NYJC_H2_ECON_ESSAY_QN_5

5. ‘Fiscal policy can be used to influence the circular flow of income to achieve economic growth’ (a) Explain this statement. [10] (b) Assess alternative policies that might be more appropriate for the Singapore economy to achieve economic growth. [15] Synopsis Answers should explain how expansionary FP can be used to influence the component of the circular flow (C,I,G.X,M,S,T) such that National Income increases. Answer should include the idea of the multiplier. 1. Intro a. Explain the circular flow of income : The term circular flow of income refers to an economic model which describes the circulation of income between entities in the economy namely Firms, households, government and the external sector. In summary it is a model that depicts how money flows through the economy. Increased Injections raises the circular flow of income and hence Y ( national income) whereas Increased withdrawals reduces the circular flow of income and hence reduces Y. The components in the circular flow are : C,I,G,X-M, savings and taxes. 2. Explain How expansionary FP is carried out FP involves the adjustments of gov’t revenue and expenditure to influence economic activities. In order to achieve economic growth, expansionary FP is conducted. Expansionary FP involves the increase in gov’t expenditure and the reduction in gov’t revenue ( e.g Taxes). Hence expansionary FP increases injections as well as reduces withdrawals to raise Y 3. Details of expansionary FP a. Raising government expenditure and the circular flow Gov’t expenditure consist of expenditure on goods and services as well as transfers. i. In raising the gov’t expenditure on goods and services, the G component of the circular flow rises and leads to a rise in Y ( Draw AS/AD and show). The rise in Y is influenced by the multiplier. {Briefly (very) explain how the multiplier process works.} Do include the formula, Y = k x AD ii. Increase transfers towards households (e.g unemployment benefits and rebates) raises the disposable income of the households and hence autonomous C. This also raises the C component of the circular flow of income and again via the ‘k’ process raises Y b. Lowering gov’t revenue and the circular flow Expansionary FP can also be conducted via reducing tax rates. i. Lowering corporate taxes (i.e. reducing withdrawals ) increases profits and hence raises the incentive to invest due to the higher returns. This raises the I component of the circular flow of income and hence increases Y via the ‘k’ process i. Similarly, reductions in personal income taxes, raises disposable income and hence raises the C component of the circular flow. This like all other components of AD raises Y via the ‘k’ process. 4. Conclusion : Expansionary FP and economic growth Expansionary FP impact on economic growth hinges on the size of the multiplier which is dependent on the mpw in the economy ( Give