NYJC_H2_ECONS_Q4

1 | P a g e Question 4 4 Germany took in 1.1 million migrants in year 2015. The government will spend 12 billion euros on accommodating and integrating them in year 2016 in the midst of a decline in exports hit by global economic weakness. Furthermor e, Germany’s inflation rate may reach the European Central Bank 2 percent price sta bility ceiling in year 2016. It is unlikely to stay there for long as there are price pressures far weaker elsewhere in the European region. Source: various (a) Explain how the combination of a decline in export revenue and an increase in government expenditure could affect the circular flow of income in Germany. [10] (b) Discuss whether an economy’s inflation rate is more likely to be determined by domestic or external factors. [15] Suggested Essay Outline Part (a) Question requirements: • Identify that export revenue and government expenditure are injections . • Using circular flow of income, explain the underly ing process (including multiplier process) of how the 2 injections result in the change in the national income in terms of direction and magnitude . • Explain the net effect on national income due to the opposing dire ction of change in the injections (i.e. decline in export revenue and an increase in government expenditure). Suggested Introduction What is circular flow of income? The 4-sector model of the circular flow of income consists of ( 1) domestic households and firms, (2) financial intermediaries e.g. banks, (3) government and (4) foreign sector for which Germany engages in both the import and export of goods and services. Identify the injections and withdrawals in the circular flow of income.

2 | P a g e Figure 1: Circular Flow of Income Suggested Body Suggested Body 1: With the aid of circular flow of income as the tool of analysis, explain how a decline in export revenue results in a multiplied decrease in national income in Germany. When there is a decline in the export revenue in the circular flow of income, firms demand less labour and other resources from households to produce output such as Cars. The households in Germany would receive lesser factor payments from firms and experience a decrease in income. With decreased income, households tend to save less, purchase less imports as well as pay less taxes to the government. These are withdrawals from the circular flow of income since this part of household income is not spent on firm’s output produced in Germany. In addition, households in Germany would also purch ase less output from firms in Germany due to the fall in income. The decreased expenditur e by households in Germany decreases the production level of firms in Germany. To produc e less output, firms will hence use less factors of production. Hence, the households in Ger many experiences another wave of declining income. As before, with decreased income, household