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 l