RI 2026 Macroeconomic Aims and Issues Student T2W5 Class Test 3 Mark Scheme

T2W5 Class Test 3 Macroeconomic Aims and Issues – Mark Scheme © Raffles Institution 1 T2W5 Class Test 3 Macroeconomic Aims and Issues Mark Scheme Singapore had experienced annual deflation in a number of years; 2020: - 0.5%, 2015: -0.5%, 2002: -0.4%, and 1998: -0.3%. With the exception of 2015, deflation in 2020, 2002, and 1998 were during economic recession period. (a) Explain one possible demand-side cause and one possible supply-side cause of deflation in Singapore. [10] (b) Discuss whether deflation or inflation is more damaging for Singapore’s economy. [15] Suggested answers for (a) Introduction • Deflation is defined as negative inflation or a sustained fall in general price levels (GPL). • The two main causes of deflation in Singapore stems from a fall in aggregate demand (AD) and a rise in aggregate supply (AS), particularly due to a fall in cost of production (COP). Body R1: Fall in AD causing deflation • In 2019, before the COVID -19 pandemic (2020), Singapore’s economy was experiencing positive growth, and its AD could be operating on the intermediate range of its AS curve with limited spare capacity. • As a small and open economy, Singapore’s (SG) economy is trade- oriented and depends heavily on trade for its economic growth. In 2020, w hen the global economy got weaker due to the onset of the COVID -19 pandemic where many of SG’s trading partners went into recessions, the real national income of SG’s trading partners falls such as in the US. This causes the average income of Americans to fall (assuming constant population size), making them less willing and able to purchase and consume goods and services, including SG’s exports to the US. • Assuming SG exports are normal goods with YED>0, the demand for SG’s exports falls, ceteris paribus, reducing the quantity of her exports, causing a fall in X component of SG’s AD. Alternatively, the following analysis also works: • Due to the weak global economic conditions in 2020 during the pandemic, households and firms became pessimistic and experienced lower confidence in the economy. • Households predict that their future income may decrease and increase their precautionary savings, causing a fall in consumption spending (C) in AD. In addition, firms expect future demand to be weak, thus reducing their expected returns on investment proj ects, causing MEI to fall and overall reducing investment spending (I) in AD. Price Adjustment Mechanism • Since AD = C+I+G+(X-M), the fall in X and/or C and I will result in a fall in AD from AD0 to AD1. The fall in AD will start to create s urpluses in the economy because current spending is below current production levels at the initial general price level P0. • The unplanned buildup of surplus inventories of goods and services will create downwards pressure on prices as firms are more willing to reduce prices to clear excess inventories. • The reduction in production, coupled with