IJC H2 ECONS P2 Suggested Answers

PRELIM SUGGESTED ANSWERS ECONOMICS UNIT @ INNOVA JUNIOR COLLEGE 1 2018 H2 Prelim Essay Q1 Question: Discuss the likely combined effects of economic growth and a rise in Goods and Services Tax (GST) on consumers and producers in different product markets in Singapore. [25] Suggested Answer Explain effects of economic growth on consumers and producers in different product markets - Economic growth – rise in real nat ional income and hence rise in household incomes - Impact on product markets depends on the income elasticity of demand of products: ● For normal goods with positive YED, demand would increase. Necessities such as rice (0<YED<1), demand would increase less than proportionate to the increase in inco me whereas for luxury goods such as cars (YED>1), the demand would increase more than proportionate to the increase in income. ➔ For normal goods, consumers’ ex penditure and hence producers’ revenue would increase as both price and quantity increases, ceteris paribus. ● For inferior goods with negative YED such as instant cup noodles, demand would decrease. ➔ Consumers’ expenditure and h ence producers’ revenue would decrease as both price and quantity decreases, ceteris paribus. Explain effects of a rise in GST on consumers and producers in different product markets - GST is an indirect tax on producer which raise unit COP (since GST is imposed on intermediate goods and raw ma terials) and thus decrease SS since producers will reduce production at any given price. The supply curve will shift upwards in a pivotal manner sinc e it is an ad valorem tax (% tax). This means that the higher the initial market price, the larger will be the tax amount and hence both original and new supply curves diverge. - The market price rises and market quantity falls. Impact on consumers’ expenditure and producers’ revenue depends on price elasticity of demand for products. ● Assuming ceteris paribus and similar initial market pr ices of the goods in the 2 markets, when SS falls due to GST, the good with price inelastic demand will result in a more than proportionate increase in price and less than proportionate fall in Qdd.

PRELIM SUGGESTED ANSWERS ECONOMICS UNIT @ INNOVA JUNIOR COLLEGE 2 ➔ Consumers’ expenditure increases (hurt consumers as they pay higher price and enjoy lesser units of good) ➔ Rise in GST would result in less revenue earned by the producers since they need to pay the government the GST from whatever they received from the consumers. Some firms in the market may end up with subnormal profit which may cause them to shut down. ➔ There is a greater negative impa ct on consumers as compared to producers, if demand is more price inelastic than supply. ● On the other hand, if the demand of good is price elastic, then there will be a less than proportionate rise in price and more than proportionate fall in quantity.  Consumers’ expenditure falls. ➔ Hence in this case, the adverse impact on producers will be greater since spending by consumers fa ll and yet producers have to pay the GST when supply is more price inelastic than demand. Explain combined effects of economic growth and a rise in GST on consumers and producers in different product markets - Market for necessities e.g. Rice ( normal good with price inelastic demand)  expenditure/ revenue rise ● Given that 0<YED<1, the rise in income leads to a less than proportionate increase in demand for rice  increase in consumer expenditure, ceteris paribus ● As rice has a high degree of necessi ty as a staple food, its demand is price inelastic  the rise in price (due to rise in GST) will lead to a less than proportionate fall in Qdd  consumer expenditure increases, ceteris paribus  Combined reinforcing effect: Rise in consumer expenditure/ producer’s revenue in the market for rice - Market for luxury goods e.g. Cars (normal good with price elastic demand)  impact on expenditure/ revenue is uncertain ● Given positive YED>1 as car is a luxury good, the demand for cars will increase more than proportionate to an increase in income  large increase in consumer expenditure, ceteris paribus ● As expenditure on cars generally ta ke up a large proportion of an average household income, its demand is likely to be price elastic  the rise in price of cars (due to ri se in GST) will lead to a more than proportionate fall in Qdd  consumer expenditure falls, ceteris paribus  Combined effect on consumer expend iture is uncertain – depends on the relative shift of demand and supply. The large increase in demand for cars (due to YED>1) is likely to out weigh the fall in supply of cars, resulting in a rise in consumer expenditure/ producer’s revenue.

PRELIM SUGGESTED ANSWERS ECONOMICS UNIT @ INNOVA JUNIOR COLLEGE 3 EV: However, for such luxury goods, the in itial prices are high and so the amount of GST to be paid is likely to be high  large rise in COP and hence large fall in SS which may be greater t han the rise in demand  so, overall consumer expenditure/ producer’s revenue may fall instead. - Market for inferior goods e.g. instant cup noodles (with price elastic demand)  expenditure/ revenue fall ● Given negative YED as instant cup noodles are deemed as inferior good, the demand will fall when income increases as people would prefer to consume better quality food in restaurants  fall in consumer expenditure, ceteris paribus ● As there’s availability of many other food substitutes, the demand for instant cup noodles is price elastic  rise in price (due to rise in GST) will lead to a more than proportionate fall in Qdd  consumer expenditure falls, ceteris paribus  Combined reinforcing effect: Fall in consumer expenditure/ producer’s revenue in the market for instant cup noodles Conclusion As analysed above, the combined effect of economic growth and rise in GST on markets of normal goods with price inel astic demand is an unambiguous rise in consumer expenditure whil e markets of inferior goods with price elastic demand would see an unambiguous fall in consumer expenditure. EV: Outcome is uncertain for other comb inations (e.g. inferior good with price inelastic demand; normal good with price elastic demand)  depends on the relative magnitude of change in demand and supply EV: All the above analysis assumes ceteris par ibus condition holds – not valid in the real world as there are many other factors which may also affect demand and supply of products. For e.g. if population size in SG increases, overall demand for all types of goods may rise, increasing consumers’ expenditure and pr oducers’ revenue in different product markets. EV: GST is a regressive tax  greater burden on lower-income groups who pay a larger proportion of their income as taxes. Assuming same rise in income for all consumer groups, the lower-income consum ers will be more negatively affected by the rise in GST especially on normal goods (necessities) with more price inelastic demand than supply

PRELIM SUGGESTED ANSWERS ECONOMICS UNIT @ INNOVA JUNIOR COLLEGE 4 Suggested Mark Scheme Knowledge, Application/ Understanding and Analysis L3 For an answer that uses appropriate demand, supply and elasticity concepts as analysis to explain the combined impact of economic growth and rise in GST on consumers and producers in different product markets. Good use of diagr ams to provide an analytic explanation. 15- 20 L2 For an answer that uses demand and supply framework with limited analysis to explain the combined impact of economic growth and rise in GST on consumers and producers in different product markets. Diagrams are not used effectively as analytical tool. Max 12 if answer only analyze combined impact on 1 product market. Max 9 if answer only analyze impact of economic growth or rise in GST. 9-14 L1 For an an