RI 2025+Macroeconomics+Aims+Issues+PoliciesT2W8%28Mark+Scheme

T2W8 Class Test 4 Macroeconomics Aims, Issues & Policies - Mark Scheme © Raffles Institution 1 T2W10 Class Test 4 (Thursday Group) Macroeconomic Aims, Issues & Policies Mark Scheme The Covid-19 pandemic led to border lockdowns creating supply chain disruptions. Many governments fear that there could be a world-wide recession as spending falls. (a) Explain how the Covid-19 pandemic may affect economic growth and balance of trade of a small and open economy such as Singapore. [10] (b) Discuss whether the Singapore government should use fiscal policy alone in managing the economy when faced with a recession. [15] Part (a) Introduction ▪ Smallness refers to ▪ limited land and thus lack of natural resources ▪ small population and thus small domestic market [C as relatively smaller % of GDP] ▪ Being small leads to need to be open: ▪ reliance on imported raw materials and even foreign labour ▪ reliance on exports as engine of growth [X as 200% of GDP] Development R1: Economic Growth measured by year-on-year % change in real GDP On AD: ▪ Covid-19 led to pessimism and people cut down on spending as they fear a looming recession. Furthermore, strict lockdowns lead to less consumption at restaurants and entertainment outlets. Border lockdowns also make it difficult for goods to reach foreign consumers. ▪ In all, the fall in C and X causes a fall in AD. Being open, the fall in X will have an adverse impact on Singapore’s AD. ▪ Using an AD-AS diagram, show the multiple shifts in AD curve to the left.

T2W8 Class Test 4 Macroeconomics Aims, Issues & Policies - Mark Scheme © Raffles Institution 2 ▪ The fall in AD works through the reverse multiplier to reduce real GDP by more than proportionate. One man’s fall in spending leads to less income for the next person. The process goes through many rounds of fall in induced consumption to reduce real GDP. ▪ With reference to Figure above, the AD curve shifts finally from AD0 to AD1. The result is either a slow-down in actual growth or in a worse-case scenario – negative GDP growth rate. On AS: ▪ goods and [sometimes] labour cannot move across borders due to government restrictions for fear of Covid-19 transmissions ▪ total restrictions or delay in shipments lead to shortages of raw materials and labour – causing rise in prices ▪ being open, the rise in import prices causes rise in production cost leading to a fall in AS ▪ Use AD-AS diagram to show how the upward shift of the horizontal and upward sloping portion of the AS curve causes a rise in GPL – known as imported cost-push inflation ▪ Due to the rising inflation, households and foreigners cut down on spending ▪ The upward movement along the AD curve leads to a fall in real GDP – thus negative growth. [Acceptable idea – but not required - no extra credit given] ▪ Answers can link to a fall in productive capacity as quantity of raw materials and labour falls – thereby affecting potential growth and future actual growth. R2: Balance of Trade Balance of trade = total revenue from exports – total expenditure on imports [answer must link to change in P and change in Q] ▪ Being small and open makes Singapore dependent on imported ra w materials as explained earlier. Singapore is also dependent on imports of final consumer goods – given its small production base. As such, the demand for such imports is price-inelastic. ▪ With shortages caused by border lockdowns, the rise in prices of such imports leads to rise in import spending as the fall in quantity demanded is less than proportionate compared to the rise in price. The total expenditure on imports rises. Ceteris paribus, this may cause a BOT deficit. ▪ In addition, a fall in spending world -wide (due to reasons explained earlier) cause a fall in demand for Singapore’s exports. Ad the price and quantity both fall due to the fall in demand, total revenue from exports faces a huge dip. The huge fall arises as Singapore sells high value-added goods and services such as pharmaceutical products, semi -conductors and refined oil.

T2W8 Class Test 4 Macroeconomics Aims, Issues & Policies - Mark Scheme © Raffles Institution 3 ▪ The analysis can also be linked to a recession that ensues. The fall in income will further worsen the fall in demand. Given that Singapore sells high value-added goods, the demand may fall by more than proportionate as world incomes decrease. This causes the TR from exports to fall ▪ The combined effect of a fall in TRx and rise in TEm will lead to a worsening BOT deficit. [Partial credit for this idea below] ▪ With the rise in import prices, production cost rises causing a fall in AS. The upward shift of the AS curve leads to a rise in GPL – aka imported cost-push inflation. ▪ With a higher relative inflation rate, exports become less competitive and demand falls. Conversely, imports become more attractive to Singapore consumers and the demand rises. The resultant fall in TRx and rise in TEm leads to a BOT deficit. Mark Scheme: Knowledge, Application, Understanding, Analysis L1 ▪ Lack application of relevant economic framework and context ▪ Critical errors in analysis ▪ Significant conceptual gaps in explanation 1 - 4 L2 ▪ Some economic analysis for both requirements (R1 and R2) but with gaps or lapses in explanations ▪ Some application of context and use of examples ▪ Lacking in full scope of analysis 5 - 7 L3 A well-developed answer that demonstrates: ▪ Rigorous analysis for BOTH requirements ▪ Good scope of coverage ▪ Good application of contextual examples 8-10

T2W8 Class Test 4 Macroeconomics Aims, Issues & Policies - Mark Scheme © Raffles Institution 4 Part (b) Introduction ▪ A recession is a fall in real GDP for at least 2 consecutive quarters. ▪ In this context, the recession caused by fall in C and X as ‘spending falls’. Being small and open and with X being 200% of GDP, a recession in Singapore is most always due to a world recession such as a recession in the USA. Typically, recessions in recent years are due to a fall in AD. ▪ To manage a recession, the government has to use policies to increase real GDP and decrease cyclical unemployment. Development R1: Fiscal Policy Thesis: FP alone can stimulate the economy ▪ Explain how expansionary FP works: ▪ An increase in G in areas such as infrastructure is a direct injection into the ci rcular flow of income . A decrease in personal income taxes raises the disposable income of households, while a fall in corporate taxes raises the post-tax profits of firms. These may cause a rise in household consumption and firms’ investment respectively. ▪ Together, the rise in AD will work through the multiplier to increase real GDP by more than proportionate. As shown in diagram below, as AD curve shifts finally from AD0 to AD1, there is a rise in real GDP from Y0 to Y1. ▪ As output rises, there will be a derived demand for labour input and that reduces cyclical unemployment. ▪ The multiplier process is based on the principle that one man’s spending creates income for the next person, and that income generates more spending. The process goes through many rounds of spending to create more income and indirect jobs. Each round of increase in AD gets smaller due to leakages in the form of savings, taxes and imports. The process does not go on indefinitely and will end when the initial increase in injections has totally leaked out as withdrawals. Eventually, the real GD P would have risen by more than proportionate to the initial increase in injections. ▪ Additional ideas on why FP can be used alone [any 1 or 2 ideas] ▪ Increase in G [part of FP] is a direct injection into the circular flow of income, and is thus likely to have a greater expansionary effect unlike ot