EJC Econs N2022 H2 EQ2

Suggested answer for 2022 A-Level Paper 2 Question 2 The Singapore government announced in Budget 2018 that the goods and service tax (GST) would rise from 7% to 9% sometime between 2021 and 2025. The intended consequence of this change is to raise tax revenue. However, following the coronavirus (Covid-19) outbreak in 2020, the incomes of many households fell. a) With the aid of diagrams, explain why an increase in GST and a fall in incomes of many households are each expected to cause a fall in expenditure on luxury goods. [10] b) Discuss whether this increase in GST is likely to raise tax revenue and whether it will lead to unintended consequences. [15] Part (a) - Question Analysis Approach Command Word Explain why Question Type Cause and effect Start point 1. An increase in GST 2. A fall in incomes of many households End Point Fall in expenditure Content and Context Content • Price mechanism • Price elasticity of demand (PED) • Income elasticity of demand (YED) • Consumer expenditure (TE) Context Luxury goods, Singapore Introduction State essay approach: An increase in GST is expected to cause a fall in expenditure on luxury good through a decrease in supply and a price inelastic demand while a fall in incomes of many households is expected to cause a fall in expenditure on luxury good through a more than proportionate decrease in demand as demand is income elastic. Body Point 1: An increase in GST is expected to cause a fall in expenditure on luxury good • GST is an indirect tax, which is initially borne by the producers. A tax imposed on a good will raise the unit cost of production, leading to a decrease in supply. • GST is also an ad-valorem tax, which is a tax imposed as a fixed percentage of the price of the good. Since the tax is fixed in percentage terms, the amount of tax ($) per unit of output increases as price increases , resulting in a leftward pivotal shift of the supply curve from SS0 to SS1 as the vertical distance between SS0 and SS1 is the amount of tax. • As supply curve shift leftward, there is a shortage at the initial equilibrium price, causing upward pressure on price, until the shortage is eliminated where quantity demanded equals quantity supplied again. Hence the increase in GST will result in an increase in equilibrium price from P0 to P1 and a fall in equilibrium quantity from Q0 to Q1. • Demand for luxury good is also price elastic. Price elasticity of demand (PED) refers to the degree of responsiveness of quantity demanded of a good to a change in the price of the good itself, ceteris paribus. Since household can give up luxury goods easily, they will be more price sensitive to a change in price of luxury good such as a car or designer bag or clothes.

• Expenditure is given by price multiply by quantity. • Since PED for luxury goods is more than 1, the increase in price will lead to a more than proportionate decrease in quantity demanded. The increase in expenditure due to the increase in price (area P1E1AP0) is less than the fall in expenditure due to the decrease in quantity demanded (area AE0Q0Q1). Therefore, an increase in GST is each expected to cause a fall expenditure on luxury goods. Body Point 2: A fall in household income is expected to cause a fall in expenditure on luxury good • A fall in income for many households would result in a fall in real disposable income, ceteris paribus. This would lead to a fall in purchasing power and households would have less ability to consume goods and services. • The demand for luxury good is also income elastic . Income elasticity of demand (YED) refers to the degree of responsiveness of demand for a good to a given change in the income of consumers, ceteris paribus. Since income is falling, household would decrease spending more significantly on luxury goods since these goods are not essential. This result in YED >1 and demand would decrease more than proportionately to a given decrease in income, ceteris paribus. This is shown by a large leftward shift in demand curve from DD0 to DD1. P1 0 Q1 Q0 Quantity GST P0 Price SS0 (7%GST) SS1(9%GST) DD0 E0 E1 Figure 1: an increase in GST on luxury goods A SSo Price P1 DD1 DD0 Q1 Qo Quantity P2 Figure 2: Fall in demand of luxury goods due to fall in income 0 B C

• The fall in demand would result in a surplus at the original equilibrium price, which puts a downward pressure on price to eliminate the surplus, until quantity demanded equals quantity supplied again. Hence the fall in income would lead to a fall in equilibrium price and quantity of luxury goods from P0 to P1 and Q0 to Q1 respectively. • Since both price and quantity has fallen, expenditure on luxury goods would therefore decrease from area 0P1CQ0 to area 0P2BQ1. Conclusion Therefore, an increase in GST would reduce expenditure on luxury good as the increase in price would lead a to more than proportionate fall in quantity demanded while a fall in incomes would cause price and quantity to fall, causing a fall in expenditure of luxury goods. Mark Scheme Level Knowledge, Understanding, Application, Analysis Marks L3 Full display of AO1, AO2 and AO3 skills: For an answer that shows well -developed explanation of why an increase in GST AND a fall in incomes of many households are each expected to cause a fall expenditure on luxury goods. • clear and accurate explanation of how changes in DD and SS lead to a fall in expenditure using PED and YED concepts • supported with appropriate diagrammatic analysis • supported with relevant examples 8-10 L2 Uneven display of AO1, AO2 and AO3 skills: For an answer that shows under-developed explanation of why an increase in GST and a fall in incomes of many households are each expected to cause a fall expenditure on luxury goods. • lacks depth of analysis (i.e. , limited effective use of relevant economic analysis or gaps in diagrammatic analysis) • lacks scope in explaining either GST increase or fall in income • lacks relevant examples 5-7 L1 Limited display of AO1 and AO2 skills: For an answer that shows limited knowledge of why an increase in GST AND a fall in incomes of many households are each expected to cause a fall expenditure on luxury goods. • listing of points, unexplained statements, or descriptive response • many conceptual errors (i.e., using AD/AS analysis, use PED with shift in demand, use XED etc) • irrelevant response such as on economic growth or expenditure on necessity • smattering of points 1-4

Part (b) - Question Analysis Approach Command Word Discuss whether → balanced answer + evaluation Question Type Cause and effect Start point Raise in GST End Point tax revenue, unintended consequences Content and Context Content Price mechanism, PED, equity Context Singapore Introduction State essay approach: The intended outcome of the increase in GST from 7% to 9% is to raise tax revenue in a sustainable manner to fund the increase in recurring healthcare expenditure due to an ageing population. However, this depends on whether the good is a luxury good or necessity. GST revenue collected from necessity will likely increase while GST revenue from luxury goods will likely decrease. The increase in GST might also lead to inequity as an unintended consequence without further government supports. Body Point 1: Explain how raising GST might increase tax revenue • As explained in part a, a raise in GST would result in a pivotal leftward shift of the supply curve, resulting in a fall in equilibrium quantity and increase in equilibrium price. Figure