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, households tend to save less, purchase less imports as well as pay less taxes to the government. Thus, this reduces the withdrawals from the circular flow. Similarly, the declining income will reduce households’ expenditure on output from firms. The cycle then repeats itself. However, the magnitude of the decrease in consumpti on/production is smaller at each successive round. This is because when household income decreases, part of it is saved, paid as taxes and paid for imports. In other words, part of the decrease in household income is withdrawn from the circular flow of income at each cycle. This process continues on until the original amount of the decrease in injections have leaked away as withdrawals. At this point,

3 | P a g e the multiplier process stops. The result of a decline of export revenue is a multiplied decrease in the national income in Germany. Suggested Body 2: With the aid of circular flow of income as the tool of analysis, explain how an increase in government expenditure results in a multiplied increase in national income in Germany. Other than households, expenditure on the firm’s output produced by Germany may also come from government. This is known as injection. When there is an increase in injection of 12 billion euros of government expenditure on output to integrate and accommodate 1.1 million of migrants (as seen from preamble), firms would demand more labour and other resources from households to produce output. The households in Germany would receive more factor payments from firms and experience an increase in income. Households in Germany would also purchase more output from firms in Germany due to the increase in income. Similar to the effects of a decline in export revenue on the national income , this would result in a multiplied increase in the national income in Germany due to an increase in government expenditure. [Students are expected to provide detailed explanation of the (reverse) multiplier process for ONE of the 2 given injections.] Suggested Body 3: Explain the net effect on national income in Germany due to the opposing direction of change in the injections (i.e. decline in export revenue and an increase in government expenditure). The extent of the decline in export revenue due to global economic weakness is unlikely to be so huge as compared to an increase in government spending of 12 billion euros in year 2016 given that Germany’s inflation rate would be approaching 2% price stability ceiling in 2016 (as seen from preamble). This could be an indication th at Germany is approaching the full employment level of national income when there is a net increase in injections due to the increase in government expenditure outweighs the decline in export revenue. In view of this, this would result in a multiplied increase in national income in Germany. Suggested Conclusion Assuming that there is no change in investment expenditure in 2016, it is likely that there would be a multiplied increase in national income in Germany given that the decli ne in export revenue is likely to be lesser than the increase in government expenditure. Marking Scheme: Part (a) Knowledge, Application, Understanding, and Analysis L3 Well developed explanation and illustration of the underlying process (including multiplier process) of how decline in export revenue and increase in government expenditure result in multiplied change in national income in Germany with relevant use of well explained examples and circular flow of income . AND Well developed explanation of the net effect on national income in Germany due to the opposing direction of change in the injections. 8 – 10 m

4 | P a g e L2 Undeveloped explanation and illustration of the underlying process of how decline in export revenue and increase in government expenditure result in multiplied change in national income in Germany with relevant use of circular flow of income . Include explanation of the net effect on national income in Germany due to the opposing direction of change in the injections. OR Well developed explanation and illustration of the underlying process (including the multiplier process) of how either decline in export revenue or increase in government expenditur e result in multiplied change in national income in Germany with relevant use circular flow of income . Did not explain the net effect on national income in Germany due to the opposing direction of change in the injections. 5 – 7 m L1 For an answer that use AD – AS framework instead of circular flow of income For an answer that shows a descriptive knowledge of the circular flow of income. 1 – 4 m Part (b) Question requirements: • Identify and explain how the domestic and external factors can cause inflat ion in an economy. • Identify and explain how t