EJC Econs N2023 H2 EQ4 - students

1 Suggested answer for 2023 A-Level Paper 2 Question 4 The exchange rate is a key policy tool in managing the economy of Singapore. (a) Explain how an appreciation of the exchange rate might affect aggregate demand and aggregate supply in an economy. [10] (b) Discuss whether management of the exchange rate is the most appropriate way of controlling inflation in Singapore. [15] Part (a) - Question Analysis Approach Command Word Explain how Question Type Cause and effect Start point Appreciation of the exchange rate End Point Changes in AD and AS Content and Context Content • Components of AD=C+I+G+(X-M) • COP affecting SRAS • Technology, quantity and quality of resources affecting LRAS Context None Introduction An appreciation of the exchange rate occurs when the value of a country's currency increases relative to other currencies. This has significant implications for both aggregate demand (AD) and aggregate supply (AS) in an economy. R1: Appreciation of exchange rate will lead to an overall fall in AD • When the exchange rate appreciates, the prices of domestically produced goods and services increase for foreign buyers. Consequently, exports become more expensive and less price competitive, while imports become cheaper as foreign goods and services are now relatively less expensive. • For instance, the gradual modest appreciation of the Singapore dollar (SGD) made Singaporean goods and services more expensive for foreign buyers. As a result, exports became less price competitive. Assuming demand is relatively price elastic for Singapore’s exports (|PEDx|>1), f or example, Singapore’s electronics exports, such as headphones produced by Creative Technology, will experience a more than proportionate fall in quantity demanded as there are many other headphones substitutes available from other countries, resulting in lower export revenue for Singapore. • Meanwhile, the stronger Singapore dollar made imports cheaper. As Singapore lacks natural resources, our demand for imported raw materials will likely be less than 1 (|PEDm|<1),

2 suggesting a less than proportionate increase in the quantity demanded for imported foreign goods and services, reducing Singapore’s import expenditure. • Assuming Marshall-Lerner conditions hold, summation of |PEDx and PEDm|>1, appreciation of SGC will most likely lead to worsening of our balance of trade position. If the balance of trade becomes a deficit, it might eventually contribute to a fall in our net exports, ceteris paribus. • Since net exports (export revenue minus import expenditure) are a component of aggregate demand, a decrease i