MJC_H2_ECONS_EQ5

JC2 H2 Prelims Question 5 (a) Explain the process whereby an increase in government expenditure can lead to a bigger change in national income. [10] (b) In view of rising government debts, discuss whether governments’ subsidies to increase its global competitiveness is justified. [15] Suggested Answer to Part A Introduction Identify the process as Multiplier process and state the multiplier and its formula: This is the multiplier process, where any increases in injection, e.g. government spending, will cause national income to increase by a multiplied amount of the rise in G. This is determined by the size of the multiplier, k, where k = 1/ 1- Marginal Propensity to Consume (MPCd) = 1/ Marginal Propensity to Withdraw (MPW) A small MPW will mean that a small proportion of additional income is allocated to withdrawals such as savings, taxes and import expenditure in the economy, theref ore the size of the multiplier will be large, resulting in a large multiplied increase in national income. Explain the underpinning of the multiplier process: For instance, a country like U.S. will have relatively higher rate of consumption due to well- developed social security systems hence less incentive to save. This means that given an amount of injection, lesser income is leaked away as withdrawals while a larger proportion of additional income is spent on domestic consumption in each round of spending. This means that every round of the i nner flow results in larger rounds of induced consumption. This results in a larger multiplied increase in national income. Development Explain the multiplier process: Let us assume a four-sector economy with an MPC of 0.9. It is assumed to be initially in equilibrium and spare capacity is available in the economy. Briefly Explain the CFo I, role of HHs and Firms : In the inner flow there are 2 key sectors, the households and the firms. The role of the households is to supply factors of production e.g. Inner flow of income Outer flow of income

land, labour, capital and entrepreneurship to the firm s in return for factor income. This income is then used to purchase goods and services or be withdrawn from the inner flow as savings, taxes and import expenditure. The role of the fi rms is to produce goods and services which households will exchange for consumption expenditure. Explain trigger(s): An injection is an addition to the circular fl ow of income which does not come from the expenditure from domestic households. In this case, the Increased spending by the government could be spent to improve public infrastructure. Explain multiplier effect: [Round 1] When $10bn of government spending is spent on infrastructure upgrading  construction firms will have to increase their output by a value of $10bn. This means that they will have to hire FOP such as skilled workers and machinery. HHs that supply factor inputs to these industries will hence receive $10bn worth of in