ACJC H2 ECONS P2 essay Q1 (GST and growth)

1 1. Singapore government is set to raise GST from 7% to 9% sometime between 2021 and 2025, depending on the state of the country’s economy / economic growth. It will also increase the GST Voucher cash pay-outs when the GST is increased, to provide more help to lower-income households and seniors. Source: Straits Time, 20 February 2018 Discuss how the combination of an increase in GST and rising economic growth might affect expenditure by consumers on different types of products. [25] Approaching the question: • Unpacking the effects of each change in question: o Using PED to explain the effects of GST on consumer expenditure (CE) on different types of products e.g. luxury goods and necessities. o Using YED to explain the effect of higher economic growth on CE on different products. • Weighing/considering the effects of concurrent changes (of both GST and economic growth increases), making considered conclusions on whether CE will rise or fall. • Evaluation will include factors that will contribute to the outcomes, such as government’s mitigation measures to help lower income households deal with effects of GST rise. Introduction • Consumers’ total expenditure is the product of price and quantity bought (price x quantity demanded). Price is determined by t he demand and supply of the good. Demand is the willingness and ability to pay for a goods at given prices at a given time ceteris paribus. Supply on the other hand is the producer’s ability and willingness to sell or produce the good at given prices in a period of time ceteris paribus. • The overall effects of the combined changes of higher GST and economic growth on different goods depends on these two critical forces: o Whether demand for a good is price inelastic or elastic in demand o Whether demand for a good will rise or fall in response to higher earnings from higher economic growth o The extent of change in demand from income change Considering how GST affects CE on different products: CE will rise if demand for good is price inelastic, vice versa for those goods with price elastic demand • GST is an indirect tax paid through the producers / sellers on the consumers’ behalf. An Increase in GST by 2% will cause SS curve to pivot out to the left, shifting upward and the gap between old and new SS curves is larger for higher prices as GST is in percentage. This supply shift will cause prices to rise towards higher equilibrium points and quantity will fall towards lower equilibrium points. • Prices will tend to rise more for products or consumers which are less sensitive to price increases. The impact of higher GST on CE arising from the increase in price can be explained by using the concept of price elasticity of demand (PED). • PED refers to the degree of change in quantity demanded in response to a change in the price of the good. PED differs between goods and for a specific good, between consumer groups, determined by extent of substitutes, importance in consumption and consumers’ income. Differentiate between price elastic and inelastic demand. Demand for

2 necessities such as food products can be considered price inelastic, while demand for non- essentials such as electronic products and luxury goods can be considered price elastic. Also, PED of food products will be lower for higher income consumers as the expenditure takes a smaller proportion of their income, while the PED will be higher for lower income consumers. Demand for high end products which have niche markets can be considered price inelastic as these goods have limited substitutes, offer high quality, cater to high income market, hence consumers’ demand for them will not be responsive to price change. • For a given increase in GST, equilibrium price will increase more than the equilibrium quantity if demand is price inelastic. This steep increa se in price will have strong influence on CE, resulting in rising CE. For price elastic demand, while equilibrium price will still go up, the increase is to a smaller extent than the decrease in quantity demanded. The more significant fall in quantity demanded will push down CE, resulting in lower CE. • As seen from figure 1 above, a leftward shift in supply curve due to the increase in GST causes a larger increase in price of goods with inelastic PED like food (to P 3) than the increase in the price of products with price elastic demand (to P2). • Generally, goods with price inelastic demand, whether due to their characteristics or the income level of consumers will see CE rising due to increased GST. With price inelastic demand, sellers have greater ability to transfer the GST increase to consumers. Considering how economic growth affects CE on different products: CE will rise for goods with positive income elasticity of demand (YED), vice versa for those with negative YED • Economic growth is the rate of increase in GDP. GDP is the monetary value of goods and services produced in a country within a period. Higher economic growth means GDP rises at a larger rate of increase. This can make possible job creation and rising household earnings. With higher earnings, households’ purchasing power to consume goods and services will rise too. • Impact of economic growth on CE can be expl ained using income elasticity of demand (YED). It refers to the change in demand arising from a given change in income. Goods with positive YED are normal goods, which means demand will rise. For inferior goods, demand will fall and YED is negative because consumers switch to consuming higher quality goods or non-essentials. YED can be elastic or inelastic depending on whether income change or demand change is larger proportionately. • Effect of higher economic growth on CE depends on whether YED of the product is positive or negative. Figure 1 Dnon-essentials P2 Q2 ST S Price P1 P3 Dnecessities Quantity of products 0 Q1 Q3

3 o Normal goods such as luxury goods or goods of higher quality will likely have positive YED. With increase in income, demand will increase, likely leading to a rise in CE. o Inferior goods such as imitation leather bags, however, have negative YED because consumers are likely to switch to better quality goods i.e. demand and CE fall as income rises. o Hence consumer expenditure on normal goods such as luxury products increases with rising income, whereas consumer expenditure on inferior goods falls when the consumers’ income rises. • The extent of the change in demand, depends on the magnitude of YED of the different products. For both normal and inferior goods, they can have elastic or inelastic income elasticity. Students should use examples to illustrate what kind of normal goods will have high or low income elasticity, e.g. cheaper luxuries such as restaurant meals can have higher positive income elasticity due to their affo rdability, compared to more expensive and less affordable luxuries such as cars and private housing. Considering the combined effects of GST hike and increase in economic growth [putting together how PED and YED determine net outcomes in CE] • GST hike can cause households having to spend more in their expenditure on various goods and services. However, with the GST hike taking place during the same period of higher economic growth, changes in CE for different goods and services is also due to shifts in pattern of consumption. Higher purchasing power can cause consumers spending more on higher quality goods. • CE will more likely increase for goods which are price inelastic in demand and with positive YED. These can be goods with some degree of brand loyalty and the quality is high enough to pull in more demand due to the income rise. The higher the extent of the positive YED, the greater the increase in demand, therefore, the greater the i