H2 Economics Detailed Summary

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(1)J1 Topics No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26. Title Chapter 1: Scarcity, Choice and Opportunity Cost Explain two ways in which an economy might move from a point within its PPC to a point on it. Discuss the most effective economic policies to move the PPC outwards. What is meant by the basic economic problem of scarcity? Discuss whether economic growth solves the problem of scarcity. Chapter 2: Resource Allocation in Competitive Markets I A manufacturer wishes to sell more of his product. How may he try to achieve his aim? Chapter 3: Resource Allocation in Competitive Markets II Explain price elasticity of demand and income elasticity of demand. A government is proposing to increase the tax on petrol. Examine the relevance of price elasticity of demand and income elasticity of demand for this proposal. Assess the relevance of elasticity concepts in explaining the effects of the worldwide recession caused by the 911 terrorist attacks on the airline industry. Chapter 4: Microeconomic Problems: Market Failure Policies on Pollution and Evaluation Summary Policies on Pollution and Congestion caused by Cars Summary Chapter 5: Government Intervention in the Market I Chapter 6: Firms and How They Operate I Discuss whether rising costs limit the size of firms over time. Banking Merger in Singapore Analysis Chapter 7: Firms and How They Operate II Discuss the view that the profit motive will always lead to a few large firms dominating the market for each and every type of product. Explain what is meant by productive and allocative efficiency. ‘A firm should be encouraged to maximize profits because this makes it efficient.’ Discuss whether this argument is true for a firm operating in an imperfect market. Distinguish between monopolistic competition and oligopoly. Explain why oligopoly is a common market structure in many economies. Explain why governments throughout the world have been involved in the supply of services such as electricity. Chapter 8: Government Intervention in the Market II. Page No. 2-3 4 5 6 7 8-9 10 11-13 14 14 15-16 17-18 19-21 22-23 24 25-30 31 31 32-38 39 40-41 42 43 44 45 46-48. 1.

(2) Chapter 1: Scarcity, Choice and Opportunity Cost 1. Introduction  Study of the use of scarce resources to satisfy unlimited human wants  Wants: things people would consume if they had unlimited income  Resources: inputs to produce goods and services  Scarcity exists due to unlimited wants + worn out goods + newer goals  Positive (can be checked by facts) vs. normative (statement of value) 2. Factors of Production  Land: productive resources supplied by nature  Labour: human effort directed to the production of goods and services  Supply: number of workers + average number of hours each worker is prepared to offer  Specialisation  Dexterity, greater use of machinery and more sophisticated production techniques  Monotony, loss of craftsmanship, increased risk of structural unemployment  Capital: man-made resource used in further production  Involves postponing present consumption  Entrepreneurship: takes risk of being in business  Information: data for the basis of knowledge-based economy 3. Opportunity Cost  Real cost in terms of the next best alternative foregone  Calculating opportunity cost requires time and information  Opportunity cost may vary with circumstance  Economic rent: difference between what is earned and what could have been earned  Used in specialization and trade 4. Production Possibility Curve  Maximum attainable combination of two goods and services that can be produced in an economy, when all available resources are used fully and efficiently, at a given state of technology  Assumptions: fixed amount of resources, factors fully and efficiently employed, technology fixed, time period give, 2-product model  Fully: using all resources available  Efficiently: do as many things you can with the resources used  Scarcity: unattainable combinations outside PPC + society has to choose among combinations of 2 goods  Shift: quantity and quality of resources (think FOP) + technology – skewed?  Choice between instant gratification and improving economy in the future 2.

(3) Wheat *Draw dotted line to show comparison between 2 countries with a common yardstick. 0. Cloth. 5. The Marginalist Principle  Consume till MPB = MPC: cost of producing an additional unit of good = benefit of consuming an additional unit of good  For the price mechanism to work, information need not be known with perfect accuracy by every individual acting in the marketplace: dependent on marginal buyers who keep suppliers on their toes 6. Efficiency  Static efficiency: how much output can be produced now from a given stock of resources at a given point in time  Dynamic efficiency: changes in the amount of consumer choice available in markets together with the quality of goods and services available  Productive efficiency: absence of waste in the production process = minimizing the opportunity costs for a given value of output  Allocative efficiency: society produces and consumes a combination of goods and services that maximizes its welfare  Distributive efficiency: goods and services produced to those who want or need them. 3.

(4) Explain two ways in which an economy might move from a point within its PPC to a point on it. [10m] Introduction Define PPC Good X A: resources not fully utilized – underemployment and unemployment. B. B: efficient use of resources – full employment. A O. Good Y. Body A. Increase employment of resources  Lower wages to be more competitive – may be enticed to produce more goods  Fiscal policy: increase government spending eg. circle line – multiplier effect  Monetary policy: lower interest rate – firms borrow more, increase investment B. Increase efficiency in use of resources  Pay based on productivity: but only for jobs where output can be measured (factory workers)  Reallocate resources to more efficient uses  Retraining. 4.

(5) Discuss the most effective economic policies to move the PPC outwards. [15m] Introduction Outward shift: increase in productive capacity – sustain economic growth over long run Body A. Labour  Increase birth rate but difficult to do so in developed countries – female labour force participation + need lots of incentives  Education and training but takes long time and does not necessarily yield results  Foreign talent through tax incentives B. Capital  MNCs – investment (machines) + learn their technological knowledge  Invest in r+d C. Entrepreneurship  Incentives and subsidies to start businesses D. Land  Reclamation Conclusion Depends on which country Eg. For USA: encourage capital goods, less consumption goods. For China: entrepreneurship. 5.

(6) What is meant by the basic economic problem of scarcity? [12m] Introduction Scarcity – scare resources, unlimited wants Body Scarcity – choice – opportunity cost 1) Individual: time; consumer; how to maximize use of limited resources – more labour / more machines 2) Firm: least-cost combination of resources in order to maximize profits 3) Government: choice between competing projects; cost-benefit analysis 4) Economy: problem of how to allocated scare resources efficiently best illustrated by the PPC Good X E 6 4. O. 5 6. Good Y. (Brief) Implications:  Trade as a solution to alleviate scarcity  Trade-off between consumer goods and capital goods  What (how scarcity affects decision-making of an economy), how much, for whom and what to produce (market system). 6.

(7) Discuss whether economic growth solves the problem of scarcity. [13m] Introduction Economic growth – increase in national income – generally get to consume more goods and services Body 1) Increase in quantity and quality of resources – increase in productive capacity  Labour: due to reduction in unemployment and underemployment  Skills and educational level  Land  Capital stock: most effective way to alleviate problem of scarcity – more capital economy produces in one period, more output capital can produce in the next to satisfy wants in society 2) Technological improvement – increase in productive capacity: better and new methods of producing goods  R + d – technological breakthrough – new products – create more wants 3) Increase in income – consumers able to satisfy wants  But with greater affluence, people have more wants due to advertising and promotions – luxury goods of the past may become necessities 4) Supply limited  Demand accelerating – China / India economic growth  Crude oil important as it is a source of fuel  Eg. land in Singapore  But technological improvements allow society to make use of renewable resources as sources of energy  But more wants created 5) Equity in distribution  Economic growth does not guarantee a reduction in income gap  Corruption, food shortages. 7.

(8) Chapter 2: Resource Allocation in Competitive Markets I *Assumption: Many buyers and sellers such that no single buyer / seller can exert control over market price (price takers) 1. Demand Theory  Demand: amount that consumers are willing and able to purchase at each given price over a given period of time  Demand curve slopes downwards  Income effect: effect of change in real income resulting from change in price of good  Substitution effect: effect of change in price on quantity demanded arising from consumer switching to, or from, alternating products  Determinants  Price  Taste: education, culture, age group, health scares  Interrelated goods: substitute vs. complement  Population: absolute change, change in composition  Seasonal changes: climate, festival  Expectations of the future: future changes in price / income  Real disposable income: changes in taxes / money income  Redistribution of income  Consumer surplus: difference between maximum amount consumers willing to pay for a given quantity of good and what they actually pay 2. Supply Theory  Supply: quantity of a good or service producers are willing and able to offer for sale at each given price over a given period of time  Determinants  Price  COP: change in price of factor inputs  Other prices: joint / competitive supply  Innovation: lower production costs  Natural factors: climate, unexpected events  Government policies: indirect taxes, subsidies  Number of sellers  Producer surplus: difference between amount received by producers and minimum amount they are willing and able to accept for the supply of a commodity 3. Market Equilibrium  Buyers and sellers satisfied with current combination of price and quantity bought or sold, and are under no incentive to change their present economic actions. 8.

(9) .  . Adjustment to equilibrium  Below equilibrium  Shortage – consumers compete for goods, bidding up prices – price increases, quantity supplied increases – shortage eliminated – market settles at equilibrium  Above equilibrium  Surplus - producers reduce prices to get rid of stocks – increase sales and decrease production – price falls, quantity demanded increases, surplus eliminated – market settles at equilibrium Shifts in supply and demand: consider individual effects on price and quantity then sum up Interrelated demand and surplus  Joint / competitive / derived demand  Joint / competitive supply. 4. Case Study  When asked to explain how a group of people intend to affect a certain market, bring in limitations  Elasticity of demand  Responses of other firms / groups of people  Analyse theoretically first, then see how and why the data fits / does not fit the theory  Desirability: consider for whom: producer, consumer, society  Effectiveness: limitations, long run vs. short run. 9.

(10) A manufacturer wishes to sell more of his product. How may he try to achieve his aim? [12m] Introduction Sell more – only considering equilibrium quantity – increase demand / supply Effect: long run vs. short run Body 1) Increase demand: explain effect on quantity demanded  Advertising and promotion: create product differentiation and brand loyalty  Competitive market: other firms will do likewise as they fear losing market share  Huge funds need to be devoted – increase COP – reduce profits  If firm passes cost increase to consumers in terms of higher prices – fall in quantity sold – assuming demand elastic – total revenue falls  But unable to increase price in competitive market – firms may engage in price wars  But in long run if campaign successful in altering people’s taste and preference – rise in quantity sold  Expanding number of markets: go regional / global  Easier to penetrate markets where demand for product more price elastic  Increase supply – fall in price – more than proportionate rise in quantity demanded  Improve quality of product / increase product differentiation through better sales service / improved packaging  Effect of money spent for r+d on  Costs then price of product  Market share in long run (increase)  Deliberate attempt to reduce price of good through discounts  Price elasticity of demand  How long discount can be sustained without eroding profits 2) Increase supply: explain effect on quantity demanded  Investment in r+d  Lower COP, more efficient production methods, better quality products  Raising productivity through greater specialization and better labour-capital combination  Sourcing cheaper sources of raw materials  Evaluation  Reduces price – may conflict with profit maximization  More effective strategy if selling product that is price demand elastic – mass produce – reap EOS – lower prices – increase sales volume more than proportionately. 10.

(11) Chapter 3: Resource Allocation in Competitive Markets II 1. Price Elasticity of Demand  Measure of degree of responsiveness of quantity demanded of good to a change in its price, ceteris paribus  Coefficient: sensitivity of consumers to price changes  Negative: inverse relationship between price and quantity demanded  Determinants  Availability of substitutes  Necessities vs. luxuries  Proportion of income  Time period: longer – switch to substitutes – more price elastic  Usefulness  Government taxation policies: raise revenue, discourage consumption  Firms’ pricing policy  Effectiveness of trade unions: can ask for higher wages if demand for product is price inelastic  Price stability: prices more volatile if demand more price inelastic when supply shock 2. Income Elasticity of Demand  Measure of degree of responsiveness of demand of good to change in consumers’ income, ceteris paribus  Coefficient  Negative: inferior good  Positive: normal good  Less than one: necessities  More than one: luxuries  Usefulness  Production plans: boom vs. recession  Targetting different income groups: segment market 3. Cross Elasticity of Demand  Measure of degree of responsiveness of demand of good to change in price of another good, ceteris paribus  Coefficient  Negative: complement  Positive: substitute  Usefulness  Effects on products’ demand when faced with change in price of rival’s product  Strong complements – can sell jointly. 11.

(12) 4. Price Elasticity of Supply  Measure of degree of responsiveness of quantity supplied of good to a change in its price, ceteris paribus  Positive: direct relationship between price and quantity supplied  Determinants  Time period: longer – supply more price elastic because possible to change anything  Factor mobility  Number of firms: more – supply more price elastic  Stocks and spare capacity: more – can produce more – supply more price elastic  Length of production period: shorter – supply more price elastic  Usefulness  Taxation: incidence  Price stability 5. Government Policies  Taxation / subsidies  Demand more price inelastic – higher incidence  Incidence: distribution of burden between consumers and sellers  Minimum price  Protect income of producers  Creates surplus for future shortages  Financing annual surpluses – burden on taxpayers – not good in long run  Cushion inefficiency  New producers attracted – increase surpluses unless government has measures to increase demand  Maximum price  Lower-income consumers to afford necessities  Protect consumers  Allocation of goods may be biased  Black market, especially during war time  Government can encourage supply by drawing on past surpluses, giving subsidies and tax relief, reducing demand by controlling income 6. Case Study  Note difference between elasticity of the product and the elasticity of the final product (which involves the use of the product)  Note difference between less inelastic and more elastic  When asked how a strategy might affect a company, consider effect on total revenue then profits. 12.

(13) 7. Essay  Limitations to using elasticity concepts to explain price changes  Elasticity concepts are static – need to relax ceteris paribus assumption in reality – simultaneous changes occur – need to consider relative magnitudes of changes in demand and supply  Coefficients of elasticity mere estimates  Consumers not homogenous group  Among high-income earners, there are the yuppies seeking the high life and are likely to be more price and income sensitive compared to foreign investors who would consider socio-political factors  May not consider some goods as substitutes. 13.

(14) Explain price elasticity of demand and income elasticity of demand. [10m]     . Definition Formula Sign Coefficients: range of values for elastic / inelastic Examples with their estimated values. A government is proposing to increase the tax on petrol. Examine the relevance of price elasticity of demand and income elasticity of demand for this proposal. [15m] Introduction Assume specific tax for simplicity Uses of petrol: firms’ and commuters’ transportation Normal good: income increase – demand for cars increase – demand for petrol increase Body 1) Demand for petrol price inelastic: explain why  Increase in indirect tax – supply falls at given price – supply curve shifts vertically upwards by amount of tax  Demand for petrol inelastic – fall in quantity demanded less than proportionate  Relevance: need high tax if government wants to reduce consumption to desired level 2) Income elasticity of demand less relevant because it is due to changes in income – tax on petrol affects price directly, not income  Government likely to be less successful if they increase tax on petrol in period of economic boom  Boom: incomes rise – demand for cars (luxury good) – increase by more than proportionately – derived demand – increase demand for petrol. 14.

(15) The terrorist attack on New York on 11 September 2001 caused a worldwide recession and an increased fear of flying, both of which severely affected the demand for travel by air. This led to the closure of some of the major airlines in the world. Assess the relevance of elasticity concepts in explaining the effects of these events on the airline industry. [15m] Body 1) Price elasticity of demand  Definition  When supply of airlines fell due to closure of major airlines – price expected to increase – quantity demanded fall by more than proportionate – total revenue fall  Relevance  Airlines should expect that reducing supply causing a rise in price can lead to a fall in total revenue  But the demand for travel for business is likely to be inelastic. So price increase – less than proportionate fall in quantity demanded – total revenue increase  Effect on total revenue depends on size of business market vs. holiday makers  Due to the ceteris paribus assumption, the above will only take place if other factors remain constant. In this context, incomes have changed causing demand curve to shift – total revenue fall 2) Income elasticity of demand  Definition  Air travel luxury good for most, necessity for business travelers  Relevance  Recession – fall in income – fall in demand – fall in total revenue  Implication: individual airlines need to reduce price / engage in non-pricing strategies to increase market share 3) Cross elasticity of demand  Definition  Potential substitutes: train / coach / ship  Degree of substitutability depends on the length of flight  Long haul flights: weak substitutes especially for business travelers  Short distance: stronger substitutes  If another airline (eg. Qantas) reduces price to increase market share – fall in demand for a particular airline (eg. SIA) – SIA reduces price – price war – may not cover costs – erode profits  Budget airlines also pose as competition. 15.

(16) . Airlines close down routes / less schedules – fall in supply – increase price  Demand inelastic: long haul flights – no close substitutes – total revenue increase  Demand elastic: short distance flights – switch to trains / coaches – total revenue falls. 4) Price elasticity of supply  Definition  Fall in price – fall in quantity supplied  But short run: supply price inelastic – less than proportionate fall in quantity supplied  Reasons  Labour: need time to retrench / reallocate labour to other departments  Flight schedule / routes: need time to deliberate which routes / schedules to close – choose the unprofitable / lowest passenger volume Conclusion Cannot look at each value separately because in real world many variables change at the same time. 16.

(17) Chapter 4: Microeconomic Problems: Market Failure 1. Market Failure  Scarce resources – need to allocate resources efficiently – objective: maximize society’s welfare (social optimality)  MSB = MSC: benefit to society from one additional unit of good = cost to society of producing one extra unit of good  Ways to allocate resources  Total government intervention  Free market (based on price mechanism)  Mixed economy (free market with some government intervention)  Free market economy  Private ownership of resources + individual decision-making guided by selfinterest  Price serves as signal for resource allocation  Automatic working of supply and demand – spontaneity – allocative efficiency  Equilibrium where demand = supply: maximization of consumer and producer surplus  Assumes no externalities + perfect competition  Market failure occurs when  Allocative inefficiency: externalities / public goods, imperfect competition  Inability of market to achieve social objective eg. income equity 2. Externalities  Cost / benefit on a third party not involved in the consumption / production of good  Negative  Types: industrial pollution, pollution and congestion from vehicles, demerit goods eg. cigarettes  External cost: second-hand smoke – health problems, fire hazard, environmental cost – littering, anti-smoking campaigns – money comes from taxpayers who largely do not smoke  To tabacco company: profit-maximising private producer: MPB = MPC  To society: to attain social optimality: equilibrium level MSB = MSC = MPC + MEC  Overproduction: deadweight loss  Positive  Types: merit goods eg. healthcare, education  External benefit: higher standard of living of everyone because of highly-skilled jobs  Under-production by free market: deadweight loss  Because of partial market failure, government intervention comes in. 17.

(18) 3. Public Goods  Non-excludable: impossible / costly to exclude non-paying consumers from receiving the good  Non-rivalrous: consumption by one person does not reduce amount available to others  Eg. National defense  Free rider – conceal demand – private producer cannot gauge demand – will not produce – non-production in free market – total market failure  Government provision necessary since public goods are socially desirable and largely indivisible 4. Inequality  Represented by the Lorenz Curve / Gini coefficient  Singapore: 0.485 in 2007  European countries: 0.25 – 0.3  Latin America and the Caribbean: 0.6  Average worldwide: 0.4 5. Essay  When asked to suggest new policies, consider whether it is possible / practical to enact them  Policies may be difficult to administer, and policing expensive  Opportunity costs involved in attempted to control negative externalities  Political implications eg. public satisfaction. 18.

(19) Policies on Pollution and Evaluation Summary 1) Identify:. Taxation. Explain:. Tax polluters per unit of MEC – COP increases for private firms – supply falls from MPC to MSC by amount of MEC. Evaluate:. * Negative externality internalized by firm: incentive for firm to be more cost-effective to maximize profits / reduce pollution * Provides revenue for government to finance other social and community development projects * Able to allow market to continue operating according to market forces and reach state of equilibrium x Requires accurate valuation of MEC / amount of pollution - Over-valuation: output below socially optimal level, reducing society’s welfare / deters production – affects economic growth - Under-valuation: output still not brought to socially optimal level x Difficult to apportion blame x Effectiveness dependent on price elasticity of demand: if highly price inelastic, effect of tax on output ineffective unless tax very large / firm able to move burden to consumers and get away scot-free. 2) Identify:. Quotas. Explain:. Ban production if pollution exceeds a certain limit – limits MEC by restricting output at socially optimal level Clearly defined amount of pollution each firm can have. Evaluate:. * Able to control level of pollution in the country as a whole X Does not allow price to equilibrate quantity demanded to quantity supplied: firms may decide to produce less so they do not exceed the maximum amount of pollution they can have (compare this to taxation) X Difficult and tedious to gauge how much pollution each firm produces: waste of resources and time on inspection X Need vigilance and commitment of government. 3) Identify:. Legislation. Explain:. Force producers to bear costs of more proper disposal of industrial wastes eg. antipollution equipment. 19.

(20) Evaluate:. x Difficult and costly: spend resources on inspection X If chances of being caught and penalties are small, legislation ineffective X Need vigilance and commitment of government X Not immediately effective because of bureaucracy involved in establishing laws X Lose voters leading to loss in power. 4) Identify:. Nationalisation. Explain:. Government takes over the polluters’ firms and ensures production at socially optimal output. Evaluate:. x Waste of resources: opportunity cost to other projects because less funds available X Difficult to accurately valuate quantity demanded X No competition: inefficient, no innovation. 5) Identify:. Campaign / advertisements to educate public. Explain:. Raise awareness of pollution situation to public in hope they might do something to curb problem. Evaluate:. x Costs of these measures might outweigh benefits X Duration needed before effects can be felt and there is no guarantee that the campaign will be effective X May be effective for only a short period of time because the public is constantly bombarded by such campaigns that it is starting to lose its intended effect. 6) Identify:. Subsidies. Explain:. Subsidise purchase of antipollution equipment so that firms’ COP does not increase that much by purchasing these equipment – firms more likely to buy the equipment than before. Evaluate:. x Opportunity cost to other public projects X No guarantee that firms will buy the equipment X Firms need time to incorporate use of new equipment: but in the long run probably mitigates the problem of pollution if firms use the equipment. 20.

(21) 7) Identify:. Urban planning. Explain:. Locate factories away from residential areas eg. Jurong Island Greenery (to reduce impact). Evaluate:. x Merely shifting the pollution to another area – does not solve the root of the problem but reduces external cost since less people affected by pollution X Contentious as to whether greenery helps to reduce impact. Summation:. Air pollution may not be due to the country itself, so need international / regional cooperation Can integrate a few policies for better results. 21.

(22) Policies on Pollution and Congestion caused by Cars Summary 1) Identify:. ERP per tax unit. Explain:. Restricts car usage (nowadays rely more on this policy) Increases cost of car journey – quantity demanded for car travel falls. Evaluate:. x Congestion in other areas / small roads X Increase business cost – pass to consumers. 2) Identify:. COE. Explain:. Restricts car ownership. Evaluate:. x Increasing affluence – income elasticity of demand for cars X Cannot stem people’s aspirations X Needs vigilance and political will (in other countries, government might not be able to have COE). 3) Identify:. Efficient and affordable public transport. Explain:. Less pollution and congestion on roads. Evaluate:. x Not all countries have resources to build an effective public transport system – LDCs: no money, DCs: complex commuting patterns X For it to be affordable, possibly need government to finance. Otherwise if left to the private firm, they would want to charge more to maximize profits.. 4) Identify:. Registration tax, annual road license. Explain:. Restricts car usage. Evaluate:. *May work if there is vigilance and commitment by government. 5) Identify:. Rebates for green vehicles eg. 20% off purchase price. Explain:. Lower price – quantity demanded higher. Evaluate:. x Still not widely advocated X May still be too expensive to afford. 22.

(23) 6) Identify:. Weekend cars. Explain:. Restricts car usage. Evaluate:. x Still not widely advocated X People associate cars with prestige (eg. Americans love for SUVs). 23.

(24) Chapter 5: Government Intervention in the Market 1. Tacking Externalities  Negative externalities [details on page 21-23]  Positive externalities  Subsidies: external benefit internalized (works like the tax)  Can be easily implemented to bring about increase in production and consumption  Difficult to valuate external benefit generated  High government expenditure – high tax rates can subsequently discourage investment in country  Firms lose incentive to be more productively efficient – inefficient firms may survive  Direct provision of merit goods  Social justice: merit goods should be accessible to all and not provided according to ability to pay  Large positive externalities: eg. free healthcare combats spread of disease  Dependants: eg. free education to protect children from irresponsible parents who fail to provide children quality education  Ignorance: consumers may not realize how much they will benefit and if they had to pay, they would rather go without it 2. Government Failure  Allocative efficiency reduced following government intervention to correct market failure  Problem of incentives  Imposition of high taxes can distort incentives  High marginal tax removes incentive for people to work harder to earn more  Disincentive to produce and consume  Desire by politicians to get elected: popular policies introduced (eg. minimum wage law)  Profit motive of private sector largely removed  Problem of information  Difficult to valuate external cost / benefit  Difficult to accurately estimate level of consumer demand for product  Problem of distribution  Increase inequity  Eg. tax on use of domestic fuel (kerosene in Indonesia) – low income households may feel greatest effect as tax on fuel oil may make life of poor worse since they use proportionately more domestic fuel than others  Bureaucracy and inefficiency: administrative costs; time lags  Shifts in government policy: too frequent changes – difficult for firms to plan ahead 24.

(25) Chapter 6: Firms and How They Operate I 1. Production in the Short Run  Short run: at least one fixed factor  Long run: period of time long enough for all factors to vary, except level of technology, which varies in the very long run  LDMR: as more units of a variable factor are applied to a given quantity of a fixed factor, there comes a point beyond which the extra output from additional units of the variable factor will eventually diminish  Stage 1: TP increases at an increasing rate, MP rises – due to specialization of labour  Stage 2: TP increases at a decreasing rate, MP falls, LDMR sets in – due inefficient use of fixed factor  Stage 3: TP falls, MP falls  MP = change in TP / change in L. 2. Theory of Costs in the Short Run Factor Total Fixed Cost Definition Sum of all costs of production do not vary with the level of output aka overhead costs Must be paid even without production Examples. Total Variable Cost Costs incurred for use of variable factors like labour Varies directly with output level. Rent of factory building, Raw materials, labour interest on capital invested in equipment. Marginal Cost Additional cost incurred in producing an extra unit of output in the short run while some inputs remain fixed MC = change in TC / change in Q. 25.

(26) Graph. Average AFC: amount of fixed curves costs per unit of output ATC = AFC = TFC / Q AVC + AFC.   . AVC: total variable costs per unit of output AVC = TVC / Q. Stage 1: AVC falls, AFC falls. Since AFC and AVC fall, ATC also falls Stage 2: AVC rises, AFC falls. Since fall in AFC > rise in AVC, ATC still falls Stage 3: AVC rises, AFC falls: Since fall in AFC < rise in AVC, ATC rises. 26.

(27) 3. Objectives of Firms  Profit-maximisation: equilibrium level of output since there is no tendency to change  Before equilibrium level, MR > MC so firms want to produce more  After equilibrium level, MR < MC and rational firms will not produce at this output level  Firm continues production as long as it can cover variable costs  Motivation of owners vs. motivation of managers: separation of control and ownership – principal-agent problem: managers tend to pursue their alternative goals while maintaining minimum level of profits to appease shareholders  Revenue maximization: managers aim to maximize firm’s short run total revenue  Long-run profit maximization: managers aim to shift cost and revenue curves so as to maximize profits over some longer time period  Growth maximization: managers may aim for expansion to maximize growth in sales volume over time 4. Theory of Costs in the Long Run  Returns to scale: measure of resulting change in output when all inputs are changed in the same proportion (can be increasing, decreasing or constant)  LRAC: lowest average cost for given level of output when all inputs are variable  Minimum efficient scale: smallest plant size beyond which no significant additional IEOS can be achieved  IEOS: savings in costs that occur to a firm due to the firm’s expansion, and have been created by firm’s own policies and actions  Technical: concerned with production process  Factor indivisibility economies: larger plant size makes it possible to effectively use indivisible factors (combine harvesters, power transmission: large and costly) – raises average output and reduces LRAC  Specialisation of labour: simpler and repetitive jobs which require less training + more efficient eg. car manufacturing  Managerial: functional specialization by employing experts to increase efficiency as a whole  Greater use of existing staff  Decentralisation of decision-making: increasing efficiency of management because of faster flow of information within firm – distortions and delays of information avoided  Commercial  Bargaining advantage and accorded preferential treatment by suppliers because they buy raw materials in bulk  Bulk sales from bulk advertising and large-scale promotion. 27.

(28) . .  Financial  Easier and cheaper to raise funds: given lower interest rate and larger loans because better credit ratings and more collateral  Raise capital through issue of shares to public who has more confidence in reputed firms  Risk-bearing  Advantage in bearing non-insurable risks eg. conditions of demand for final products and supply of raw materials  Diversification of products and markets  Diversification in sources of supply  R+d  Better quality products – increased market share and demand  Better methods of production – more productively efficient – lower average cost  Welfare: making workers feel they belong to the company – more apt to increase efficiency and productivity of company IDOS  Complexity of management  Principal-agent problem  Bureaucracy  Strained relationships: impersonal – no loyalty to firm – apathy, strikes EEOS: savings in costs that occur to all firms in an industry due to the expansion of the industry  Economies of concentration  Availability of skilled labour: demand for labour large enough – special educational institutions / firms can collaborate to develop training facilities • No lack of labour to employ because experts want to migrate there eg. Silicon Valley  Well-developed infrastructure to cater to that industry  Reputation: builds up name which consumers associate with quality – encourages brand loyalty and steady clientele  Economies of disintegration  Subsidiary industries developed to cater to needs of major industry • Eg. car industry in Japan: range of firms specialize in production of different inputs for car manufacturing – provide output at lower prices to main industry because specialization allows subsidiary firms to produce at large scale – enjoy EOS  Process waste products into useful products and sell them to cover COP  Economies of information: publications help improve productivity of firms (research and expertise). 28.

(29) . EDOS  Increased strain on infrastructure: taxed to limits eg. congestion – loss of time and increased fuel consumption  Rising costs of FOP: growing shortage of specific raw materials / skilled labour. 5. Growth of Firms  Methods of growth  Internal expansion: make more of existing product or extending range of product when it builds a new bigger plant  Merger  Vertical integration: firms engaged in different stages of productive process • Backward integration vs. forward integration • Eg. Starbucks merge with firm producing coffee beans – wants guaranteed access to raw materials  Horizontal integration: firm takes over similar firm at same stage of production in the same industry • Eg. Coffee Bean and Starbucks merge • Eg. DBS and POSB • Market domination  Conglomeration  Eg. bank taking over developing firm to build properties  Diversify output 6. Survival of Small Firms  Demand-side factors  Nature of product  Bulky and perishable goods: small, localized markets eg. fresh fish  Variety preferred to standardization eg. fashion  Specialised products: limited markets eg. highly specialized machines  Prestige markets: limited by price eg. sports cars, luxury yachts  Direct and personalized services eg. lawyers, doctors  Geographical limitations: high transport costs for bulky products – local market rather than national market  Supply-side factors  DEOS set in early: optimum size of firm small  Vertical disintegration: entire production process broken into series of separate processes and different small firms perform each process  Low BTE  Lack of capital. 29.

(30)  Unwillingness to take greater risks  Larger firm – higher expenditure – greater risk of investment  Fear of future fall in price of final product: expansion of output – increase market supply – excess supply – lower prices and lower profits  Banding: small firms may band to gain advantages of bulk buying while still retaining their independence  Profit cycles: early stage of product cycle – total demand for product low  Non-profit maximization attitudes  Owner values independence or wants to maintain control among family members  Contented with reasonable income from domestic market  Unwilling to take increased risks associated with expanding into foreign market 7. Case Study  Factors: think long run vs. short run, demand-side vs. supply-side  EOS – lower LRAC – able to reduce price  Profits plough to r+d – better quality products + further reduction in AC  Block new entrants due to enormous FC – less existing competitors – increase market share  Always end EOS with AC  If a particular industry is stated in the extract, try to give egs of EOS specific to the industry 8. Essay  Survival of small firms: for conclusion, use banding / small firms may want to merge in the face of globalisation. 30.

(31) Discuss whether rising costs limit the size of firms over time. [15m] Introduction  Size: sales revenue / turnover, level of output, market share  Over time – long run – firm no longer constrained by fixed factor Body 1) Can limit  Short run cost  Reason: over-use of fixed factor, inefficient labour-capital combination – increase MC – eventual increase in AC  Increase costs – fall in profits if total revenue is constant – constrain firm’s ability to expand 2) Will not limit  Long run  All inputs can vary – firm can expand – enjoy fall in LRAC due to internal EOS (list 2 egs)  Fall in LRAC – fall in price to ward off competitors (erecting barriers to entry) – increase profits – plough into r+d – better quality products + if yields results – further fall in AC due to better production methods  Size of firm determined by demand for firm’s product – if firm making supernormal profits – can still expand in size even if cost increases eg. monopoly selling unique products Conclusion: However, size of firm over time constrained by MES (list 1 eg of internal DOS). MES huge eg. electricity / water compared to MES limited eg. fashion. Banking Merger in Singapore Analysis Why merge?  Face competition from foreign banks – Singapore wants to expand beyond our shores: big – enjoy EOS – fall in AC – can compete with foreign banks  Core part of Singapore economy – 1997 Asian financial crisis – big  stable Why should not merge?  Possible monopoly power  Increase price  Quality of service  Reduction / removal of familiar products and services – affects consumer satisfaction  Neglect lower-income group  Retrenchment 31.

(32) Chapter 7: Firms and How They Operate II 1. Comparison of the 4 Markets Type Perfect Competition Number of  Large buyers / sellers  No one buyer / seller can influence price  Firm price taker. Monopoly  Only one firm  Firm price setter. Oligopoly  Few large firms  Interdependent. Barriers to entry.  .   . Substantial Natural Artificial: legislation, collusion / mergers, non-price competition, advertising. . Homogeneous / differentiated.    . None FOP perfectly mobile No transaction / transportation costs Minimal sunk costs. . Nature of products.  . Homogeneous Buyers no preference for any firm.  . Monopolistic Competition  Large  FOP relatively mobile  When firm makes decisions, does not have to worry how its rivals will react High  No / Low Natural: huge sunk costs  Firm lowers price – (AFC falls over very profits spread thinly large output – AC falls over many rivals – continuously – enjoys rivals suffer negligibly huge IEOS), exclusive  Retaliation unlikely ownership of essential  No collusion – keen raw materials competition Artificial: non-price competition, contrived barriers (cartel), legal protection: exclusive rights (patents, tariffs to block foreign firms) No close substitutes  Differentiated: CED and PED very low quality, design, location, promotion  Demand price elastic. 32.

(33) Knowledge.  . . Firm’s curve. . Perfect  Seller knows rivals’  prices, market costs and available technology Buyers know all sellers’ prices, quality and availability of products – will not purchase at a higher price than equilibrium price. P = AR = MR.  . Imperfect Consumers not fully aware of COP.   . P > MR Cannot increase both output and price at the same time as curve is downward sloping.   . Imperfect  Production methods and prices Cost structures differ as some firms enjoy more favourable locations / rentals. Imperfect. P > MR Some degree of control over own prices No single equilibrium price in market – no market demand curve. P > MR Firm increases price – other firms will not Firm decreases price – other firms follow – may lead to price war Price rigidity: menu costs, fear of harming firm’s image (fall in price – fall in quality).   . . 33.

(34) Examples. Firm’s SR equilibrium Firm’s LR equilibrium.   . Stock market Forex market Agricultural products: many farmers in LDCs.   . Utilities Starhub’s EPL coverage SMRT for NS and EW lines. . Bubble tea. Supernormal, normal / subnormal profits  MC = MR and MC must be rising Normal / supernormal  Normal profits profits Firm will shut down if subnormal profits.    . UK brewery industry Taxi companies OPEC Mobile service provision. . Normal / supernormal. .  . LR equilibrium curve. Normal profits New firms will enter industry to erode supernormal profits. . . Productive efficiency.  . Efficient Firm produces at MES. Allocative efficiency.  . Efficient P = MC. . Inefficient unless by coincidence. Inefficient  Inefficient unless by Will settle at LRAC that coincidence is not necessarily at MES  Firm’s POV: all points on LRAC  Society’s POV: MES  Inefficient  P > MC  Could be seen as premium society pays for product differentiation  . 34.

(35) 2. Analysis of Imperfect Market Structures Type Economic efficiency. Variety of products. R+d and new profits. Monopoly  Allocative inefficiency: P > MC, output below optimum  Productive inefficiency  X-inefficiency but increasingly reduced due to globalisation, reduced customs duties and barriers to trade  Dynamic efficiency: r+d  Unique  Possible innovation and new products: BTE stimulus to the creativity required to destroy barriers – monopoly profits stimulates new entrants producing new and competing products  Profits lead to unequal income distribution: dollar votes + shift of consumer surplus to producer  Supernormal profits – plough into r+d – better quality products + better methods of production – lower AC but there is no guarantee that monopolies will do this. Monopolistic Competition  Allocative inefficiency: P > MC  Productive inefficiency: do not utilise optimal plant capacity, do not exhaust potential for further EOS because all small firms  Dynamic inefficiency: no r+d. Oligopoly  Allocative inefficiency: P > MC, output below optimum  Productive inefficiency  Dynamic efficiency: r+d. . Large variety – increase in consumer welfare. . Differentiated. . More equity: no redistribution of income from consumers to shareholders Normal profits: no additional profits to plough into r+d. . Supernormal profits ploughed into r+d. . 35.

(36) Theory vs empirical evidence. . MES high – IEOS – lower MC than PC industry – lower P and higher o/p but monopolies charge high prices by restricting output P/R/C Pc. MCpc. MCm.  . Wasteful competition Advertising provides better consumer information which helps move market structure closer to PC model but loss of consumer sovereignty.  . . Pm.  MR.   . . . AR. 0 Q Q Q Practise price discrimination [has both costs and benefits] Natural monopolies Perfectly contestable markets: costs of entry and exit by potential rivals are zero, and when such entries can be made very rapidly eg. deregulation of airline industry in 1978 Hit and run competition: market contestable for certain seasons eg. parcels service during festivals Reduces wasteful competition (instead of extensive advertising, money can be spent to produce more goods). High price rigidity: price stability Wasteful competition: more likely to engage in extensive advertising – encourages price competition, with increased sales volume and reaping of EOS, price reduce further But possible monopoly power through collusion But multiple branding gives consumers misguided information in thinking products are from different firms. 36.

(37) 3. Price Discrimination  Producer sells specific commodity to different buyers at two or more different prices  Same consumer charged different prices for same product for reasons not associated with cost differences  Conditions  Possible  Seller has control over market supply  Market segmentation and identifiable groups + no resale  Profitable: each market as different PED  First degree  Practice of charging each customer his reservation price  Captures all consumer surplus as revenue  Eg. auction sites  Impractical to charge each customer a different price  Firm usually does not know the reservation price of each customer: consumers do not tell and producers may not want to spend time and resources to find out  Second degree  Charge different prices for different blocks of the same product to the same buyer  Eg. photocopying shops  Third degree  Sells same product at different prices to different customers  Conditions  Two or more markets which can be separated  PED of each market must be different  Higher price charged in market with more price inelastic demand.  . Cost: loss of consumer surplus Benefits  Firm: higher profits and may use these profits from one market to withstand possible price war in breaking into another market  Consumer  Consumer may not have been able to afford good otherwise 37.

(38)  Higher profits may be reinvested into r+d – better quality products + better methods of production  Provision of goods that would otherwise not be produced due to high costs if production and consumption of good is one that confers positive externalities on society • Additional profits might exceed losses such that firm will still continue producing the good. 38.

(39) Discuss the view that the profit motive will always lead to a few large firms dominating the market for each and every type of product. [15m] 1) Barriers to entry  Few large firms merge – greater market share – reap EOS – fall in LRAC – fall in price – ward off rivals / block new entrants (natural BTE) – able to maintain supernormal profits  If plough into r+d – better methods of production – further fall in AC - make more profits  But some industries have low BTE (technology easily replicated) – low sunk cost eg. retail, grocery 2) Market size  Small: eg. Singapore television broadcasting Mediacorp vs. Mediaworks  Firms will eat into each other’s market share – erode profits – so to keep profits just let one firm dominate  Market big: eg. US then can afford to have few large firms 3) Nature of product  Large firms: unique products with no close substitutes  Small firms: availability of substitutes, prestige market / services, localized demand, perishables, limited MES – fashion, specialization, personalized services 4) Government Intervention / public’s desire  Few large firms will help to reduce price – increase in consumer surplus – increase in consumer welfare  Supernormal profits – plough into r+d to produce better quality products  Will still have competition unlike monopoly – still have the incentive to be more cost-efficient / innovative. 39.

(40) Explain what is meant by productive and allocative efficiency. [10m] 1. Allocative efficiency  Definition: situation in which it is impossible to change the allocation of resources in such a way as to make someone better off without making someone else worse off  Assumption: no externalities / public goods – P = MC – right amount + type of good produced to maximize societal welfare Price S (MC). D (MB). . 0 Quantity  If MB < MC, last unit of good less than opportunity cost of producing that unit – society benefits from not producing that last unit  If MB > MC, last unit of good more than opportunity cost of producing that unit – society benefits from producing that last unit Assumption aside, MSB = MSC  Perfect competition: firm price taker  MR = MC = P – allocatively efficient P/R/C MC MR. P1. 0. Q1. Quantity. 40.

(41) 2. Productive efficiency  Long run concept  Firm’s POV  Any given level of firm’s output produced at lowest possible AC – all points on LRAC curve are productively efficient  Society’s POV  LRAC minimum – firm is at optimum size / MES – all IEOS exploited P/R/C LRAC. P1. MR. 0. Q1. Quantity. 41.

(42) ‘A firm should be encouraged to maximize profits because this makes it efficient.’ Discuss whether this argument is true for a firm operating in an imperfect market. [15m] *When comparing efficiency, only talk about long run 1) Allocative efficiency: P > MC true for all imperfect markets because they are price setters – deadweight loss to society – allocatively inefficient 2) Productive efficiency: Not operating at MES (where LRAC cuts MC) – not fully exploited all IEOS – productively inefficient P/R/C. Triangle = DWL MC. Pm Pc. LRAC. MR. AR. 0 Qm Qc Quantity  PC industry needs to be at MES because it needs to be as cost-effective as possible – price taker – cannot pass cost increase to consumers  Vs. imperfect market need not be at MES because price setter – can pass cost increase to consumers 3) X-inefficiency  Monopoly: lax in cost control – no existing competition – can pass cost increase as price increase  But monopoly can also be cost efficient due to fear of new entrants  Globalisation and international competition  If market is contestable  Force monopoly to be cost efficient  Oligopoly more likely to be cost-efficient compared to monopoly but wastage of resources – large scale advertising / promotion – increase cost for firm and opportunity cost to society as the money could have been used to produce more goods 4) Dynamic efficiency  Supernormal profits in long run – able to invest in r+d – better methods of production – fall in AC in very long run  Vs. PC industry: no dynamic efficiency 42.

(43) Distinguish between monopolistic competition and oligopoly. [10m] Type Number of sellers Nature of product. Monopolistic competition  Many – one firm’s action less likely to affect others  Differentiated eg. retail: restaurants – affect demand curve – demand price elastic. Oligopoly  A few large firms – interdependence – one firm’s action likely to evoke responses from rivals  Homogeneous / differentiated eg. mobile service provision, petrol companies / taxi companies, OPEC – kinked demand curve P/R/C. P/R/C. Pe. AR. AR. Quantity. 0. 0. Smaller scale. . Firm increase price: rivals will not follow – quantity demanded for firm’s product falls more than proportionately – demand price elastic Firm reduces price: rivals likely to follow – price war + quantity demanded for firm’s product increases less than proportionately – demand price inelastic Larger scale. Less. . More: large market share. Low / no – low sunk cost + technology easily replicated – long run normal profits. . High – natural: high sunk cost eg. utilities, telecomm – TFC very huge – LRAC keeps falling – enjoys huge EOS – very low LRAC– new entrants cannot produce at such low LRAC Artificial: patents Ensure supernormal profits in long run. . . Non-pricing  competition Likelihood  of colluding BTE . Quantity.  . 43.

(44) Explain why oligopoly is a common market structure in many economies. [15m] 1) Firms want to be big to maximize profits  Merger of small firms – EOS – fall in LRAC – fall in price – ward off rivals + block new entrants  Monopoly – attracted by supernormal profits – monopoly loses its power 2) Society may desire oligopolies  Oligopoly – competition – greater innovation through r+d which monopolistic competition cannot afford since it only makes normal profits  Vs. monopoly – lax – X-inefficiency 3) Government’s intervention  Singapore government – face of international competition in a free market, local firms have to be big eg. banking – go regional – liberalization and deregulation of industries: mobile service industry, taxi companies  Firms prefer operate in oligopolistic structure rather than monopolistic: monopolies more closely watched by government vs. oligopolies harder to observe whether they are colluding 4) Some industries due to huge sunk cost – oligopolistic / even natural monopoly eg. utilities, telecommunications, transport, TV broadcasting in Singapore since market size is too small – one single player most efficient. 44.

(45) Explain why governments throughout the world have been involved in the supply of services such as electricity. [12m] Introduction  Government – social benefits + social costs which private firms unlikely to take into account  Electricity – essential good for households and businesses Body 1) Could be a natural monopoly  Market size cannot operate with more than one player at MES: huge sunk cost – AC keeps falling – private firms likely to be monopolistic – charge very high prices – need for regulation P/R/C. Pm. Pc. AC MR 0. Qm. AR Qc. MC Quantity. 2) Private – does not cater to lower income group vs. government more likely to do so 3) Huge initial investment – private firm likely to charge higher price to cover costs vs. government can subsidise from revenue / taxes 4) If there is competition among a few private firms – wastage + duplication of resources vs. government: save costs for advertising 5) Earns revenue for government since it is essential Conclusion Main point is that government does not want to risk anything because electricity and similar services are so essential. 45.

(46) Chapter 8: Government Intervention in the Market II 1. Regulation of Natural Monopolies  MC pricing: monopoly charge a price that is equal to MC in order to achieve allocative efficiency  But monopoly incurs a loss – shut down – public deprived of vital service  Need to be supplemented with government subsidies: costly to government, burden on taxpayers  2-tier pricing: consumers pay a fixed sum of money for access to service and price per unit consumed to cover marginal cost  Eg. electricity, gas  Producer meets all COP and minimizes loss of social welfare  AC pricing: monopoly charge a price equal to AC – lower price and greater output – increase in society’s welfare  Normal profits – viable in long run  Still not allocatively efficient  Firms no incentive to keep costs low since price is at whatever AC they are at  Problems  Difficult to obtain accurate information on demand and cost estimates: firms tend to overstate cost, market conditions change constantly, costly to acquire new information  Regulatory lag: firms may have to operate at a loss during time lag  Costly to administer 2. Taxation  Lump-sum tax on monopolist’s excessive profits – shifts AC curve upwards – profits reduced – normal profits  Redistribute income from producer to consumer  Use tax revenue to subsidise welfare schemes / production of merit goods  May create disincentive for monopolist to be cost-efficient  Monopoly can pass burden to consumers due to price inelastic demand  Dynamic efficiency compromised 3. Legislation  Anti-trust laws: Anti-trust Act (US) / Competition Law (Singapore): break up monopoly  Eg. Microsoft Corporation: one firm own Windows operating system, the other will own applications  May not be applicable to natural monopoly / monopolies with great incentives to undertake r+d  Forbidding certain practices: eg. predatory pricing: setting price below COP to eliminate competition. 46.

(47) . . Imposing standards of provision eg. Public Transport Authority in Singapore governs standards of public transportation to ensure guaranteed quality of product Insisting on certain levels of competition in industry: Singapore government increasingly deregulates monopoly. 4. Nationalisation  Growth  Industries with major investment eg. steel and coal industry, large spending on r+d required  Unfair competition of state-owned enterprises with private sector  Efficiency  Natural monopoly, presence of positive externalities, eliminate wasteful duplication  Lack of competition pressure – lack of incentive – X-inefficiency  Bureaucracy – heavier burden on tax payers  Sunset industry  Decision may be made for political rather than economic reasons eg. just to keep employment figures high  Equity  Special pricing policies eg. free bus rides for pensioners  Service which would otherwise not be provided eg. bus route to remote areas  State monopoly no less disadvantageous to consumer than private one – no higher authority to maintain checks and balances  Stability  For strategic reasons eg. national defence  Seen as a move towards communism 5. Privatisation  Competition  Increased competition – cost efficiency + benefits for consumers eg. lower prices, wider choice, improved quality  Unfair competition of state-owned enterprises with private sector  Could be worse outcome  If state monopoly replaced with private monopoly, possibly lower output and higher price  If high BTE. 47.

(48) . . Efficiency  Greater efficiency  Commercially sounder decision making eg. higher returns on investments  Greater accountability to public – constantly need to perform well or risk takeover by another firm  Natural monopolies, externalities, equity issues Revenue  Revenue from selling state assets  Higher corporate tax receipts if privatized company is profitable  Long term loss of revenue had the privatized firm been profitable. 48.

(49) J2 Topics No. 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53. Title Chapter 9: Key Economic Indicators How far can this information lead you to conclude that there is a rising standard of living in Singapore? Discuss the factors that contribute to economic growth in a country. Chapter 10: Income and Employment Determination Explain what information an economist would require to decide whether the US needed ‘an economic stimulus’. Explain what is meant by the equilibrium level of national income. Analyse the effect on the equilibrium level of income of an increase in the level of savings and an increase in the level of exports. Discuss the extent to which the US fiscal stimulus might lead to a sustained increase in national income. What are the main causes of Singapore’s recessions? Chapter 11: International Economics Explain the theory of comparative advantage. To what extent does the theory of comparative advantage explain the pattern of trade between Singapore and the rest of the world? Discuss whether protection offers any advantages over specialization. Explain the rationale for free trade and discuss the extent to which FTAs are beneficial. To what extent can economies benefit from globalisation? Discuss the opportunities and threats of globalisation for Singapore and other Asian economies. Consider the effects, other than on the general price level, of Singapore’s changing tax structure. Policies to remedy Singapore’s recession Evaluate methods the Malaysian government might use to slow down import growth and increase new export business. “To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” How far do you agree with the statement? “To be considered successful, an economy needs to achieve low unemployment, low inflation and stable economic growth.” Explain this statement. Discuss whether fiscal policy is the most effective way for Singapore to sustain a successful economy. In the fourth quarter of 2004, Singapore’s unemployment rate rose to 3.7%. Discuss whether supply-side policies are the best way of achieving full employment in Singapore. Why Singapore does not use interest rate policy Problems with exchange rate instability. Page No. 50-51 52-53 54 55-58 59 59 60 61 62 63-66 67 68-69 70-71 72-74 75-76 77 78 79 80 81 81 82 83 84 84. 49.

(50) Chapter 9: Key Economic Indicators 1. Key Macroeconomic Aims  Strong sustained economic growth  Low inflation  Low unemployment rate  Healthy BOP 2. National Income Statistics  Gross domestic product: value of all final goods and services produced within a given country during a given period of time  Measure economic growth  Limitations  Understate nation’s output: omission of non-market activities (voluntary welfare services) and underground economy  Difficulties in measuring SOL • Leisure time • Externalities • Production does not equal consumption: expenditure could be for potential growth • Income distribution • Other social factors: eg. crime rates, freedom  International comparisons • Difference in account procedures and items included • Exchange rates: need to use PPP • Population: need GDP per capita • Difference in climate and culture: different needs – different costs • Difference in underground economy: Sweden’s underground economy 13% of GDP  Alternative measures of SOL  HDI: life expectancy, education, GDP per capita at PPP rates  MEW: leisure, GDP per man hour  Gross national product: value of all final goods and services produced by residents of a country, regardless of the location of production, during a given period  Net national product: GNP – depreciation  Nominal: at current prices vs. real: at constant prices. 50.

(51) 3. Inflation Rate  CPI: measures change in price of fixed basket of goods and services commonly purchased by households in a specified time period  Limitations  Not an accurate measure of COL  Substitution bias: consumers substitute toward goods that have become relatively cheaper – overstates COL  Quality adjustment: CPI increase might be due to quality adjustments – overstate inflation  New products: price declines sharply a few years after introduction – not added to market basket until years after introduction – price declines not recorded 4. Unemployment Rate  Unemployed: people aged 15 and over who are without work but were available for work and were actively looking for a job  Frictional unemployment: unemployment because time taken for workers to search jobs and for firms to search for suitable workers  Structural unemployment: workers do not have the skills needed to obtain longterm employment  Cyclical unemployment: unemployment during recession 5. Balance of Payments  Record of country’s international transactions  Current account  Visible: imports and exports of goods and services – BOT  Invisible: profit repatriation, interest, dividends, unilateral transfers  Capital account  Portfolio: bonds, shares, money in banks  Direct: FDI  Financial account: something like bank reserves. 51.

(52) Singapore has enjoyed another year of robust growth in 2007, and the real GDP growth was 7.5% for the year. A record 172000 jobs were created in the first 3 quarters. However, in recent months, inflation has picked up and the inflation rate for the month of November alone was 4.2%. How far can this information lead you to conclude that there is a rising standard of living in Singapore? [25m] Introduction  SOL – material and non-material well being of each citizen Body A) Material well being  Real GDP per head: on average how much goods / services each citizen gets to consumer  Real: adjusted for inflation as converted to constant prices  High for a developed country  Limitation: does not show effect of changes in population size  Per head: effect of population size eg. if GDP increases by 7.5% but population increases by 9%, GDP per head falls  Singapore: over 1 year: changes in population size little but could have been some increase due to open-door policy  Income gap – Gini coefficient  Gini coefficient globally used as a measure of income disparity, with 0 indicating perfect equality and 1 perfect inequality  Singapore: 0.52 in 2006  Increasing gap in Singapore due to globalisation: displaced by machines, structural changes, influx of foreign workers, outsourcing  Type of spending  Capital vs. consumption goods  Government spending  Defence vs. spending that directly increases SOL  172000 jobs  High incomes – increase consumer spending which increases demand for goods and services, generating more jobs and employment  Due to investments by foreign companies eg. in 2007 plant specializing in harnessing solar energy set up in Singapore – indicates investor confidence  Limitations: 60% jobs went to foreigners, number of jobs destroyed vs. number of jobs created, size of labour force may have changed so it is not that unemployment rates fell, composition of jobs (for lower-skilled workers?), ratio of dependants to working population. 52.

(53) . Inflation rate  Real: adjusted for inflation  Cause: mainly cost factors like high imported oil price, imported food shortages, partly GST  Lower-income group suffers more in the face of further increase in prices / income gap. B) Non-material well being  Education – literacy rate  Singapore: high literacy rate due to compulsory primary education, heavily subsidized  Government emphasis on upgrading of skills and training subsidies to firms for such purposes  Healthcare – infant mortality rate / life expectancy  Singapore: individual responsibility + government spending – 3M framework – Medisave, Medishield, Medifund  Avoid excessive burden on state and tax payers  With increasing medical costs + ageing population, QOL of some (lowerincome group?) may be affected  Means-testing  Leisure: GDP per man hour  Others: negative externalities eg. pollution Conclusion  Other indicators: HDI, MEW, GNP. 53.

(54) Discuss the factors that contribute to economic growth in a country. [12m] Introduction  Economic growth measured by GDP growth rate and is the means to improve living standards Body 1) Quantity and quality of resources  Quantity and availability enhance growth potential  Land: includes natural resources like mineral deposits and oil eg. oil-rich Saudi Arabia  Labour – labour-abundant countries like China and India  Entrepreneurship – availability of talents and risk-taking individuals eg. selfmade entrepreneurs in Hong Kong  Quality can be enhanced through government effort and policies  Increase labour productivity through training and education  Entrepreneurship  Capital – government efforts to make it more conducive for fixed capital formation 2) Role of government  Augment quality of labour through education and training  Strategise economic direction eg. change structure of economy in face of loss of comparative advantage and nurture comparative advantage in new areas  Conducive environment for business  Political stability  Price stability: reflection of good macroeconomic management by government, competitive price and lowered COP – ability to attract FDI due to lower wages  Efficient infrastructure  Attractive corporate taxes  Less bureaucracy and red tape  Ability to explore new markets / help businesses go global 3) Level of consumption, investment and government spending in economy  High consumption conducive when economy has unutilized resources while high savings conducive when economy near or at full employment  Savings provide investment funds necessary for growth  Government fiscal and interest rate policies  High export revenue due to competitiveness. 54.

(55) Chapter 10: Income and Employment Determination 1. Aggregate Demand  Total level of spending in an economy  AD curve slopes downwards because  Wealth / real balance effect: GPL higher – purchasing power of financial assets falls – discourages domestic consumption – lower level of output  Interest rate effect: higher GPL – increase demand for money from households and firms + might shift wealth out of financial assets – decreasing supply of loanable funds – increase in interest rates – more expensive to purchase goods and services on credit – households purchase less goods + businesses invest less – lower national output  International substitution effect: higher GPL – locals buy more foreign goods + foreigners buy less domestic goods – net exports fall – lower national output  Factors that cause a shift  Changes in expectations: income and profits, real wealth, inflation  Changes in government policies  Changes in world economy: income abroad, foreign price level, exchange rates 2. Aggregate Supply  Total output of goods and services that firms as a whole would like to produce and sell at each possible price level  Shape  Horizontal: producers can produce all they want due to abundant resources  Upward sloping: output rises but pressure on prices  Vertical: need time to adjust to new cost structures  Factors that cause a shift  Change in input prices  Change in quality of labour input  Change in expected rate of inflation  Change in technology  Government policies (local and foreign). 55.

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