ACJC External Macro Tutorial Worksheet Section C Essay Answer

1 Question 4 Between 2012 and 2013 the number of Singapore dollars required to buy US dollars and Chinese Renminbi increase by 3.5% and 6.6% respectively, while the number of Singapore dollars required to buy Japanese Yen and Malaysian Ringgit fell by 15.2% and 3.5% respectively. Source: Monetary Authority of Singapore (a) Explain how an appreciation of a country’s currency might affect the current account of its balance of payments. [10] (b) Discuss the likely overall effects of the changes in the exchange rate in 2012-2013 on Singapore’s domestic economy. [15] (2016 A-Level Paper 2 Question 6) Question analysis: Command Explain how Concept • Currency appreciation • Current account of Balance of Payments Context Not given but students can use Singapore since it is given in the preamble Introduction: Unpack meaning of appreciation of currency (SGD) and current account of Balance of Payments • The exchange rate of a currency is its price (in the foreign exchange market) in terms of other currencies. • A country’s exchange rate is determined by the demand and supply conditions in the foreign exchange market. An appreciation of a country’s currency (say SGD) against the Japanese Yen (¥) or Malaysian ringgit (MYR) implies that less SGD is required to buy JPY¥100 or MYR100. • The current account in the balance of payments records a country’s international transactions of exports and imports of goods and services as well as primary and secondary income transfers. Requirement 1: Explain how currency appreciation may worsen the current account • Currency appreciation will cause the country’s exports to be more expensive in foreign currencies and imports to be cheaper in domestic currency. • Impact on exports: o With the increase in export prices in foreign currencies , quantity demanded will decrease. The extent of decrease in quantity demanded depends on PED. o The export revenue (price x quantity) in domestic currency will certainly fall since there is no change in export prices in domestic currency and quantity demanded has decreased because of the higher export prices in foreign currencies . The extent of decrease is greater when PED > 1. • Impact on imports: o Singapore context: With the decrease in import prices in domestic currency, quantity demanded increases. If the PED value of imports is less than 1 due to a lack of domestic substitutes, quantity demanded will increase less than proportionately,

2 ceteris paribus. This results in a decrease in import expenditure in domestic currency. (Note that students may also explained that PEDM > 1 in the context of other countries. The question does not require a specific context for part a . In such a context, import expenditure would fall, improving the current account.) o Since both export revenue and import expenditure have decreased in domestic currency, the impact on net export revenue (X -M) is uncertain and depends on the Marshall-Lerner Condition. o If the sum of the price elasticities of demand for exports and imports is greater than one, such as in the case of Singapore, the Marshall-Lerner condition holds, suggesting that the fall in X will outweigh the fall in M, leading to a fall in (X-M) hence worsening of the current account. Note to students: When to use Marshall-Lerner Condition? • Marshall-Lerner Condition is needed to explain how exchange rate changes affect the trade balance. • This question is on the current account. Since the trade b alance is an important component of the current account, Marshall-Lerner condition should be used to answer this question. Requirement 2: Explain how currency appreciation may improve the current account through the impact on GPL. • Singapore, being a resource-scarce country, is highly dependent on imports for factor inputs as well as necessities such as food. • The appreciation of SGD will lower the price of imported resources in terms of SGD, lowering the unit cost of production in the economy . With a lower unit cost of production, it is more profitable for firms to produce , firms are more willing and able to produce and the SRAS increases from SRAS1 to SRAS2. • • Producers pass on the cost savings to consumers by decreasing the price of goods from P1 to P2, including export ed goods. Many of Singapore’s key exports such as petrochemical s and refined oil have high import content. Thus, this will help to mitigate the increase in price of exports in foreign currencies as explained in the earlier paragraph. • If the cost savings are large enough, export prices may also decrease, making exports more competitive. Assuming PED value of exports is more than 1, export revenue will increase. • Coupled with the decrease in import expenditure for import dependent countries (as explained in the earlier paragraph), an appreciation of SGD may even lead to an increase in net export revenue, improving her current account.

3 Conclusion: • The impact of an appreciation of a country’s currency on her current account, depends on the sum of value of PED for exports and imports, as well as the nature of her imports. (b) Discuss the likely overall effects of the changes in the exchange rate in 2012 -2013 on Singapore’s domestic economy. Question analysis: Command Discuss → a balanced 2 -sided view is to be presented before the answer presents an overall well-reasoned judgement Concept • Currency appreciation and depreciation • Domestic macroeconomic aims • AD/AS analysis Context Singapore Introduction: Unpack the changes in Singapore’s exchange rate in 2012-2013 • Based on the information given, SGD has appreciated against Japanese Yen (¥) and Malaysian Ringgit (MYR) but depreciated against USD (US$) and Chinese Reminbi (RMB). • The changes in Singapore’s exchange rate against these foreign currencies would significantly impact the country’s economic growth, unemployment and inflation as these countries are Singapore’s key trade partners. Requirement 1: Explain the effect of SGD appreciation against ¥ and MYR on Singapore’s domestic economy Impact on SRAS: • SGD appreciation against ¥ and MYR ➔ Price of imported factors of production such as raw materials and semi-finished goods falls in domestic currency ➔ Firms will pass on lower unit cost of production to consumers in the form of lower prices ➔ SRAS increases ➔ less cost- push/imported inflation and increase in RNY when consumption expenditure rises in response to the lower prices /investment expenditure rises in response to improved expectations of future profits. Impact on AD • SGD appreciation against ¥ and MYR ➔ Price of exports rises in foreign currencies, leading to a fall in quantity demanded + Price of imports falls in domestic dollar ➔ decrease in export revenue and consumers switch away from local goods ➔ overall AD decreases ➔ economy has greater spare productive capacity ➔ less competition for resources ➔ price of factors of production such as wages fall ➔ firms will pass on lower unit cost of production to consumers in the form of lower prices ➔ decrease in RNY and increase in demand -deficient unemployment since firms are cutting down on production in response to an unplanned decrease in inventories. Briefly explain reverse multiplier process. • Overall, the economy can still grow as shown in the increase in RNY from Y 1 to Y 2 if the increase in SRAS outweighs the decrease in AD as shown in the diagram below.

4 Note to students: When to use Marshall-Lerner Condition? • Marshall Lerner condition is only used to explain how exchange rates affect the trade balance. • In this question, the end point is to explain the change in AD/AS, not the change in the trade balance. Thus, Marshall-Lerner Condition is not required. Evaluation 1: • Singapore’s economy can indeed still experience overall po