may reduce structural unemployment
• Environment Benefits GDP (Market Price)
• Environmental consciousness tends to increase + NPIA
with increase in affluence GNP (Market Price)
+ Subsidies / - Indirect Tax
Singapore’s Policies GNP (Factor Cost)
Conducive environment to attract foreign investment, such - Capital Depreciation
as maintaining strong infrastructure and investing heavily in NNPFC (National Income)
education to train workers.

~ these notes were created by benjamin ng tze wee ~


SOL: Quality of life, encompassing both material and non material well being. Material well being refers to the quantity and
quality of goods and services available, while non-material well being includes social factors like working hours, stress
and pollution.
Can we conclude from the increase/decrease in GDP that SOL has risen/fallen?
Factor
Increase/Decrease in GDP
Changes in Price Level
Changes in Population
Composition of GNP/GDP
Distribution of GNP/GDP
Non-Monetary vs Monetary Transactions
Nature and Reliability of Data
Social Factors
~ these notes were created by benjamin ng tze wee ~
H2 Economics
Macroeconomics
Elaboration Remarks
Increase in the quantity and quality of goods
and services in the market, available to the ↑ in GDP, ↑ in Material Well Being, ↑ SOL
consumers for consumption
Nominal GDP does not take into account
changes in Price level, and thus may be
misleading.
If Inflation rates are high, ↑ in Nominal GDP is
mainly due to increase in prices and negligible
Real GDP should be used as it measures the
value of output at constant prices. As such, an increase in output and SOL
increase in real GDP will indicate a rise in
output, and hence SOL
Populations tend to change over time, and
thus an increase in GDP may not indicate an If population increases faster than real
increase in an individual’s share of national
national income, individual’s share of NI will
income.
be falling even if GDP ↑
GDP per capita should be used instead.
If a large proportion of the increase in GNP is
due to higher spending on defense or space
exploration, SOL would not have increased.
GDP measures a country’s output, and thus
includes both consumption goods and A rise in NI that arises from a rise in exports
investment goods, but SOL is only affected by does not correspond to a rise in SOL if income
consumption goods. generated is not spent on consumer imports
A fall in national income due to increase in
consumer
Increase in GNP may not be equitably
distributed to the people / sectors, thus one
cannot say that the average person is better If the small majority (the rich) reaps in most of
off. the benefits from the increase in NI, while the
majority remain poor, the SOL of the average
Indicators like the Gini Coefficient are needed person would not have increased.
to show whether the increase in NI also
caused widening of the income disparity
If a transaction which was previously non-
monetary becomes a monetary one, NI figures
will see a rise without a corresponding E.g. Voluntary Charity Work contributed to the
increase in welfare. total output of final goods and services in a
country, but are not accounted for in NI
NI understates the true level of production as
some services do not pass through the market
National income figures are mere estimates
based on samples.
E.g. Income tax may be understated for
The country may also lack proper accounting
occupations like hawkers.
systems, where officials lack expertise in data
collection, or where there are many
inaccessible areas
GDP does not measure intangibles which Rising NI and production leading to higher
affect the quality of life and the general well levels of pollution will cause SOL to fall.
being of the society at large. (non-material
well being) Rising NI due to increased productivity from
an increase in working hours may actually
Other indicators like HDI and PQLI are needed cause SOL to fall.

Can we conclude that one country has a higher/lower SOL just because it has a higher/lower GDP?
Factor
Different Accounting Practices
Different Size of Non-Monetized Sector
Different Currencies are Involved
Differences in Composition of NI
Differences in Distribution of Income
Differences in External Costs
Differences in the work hours vs leisure time
Differences in availability, reliability of data
~ these notes were created by benjamin ng tze wee ~
H2 Economics
Macroeconomics
Elaboration Remarks
Different Provision for depreciation because of
different accounting practices and tax laws
Different methods of valuing inventory /
Exclusion of change in inventory in NI
Developed countries have goods and services
exchanged in an organized market, but barter
trade (not in NI) may still be prevalent in low
income families
Exchange rates are volatile, does not reflect
actual purchasing power and may be subject PPP must be used to offset the shortcomings
to manipulation by the government or to of the official exchange rate
huge capital flows
Real income of some developing countries
may be lower but production is concentrated
on consumer goods and services
Lower Living standards despite a high GNP
may be due to greater inequality in the
distribution of income
Higher output may be accompanied by higher
levels of pollution, congestion and depletion
of natural resources
A higher GDP may be the result of people
working harder or longer hours
Comparing relatively more accurate estimates
of advanced countries with relatively
inaccurate figures of more backward countries
will yield misleading results
 H2 Economics
Macroeconomics

AE = Y
For use when the question is regarding the effect of changes to C G I X M on national income and employment, or to explain recession
or the solving of it by increasing AE such that it diminishes the deflationary gap as the economy moves towards full employment

AE = C + G + I + (X - M)
There is only one level of national income where AE equals the total value of goods and services produced.
Equilibrium Level of National Income is the level of NI which, when reached, will be maintained until further disturbed
Aggregate Expenditure is the total planned expenditure on goods and services in an economy.

Consumption (C) = a + bY

a: Autonomous Consumption, minimal amount of consumption that households will still spend on even if Y = 0
bY: Income-Induced Consumption, consumption that increases as income increases (b: MPC)

Consumption and Savings APC: Proportion of Total Income that is consumed

MPC: Change in consumption as income changes

Represents the gradient of the Consumption Function

Determinants:
1. Wealth
i. More Accumulated Wealth, ↑C
2. General Price Level
i. Increase Price Level
ii. Erodes the real value of income, C↓
3. Expectations about Future Income
i. Expect Rising Incomes, ↑C now
4. Consumer Credit
i. Lower interest rate, lower cost of borrowing, ↑C
5. Distribution of Income
6. Taxes
i. Increase in tax lowers disposable income, thus C↓

Investment (I): Expenditure over a given period on the production of capital goods and on net additions to stocks of goods
NOTE: Changes in I increases NI by a magnified amount the multiplier, but also increases LRAS and Productive Capacity

Firms aim to maximize profits, and thus they will only invest if the expected rate of return is greater than the expected rate of
interest. As such, there is an inverse relationship between interest rate and level of investment, as shown by the MEW curve.

MEI Determinants:
1. Business Expectations
1. Business Optimism: Expected rate of return higher, I ↑
2. Business Pessimism: Vice Versa
2. Cost of new capital goods
1. If cost of K suddenly increase, I ↓
3. Innovation and Technology
1. Improvement in I&T stimulate a demand for additional
capital goods, causing I ↑
4. Profit Taxes
1. Firms estimate rate of returns by considering expected
after-tax profits
2. Rise in corporate tax thus decreases the expected rate
of return, causing I ↓
3. It also decreases the amount of money firms have for
investment

Government Expenditure (G) represents the current spending and capital spending by the government on the provision of
social goods and services. It is assumed that G is autonomous.

Net Exports (X-M) refers to the difference between the value of exports and values of imports, and is dependent on external
factors which are often beyond the control of governments. It is also assumed to be autonomous.
~ these notes were created by benjamin ng tze wee ~
 H2 Economics
Macroeconomics

Determining Equilibrium National Income: the AE = Y Diagram

Note: x-axis for the diagram refers to nominal national income, does not take into consideration price levels

AE = Y

Below Full Employment: Deflationary Gap

• Shortfall of AE below NI at the full employment level
• Situation of Economic Recession
• Deficient Demand causes unemployment

Above Full Employment: Inflationary Gap

• Excess of AE over NI at the full employment level
• No spare capacity
• Any shift in AE only causes demand pull inflation
• Rise in Nominal GDP but no rise in Real GDP

Multiplier Effect
The rise in AE will cause a magnified change in NI based on the multiplier ratio (k), where k = ∆ NI / ∆ AE = 1/MPW = 1/ (1-MPC)

Normal Multiplier:
Assuming Singapore has an MPC of 0.5 and a resulting MPS of 0.5, an injection of $40 million will have the following effects. It
causes NI to rise initially by $40 million, and this increases people’s income by $40 million. These people, in turn, spend a portion
of this new income of $20 million, while saving another $20 million. This in turn generates new income of $20 million for
producers, who will spend half of this new income ($10 million), while saving the other half. The cycle continues until
equilibrium national income is reached, where total injections = total withdrawals, and the total expansion of NI is $80 million,
where k = 2.

Reverse Multiplier:
Assuming that Singapore has an MPC of 0.5 and a resulting MPS of 0.5, a leakage of $40 million will have the following effects. In
the first stage of the multiplier, NI will contract by an initial amount of $40 million, and this will cause a decrease in income of the
people, who will in turn decrease consumption by $20 million, and another $20 million is lost in savings. The second stage of the
multiplier will cause the NI to fall by a further $20 million due to the lowered consumption, and this in turn will decrease the
consumption of the people by a further $10 million. The third stage will see the NI contracting by another $10 million, and the
cycle will continue until the equilibrium national income is reached again. As such the total contraction of NI is $80 million, as
the multiplier k = 2.

The Singapore Scenario: Very low multiplier (0.54)

High MPS: Traditional values of thrift, Compulsory Savings Scheme (CPF)
HIgh MPM: Trade volume 300% of GDP, highly dependent on foreign imports for raw materials as well as consumption
goods as Singapore herself lacks natural resources.

~ these notes were created by benjamin ng tze wee ~

 H2 Economics
Macroeconomics

AD / AS Analysis
For use when the question is regarding the changes in price level as national income changes, comparing inflationary growth and non-
inflationary growth as well as showing demand pull inflation and cost push inflation.

Factor Aggregate Demand (AD) Aggregate Supply (AS)

Definition Shows the inverse relationship between price level Amount of goods and services all firms in the
and real equilibrium output at which planned economy are willing to supply at different price
expenditure equals actual income levels over some given time, usually a year
Graph

Slope of Graph Downward Sloping Three Ranges

Factors that Shift Curve
Type of Inflation
Causes
Fall in domestic price levels will
• Increase PP of $ C↑
• Exports more competitive X↑
• Domestic Goods preferred M↓
Changes in C G I X M
• Changes in Economic Outlook
• Changes in expected inflation rate
• Government Policy (Fiscal)
• Changes in Money Supply
• Changes in Interest Rate
• Change in Exchange Rate
• Changes in Trading Partner’s NI
Inflation
A sustained increase in general price level
Demand Pull Inflation:↑AD exceeds ↑AS, economy
with limited/no excess capacity
Increase in C G I X M (See Determinants of AD)
Increase in Money Supply
Excessive growth of the money supply can cause an
increase in AD as people have more money to spend Import Price Push
on goods and services
Keynesian Range: Excess Capacity
Intermediate Range: Some Supply bottlenecks
Classical Range: No Excess Capacity
SRAS
• Changes in input prices or COP
• Supply Shocks
Both LRAS and SRAS
• Incentives like Lower Marginal Tax Rate
• Changes in Institutional-Regulatory Env.
• Capital Stock and Human Capital
• Technology and Entrepreneurship
• Labour Force
Cost Push Inflation: Caused by ↓AS (SRAS) due to
rising Cost of Production
Wage Push
Wages rise faster than productivity gain
*Wage-Price Spiral
Increase in P of imported raw materials, increase Cost
of Production

Profit Push
Firms use market power to raise prices and extract
more profits

Tax Push
Adds to cost of living
Firms raise prices to offset costs
Graph

~ these notes were created by benjamin ng tze wee ~

 H2 Economics
Macroeconomics

Effects of High Inflation

Effects on Economic Growth If mild, firms may experience higher profits margins Firms who are unable to keep up with rising costs by
as factor costs are unlikely to rise in the short term improving productivity and efficiency will feel a
due to pre-agreed contracts, thus investment and significant pinch in profit margins, as such
growth is encouraged investment is discouraged
Effects on Income Redistribution Some segments of the population may experience windfall gains, and others losses:

Effects on Unemployment
Effects on Allocation
Fixed Income Earners suffer, as their real income falls while Variable Income Earners do not.
Firms benefit during DPI as profits increase, but suffer during CPI as profits diminish
Savers suffer as the real value of their savings decrease
Debtors gain because the value of the loan will be less in real terms
Reduces Unemployment Increases Unemployment
Results in Misallocation of Resources due to distortion of price signals in the market. E.g. Producers may be
unable to distinguish normal price increase from real price increase, as such they may end up producing
more even though real prices might not have changed.

Effects on Balance of Payments
Effects on Currency Value
Renders unneeded administrative cots to keep up with the constant change in nominal values (menu costs)
Px ↑, causing Qd ↓ as exports lose their competitiveness in the foreign market.
Demand for imports increase as foreign goods are cheaper than domestic goods
Falling Export Revenue, Rising Import Expenditure (this assumes PED > 1)
BOP Deteriorates
Falling BOP Causes Exchange Rates to weaken

Continuous High Inflation may also erode investor’s confidence, and thus are likely to pull their capital out of
the country. This causes massive capital flight, and thus currency crisis (sharp devaluation)

Decreased Purchasing Power of currency

Effects of Low and Stable Inflation
Low and Stable Inflation (2-5%) is a sign of a buoyant and expanding economy with jobs and output growth

Stable Prices and Business Optimism causes investors to have a higher expected rate of return, and as such I ↑
• Increase in AE Magnified Increase in NI and Y based on the multiplier, k Actual Growth, High Employment
• Increase in LRAS Increased Qty of Capital Goods Increased Productive Capacity Potential Growth
• Allow for Non-Inflationary Economic Growth

Savings are also encouraged, as Interest Rate > Inflation Rate, and thus increasing funds for investment

Exports more competitive if inflation rate is lower than that of other countries, Quantity Demanded of Exports increase (more than
proportionately if PED > 1), increasing Export Earnings, Improving BOP and Strengthening the Exchange Rate
The Singapore Scenario
Prices of certain essential items like cooking oil, bread, milk and other diary products have gone up significantly over the past year
• Snowstorm in China disrupts food supply, causing supply shocks
Import Price Push Inflation
• High Global Prices of food and oil, increasing Cost of Production
Tax Push Inflation
• Rise in GST from 3% to 5%
Rising Values of Property increase in rental and business costs

~ these notes were created by benjamin ng tze wee ~

 H2 Economics
Macroeconomics

Unemployment
Refers to the number of people of working age who are without work, but willing and able to take up employment
The labour force refers to all within working age, who are willing and able to work, and are either employed or seeking employment
Unemployment Rate = No. of Unemployment / Labour Force x 100%
Full Employment is when the economy has no cyclical unemployment

Cyclical Unemployment
Cause Demand Deficient, Decrease in AD, such as during the downswing
Firms find that they cannot sell at current output, so stocks pile up
Firms thus cut back on proportion and fire workers
Policy Raise AD through fiscal and monetary policies
Structural Unemployment
Cause Changing structure of the economy causes mismatch between worker’s skill and job requirements.
This can be caused by a change in the pattern of demand or methods of production. It arises when
changes in technology or international competition change the skills needed to perform or change
the location of jobs.
Policy Provide finance of unemployed workers who wish to acquire new skills that are currently in
demand
Steer the education system towards the needs of the economy.
Supply Side Policies (Shift AS)
Seasonal Unemployment
Cause Unemployment that varies with the season or weather, predominantly occur in temperate
countries.
Usually not a serious problem unless economy is heavily dependent on those industries
Policy Diversify its industries
Frictional Unemployment
Cause It takes time for workers to match with suitable jobs [Imperfect Information]
Not a cause of concern, may be good as a better match between workers and job after some
deliberation would mean the economy becomes more efficient
Policy Improve Job Information services by providing job centers
Effects of Unemployment
Loss of Production and Income
Decrease in an economy’s actual output, possibly causing deflationary gap
Standard of Living is lowered

Loss in Human Capital

Prolonged unemployment may cause to lose touch of the skills and knowledge he once possessed, and may face
increasing competition with the fresh graduates

Cost to the Unemployed and their Families

Workers lose their financial security. possibly leading to loss of self esteem, stress, and even suicide and mental illness

Loss in Tax Revenues

Loss in income, thus government loses tax revenues from income tax.
Unemployed do not pay income tax, and spend less thus lowered collection of GST.
There is also increased expenditure on welfare payments

Loss in Social Stability

Leads to greater incidence of crime, violence on streets, drug abuse, alcoholism and vandalism

~ these notes were created by benjamin ng tze wee ~

 H2 Economics
Macroeconomics

Fiscal Policy
The deliberate manipulation of government expenditures and taxes to promote macroeconomic goals

Taxation Government Expenditure

Types
Progressive Tax: Tax takes a higher proportion of one’s Current / Ordinary Expenditure includes the expenditure
income as income increases, more equitable incurred in the day-to-day routine work and is recurrent year
Regressive Tax: Percentage of income paid in taxes falls as after year
income increases, heavier burden on the poor
Proportional Tax: Percentage of income paid out in taxes is Development / Capital Expenditure includes spending on
the same as income rises public investment

Direct Taxes are paid directly by the individual on which the

tax falls. Reduce disposable income of the individual.
Indirect Taxes is one where the incidence of the tax can be
shifted from the seller from the seller to the buyer. It shifts the
supply curve of goods, and they reduce the real value of
income through the rise in prices
Purpose
Raise Revenue for government to finance its expenditure, Provision of Public and Merit Goods
including the provision of goods and services not efficiently
produced by the market Redistribute Income and Wealth through benefits and
pensions
Reduce inequalities of income, by taxing the rich more
proportionately than the poor (progressive tax) and using tax Regulate Economic activities and promote economic growth
revenues to provide essential goods and services to everyone
regardless of income. Pay interest on the National Debt

Correct Market Failure (esp. Negative Externalities)

Promote economic growth by giving tax holidays for the initial

years for companies/industries. (S’pore corporate tax is 17%)

Influence Level of total Expenditure

Effects
Distribution of Income Resource Allocation
Incentive to Work
• Income Effect: Higher taxes force people to work more so Income and Wealth Distribution
that they have to cut down less on consumption • Expenditure on health, educational services etc benefit
• Substitution Effect: Higher taxes encourage people to mainly the poor, thus reducing extent of the inequalities
work less as an extra hour taken in leisure involve a of income and wealth distribution
smaller sacrifice in consumption
Resource Allocation: favor the untaxed / lower taxed good Economic Growth
Consumption • Capital expenditure promotes potential growth
• Indirect: Reduce Qd of good (shift SS, DD unchanged)
• Direct: Reduce Yd, discouraging consumer spending Price Stability
Ability & Incentive to Save • G can be varied to raise / lower AD to reduce inflation or
Ability & Incentive to Invest to promote economic growth
• Profits reduced to higher taxation, reducing investment

~ these notes were created by benjamin ng tze wee ~

 H2 Economics
Macroeconomics

Discretionary Fiscal Policy

Expansionary Fiscal Policy increase G and/or decrease tax so as to boost AD, AE and NI, reducing cyclical unemployment
Contractionary Fiscal Policy entails a reduction in G and/or increasing tax so as to reduce AD and demand-pull inflation

Limitations Uses
Remedy for :

Crowding-out Effects Unemployment

where does the money for fiscal spending come from?
If G was financed through tax, consumers will have less to
spend, and if it was financed through loans, it will cause
interest rates to increase, cutting back on investment. The
increased government spending thus will be offset by lower
private household consumption ad lower private sector
investment
Limitations of tax cuts
May not stimulate consumption if only viewed as temporary
measures. Investment is also dependent on business outlook
as well, and thus tax cuts with a bleak economic outlook may
not stimulate investment
Relative Inflexibility
Much of government expenditure is tied down to long term
contracts, and budgets are only drawn up once a year.
Time Lags
Size of Multiplier
Small k means that increasing AE will only cause a small
increase in NI, limiting the effectiveness of fiscal policy to raise Income Disparity
output and employment
Expansionary Fiscal Policy can increase AD/AE through
increasing G, to stimulate corresponding increases in C, I and X
so as to shift AE upwards, causing a magnified increase in
national income and employment as there would be the
creation of demand for labour.
It can only solve cyclical unemployment. Structural and and
frictional unemployment would require Supply Side Policies
Inflation
Contractionary Fiscal Policy can be reduce Demand Pull
Inflation by causing AD to decrease
Cannot solve cost push inflation, requires SS Policies
Slow Growth
Expansionary Fiscal Policy can bring about actual economic
growth by increasing AD.
For sustainable non-inflationary growth, shifts in AS brought
about by SS policies are also needed
Progressive income tax, the provision of merit and public good
and the provision of transfer payments will aid in the
achievement of a more equitable distribution of income

~ these notes were created by benjamin ng tze wee ~