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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

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26

involved in the supply of services such as electricity.

Chapter 8: Government Intervention in the Market II

46-48

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

Wheat
*Draw dotted line to show comparison
between 2 countries with a common
yardstick

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

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

B
A

A: resources not fully utilized

underemployment and
unemployment
B: efficient use of resources
full employment

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

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

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
(Brief) Implications:
Y
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)

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

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

10

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

11

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

12

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
peoples 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

13

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

14

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 rivals product
Strong complements can sell jointly
15

16

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

17

When asked how a strategy might affect a company, consider effect

on total revenue then profits

18

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

19

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

20

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

21

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

22

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

23

Chapter 4: Microeconomic Problems: Market Failure

1. Market Failure
Scarce resources need to allocate resources efficiently objective:
maximize societys 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 self-interest
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

24

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

25

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

26

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 societys 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

27

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

28

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

29

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:
cars

x Increasing affluence income elasticity of demand for

X Cannot stem peoples 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

30

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)

31

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

32

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

33

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
Definiti
on

Total Fixed Cost

Sum of all costs of
production do not
vary with the level of
output aka overhead
costs
Must be paid even
without production

Total Variable Cost

Costs incurred for
use
of
variable
factors like labour
Varies directly with
output level

Exampl
es

Rent
of
factory Raw
building, interest on labour
capital invested in

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

materials,

34

equipment
Graph

Averag
e
curves
ATC =
AVC +
AFC

AFC: amount of fixed

costs per unit of
output
AFC = TFC / Q

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

35

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 firms 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 firms
expansion, and have been created by firms 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
36

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

37

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

38

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)

39

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
40

 Lack of capital

41

 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

42

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 firms 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 firms 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
43

Reduction / removal of familiar products and services

affects consumer satisfaction
Neglect lower-income group
Retrenchment

44

Chapter 7: Firms and How They Operate II

1. Comparison of the 4 Markets
Type

Perfect Competition

Number of
buyers /
sellers

Barriers to
entry

Monopoly

Large
No one buyer /
seller can influence
price
Firm price taker

Only one firm

Firm price setter

None
FOP perfectly
mobile
No transaction /
transportation
costs
Minimal sunk costs

High
Natural: huge sunk
costs (AFC falls
over very large
output AC falls
continuously
enjoys huge IEOS),
exclusive
ownership of
essential raw
materials
Artificial: non-price
competition,
contrived barriers
(cartel), legal
protection:

Monopolistic
Competition
Large
FOP relatively
mobile
When firm makes
decisions, does
not have to worry
how its rivals will
react
No / Low
Firm lowers price
profits spread
thinly over many
rivals rivals
suffer negligibly
Retaliation
unlikely
No collusion
keen competition

Oligopoly

Few large firms

Interdependent

Substantial
Natural
Artificial:
legislation,
collusion /
mergers, nonprice
competition,
advertising

45

Nature of
products

Homogeneous
Buyers no
preference for any
firm

exclusive rights
(patents, tariffs to
block foreign firms)
No close
substitutes
CED and PED very
low

Differentiated:
quality, design,
location,
promotion
Demand price
elastic

Homogeneous /
differentiated

46

Knowledg
e

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

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

P > MR
Firm increases
price other
firms will not
Firm decreases
price other
firms follow

Firms
curve

P > MR
Cannot increase
both output and
price at the same
time as curve is
downward sloping

47

demand curve

Examples

Firms SR
equilibriu
m
Firms LR
equilibriu
m

Stock market
Forex market
Agricultural
products: many
farmers in LDCs

Utilities
Starhubs EPL
coverage
SMRT for NS and
EW lines

Normal profits

New firms will enter

industry to erode
supernormal profits

Bubble tea

may lead to price

war
Price rigidity:
menu costs, fear
of harming firms
image (fall in
price fall in
quality)
UK brewery
industry
Taxi companies
OPEC
Mobile service
provision

Supernormal, normal / subnormal profits

MC = MR and MC must be rising
Normal /
supernormal profits
Firm will shut down
if subnormal profits

Normal profits

Normal /
supernormal

LR
equilibriu
m curve

48

Productive
efficiency

Efficient
Firm produces at
MES

Allocative
efficiency

Efficient
P = MC

Inefficient unless
by coincidence

Inefficient
Inefficient unless
Will settle at LRAC
by coincidence
that is not
necessarily at MES
Firms POV: all points on LRAC
Societys POV: MES
Inefficient
P > MC
Could be seen as premium society pays for product differentiation

49

2. Analysis of Imperfect Market Structures

Type
Economi
c
efficienc
y

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
Variety of Unique
products Possible innovation and
new products: BTE
stimulus to the creativity
required to destroy barriers
monopoly profits
stimulates new entrants
producing new and
competing products
R+d and Profits lead to unequal
new
income distribution: dollar
profits
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

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
Large variety increase in
consumer welfare

More equity: no
redistribution of income
from consumers to
shareholders
Normal profits: no
additional profits to plough
into r+d

Oligopoly
Allocative inefficiency: P >
MC, output below optimum
Productive inefficiency
Dynamic efficiency: r+d

Differentiated

Supernormal profits
ploughed into r+d

50

guarantee that monopolies

will do this

51

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

MCp
c

MC
m

Pm

Practise price
discrimination [hasMR
both AR
0
Q Q
Q
costs and benefits]
c m
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

Wasteful competition
Advertising provides better
consumer information
which helps move market
structure closer to PC
model but loss of consumer
sovereignty

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

52

competition (instead of
extensive advertising,
money can be spent to
produce more goods)

53

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

54

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
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

55

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 others 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 / publics 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

56

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
Pric
e
S (MC)

D
(MB)
0
Quantit
If MB < MC, last unit of good less than opportunity cost of
y
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

P1

MR

Q1

Quanti
ty

57

2. Productive efficiency
Long run concept
Firms POV
Any given level of firms output produced at lowest possible
AC all points on LRAC curve are productively efficient
Societys POV
LRAC minimum firm is at optimum size / MES all IEOS
exploited
P/R/
C
LRA
C
P1

MR

Q1

Quanti
ty

58

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 needs to
Qm
Quantity
PC industry
beQc
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

59

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

60

Distinguish between monopolistic competition and oligopoly.

[10m]
Type
Number
of sellers
Nature of
product

Monopolistic
Oligopoly
competition
Many one firms
A few large firms
action less likely to
interdependence one firms
affect others
action likely to evoke responses
from rivals
Differentiated eg.
Homogeneous / differentiated
retail: restaurants
eg. mobile service provision,
affect demand
petrol companies / taxi
curve demand
companies, OPEC kinked
price elastic
demand curve
P/R/C

P/R/
C

Pe

AR
0

AR

Quantit
y

Smaller scale

0
Quantit
y will
Firm increase price: rivals
not follow quantity demanded
for firms product falls more than
proportionately demand price
elastic
Firm reduces price: rivals likely
to follow price war + quantity
demanded for firms product
increases less than
proportionately demand price
inelastic
Larger scale

Less

More: large market share

Low / no low
sunk cost +
technology easily

High natural: high sunk cost

eg. utilities, telecomm TFC
very huge LRAC keeps falling

Nonpricing
competiti
on
Likelihoo
d of
colluding
BTE

61

replicated long
run normal profits

enjoys huge EOS very low

LRAC new entrants cannot
produce at such low LRAC
Artificial: patents
Ensure supernormal profits in
long run

62

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) Governments 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

63

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

AR

MC
0
Qm
Qc
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

64

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 societys 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 monopolists 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

65

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
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 Xinefficiency
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

66

 If state monopoly replaced with private monopoly,

possibly lower output and higher price
If high BTE

67

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

68

J2 Topics
No

Title

29
30

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 Singapores 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 Singapores changing tax structure.
Policies to remedy Singapores 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.

31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48

49
50

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

69

51

52
53

In the fourth quarter of 2004, Singapores 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

83

84
84

70

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 nations 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: Swedens
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

71

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 long-term employment
Cyclical unemployment: unemployment during recession
5. Balance of Payments
Record of countrys 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

72

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,
73

composition of jobs (for lower-skilled workers?), ratio of

dependants to working population

74

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 (lower-income group?) may be affected
Means-testing
Leisure: GDP per man hour
Others: negative externalities eg. pollution
Conclusion
Other indicators: HDI, MEW, GNP

75

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. self-made 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

76

77

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)

78

3. Consumption Function
Act of using income for the purchase of goods and services to
satisfy current wants
Consumption
Y=C

C = a + bY

X
W
Income

W = dissavings, X = breakeven point, Z = savings

C = a+bY
a represents autonomous consumption: level of consumption
that does not vary with income still need to consume even
though no income
bY represents induced consumption: household expenditures
that vary directly with income
b: MPC = change in C / change in Y
Non-income determinants
Wealth: amount of money, fixed assets and financial assets
households have
Expectations of future prices and income
Distribution of income
Interest rate and availability on credit
Tastes and attitudes

4. Investment
Act of acquiring new fixed capital assets and accumulating stocks
and inventories
Autonomous: not influenced by national income vs. induced
Expected rate of return > rate of interest will invest
Factors that cause shift
Business confidence and expectations
Cost and availability of capital goods
Rate of change of income: accelerator effect
Government policies
79

 Change in technology

80

Interest rate

Investment

5. Equilibrium Level of Income

AE

Y = AE

Autonomous
consumption

Y2

Y0

At OY1
AE = aY, Y = by AE < Y
unplanned inventory investment
ab
next period firms reduce output
Y1 falls to equilibrium Y0

National output

At OY2
AE = dY2, Y = cY2 AE > Y
excess demand, firms draw on
stocks
unplanned disinvestments cd
next period firms increase output
Y2 rises to equilibrium Y0

6. The Multiplier Effect

81

A change in any component of aggregate expenditure (ie. C, I, G or X)

will work through the multiplier to change the national income more
than proportionately. As shown in the diagram below [refer to diagram
above], an increase in AE will cause the AE curve to shift from AE0 to
AE1. At the original level of national income Y0, since AE is now greater
than actual national output, there is an unplanned fall in stocks of AB.
In the next period, firms would increase output, causing the level of
national income to rise eventually to Y1, where the new AE equates the
national output.
The initial rise in income due to (any rise in component: depends on
question context) will induce consumption by recipients of the income.
As one mans spending generates income for the next person, the
national income will eventually rise by a multiple of the initial rise in
the AE. Assuming an initial injection of $100m and a constant MPC of
0.5, the national income will eventually rise by 2 times the initial
injection.
In short, the multiplier measures the change in national income as a
result of the change in AE. It has a direct relationship with the MPC,
expressed as k=1/(1-MPC).
Evaluation
Magnitude of increase in NY depends on size of multiplier
Larger the MPW, smaller the multiplier
May lead to demand-pull inflation if near or at full employment
BOP inflation affects price of exports and may have adverse effect
on BOT
7. Inflationary / Deflationary Gap
Amount of AE that falls short of (cd)/ exceeds (ab) the level
necessary to achieve FE

82

Explain what information an economist would require to decide

whether the US needed an economic stimulus. [10m]
Introduction
Weak economy assume pending recession fall in GDP for 2
consecutive quarters (negative GDP growth)
Development
Fall in real GDP
Components of AD: fall in AD fall in GDP
Consumption level of households: due to fall in income /
saving in fear of retrenchment
Fall in investment: business pessimism, induced: fall in GDP
fall in investment
Inflation: fall in GDP fall in AD fall in GPL / fall in inflation rate
Need inflation rate to arrive at real GDP
Firms and bankruptcy, firms and decreasing profits
Stock markets: indices fall confidence fall
OR
Fall in real GDP
What causes fall: C/I/G/X-M: BOT: more relevant for Singapore since
Singapores recession mainly due to BOT
GDP income, wages and profits, bankruptcy
Inflation: fall in GPL but stagflation (economy weakening but price
increasing) price increase in US not due to recession: not AD
factors but AS factors
Unemployment rate rough guide: 4% - cyclical no job demand
deficient unemployment
Explain what is meant by the equilibrium level of national
income. [10m]

NY: as measured by GDP (definition)

Equilibrium: no tendency to move from that equilibrium
Describe briefly components of AE
C (households): shape of AE follows shape of consumption
function C=a+by
Simple explanation of components
Sign of 45 degree line: every point is an equilibrium point where
AE=Y
Equilibrium level of NY: planned AE = Y. AE curve cuts 45 degree line
Adjustment to equilibrium

83

Conclusion: when economy is in equilibrium, may not be at full

employment / recession

84

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. [15m]
A.

Savings
Y=C+S
Increase in S fall in C AE falls AE curve shifts from AE1 to AE2
Show adjustment to equilibrium
Summation: increase savings fall in C works through multiplier
fall in NY by a few multiples
Evaluation
Savings can be good for economic growth increase supply of
loanable funds interest rate falls cost of borrowing falls
increase I increase productive capacity increase AS
increase NY
Summation: S decreases actual growth but increases potential
growth
B.

Exports
Increase X increase AE AE curve shifts from AE2 to AE1
Show adjustment to equilibrium
Evaluation
Increase X if have unemployed resources increase NY
Increase X if near / at FE NY may not increase as fast /
demand-pull inflation
Discuss multiplier process in detail
Conclusion
Magnitude of change in national income depends on size of
multiplier
Larger MPW, smaller K
Eg. Singapore

85

Discuss the extent to which the US fiscal stimulus might lead

to a sustained increase in national income. [15m]
Introduction
Fiscal: increase G, decrease T
Sustained: actual + potential growth
Development
How fiscal stimulus works: lower taxes (increase C/ increase I) +
increase G increase AD increase NY: actual growth, cannot
sustain
Multiplier in detail
Evaluation: depends on size of multiplier
USA MPM could be high because hug e trade deficit may
reduce size of k
Crowding out effect: increase in G if borrowed from public
decrease in supply of loanable funds increase in interest rate
crowd out C/I cannot sustain
Effects of taxes on C and I unpredictable due to pessimism
Reaches FE: cannot sustain
Therefore need supply-side measures to increase AS for sustained
growth potential growth / increase in productive capacity
Increase in G on infrastructure facilitates business increase AS
Tax increase NY (potential)
Decrease personal taxes increase incentive to work
increase AS
Decrease corporate taxes increase I increase LRAS
Condition: if rebates are permanent but according to
preamble, rebates seem to be one-off
Conclusion
More policies to boost AS education and training increase
productivity increase LRAS

86

What are the main causes of Singapores recessions? [10m]

1) Factors leading to fall in AD
External factors pessimism eg. 911, SARS (only caused a
slowdown in Singapores economy), 1997 Asian crisis C/I fall
Trade deficit: value of X fell due to 911
Lose CA goods more expensive
Fall in income of trading partner
2) External recessions
US recession US GDP fall buy less Singapore goods Singapores
X falls AD falls GDP falls (multiplier effect)
Singapore may not be that affected can ride on growth of China /
India
But China huge trade partner of USA
Singapore: international momentum
Extension of MRT increase G k increase NY
IR: increase I increase NY + tourist revenue
YOG: tourist revenue
Cannot sustain since k is small
3) Supply-side factors
Supply shocks: 1973 oil crisis increase COP fall in AS
But overwhelming cause is due to AD, but recognize that fall in AS can
also create a recession

87

Chapter 11: International Economics

1. Theory of International Trade
Exchange of goods and services between countries, involving the
use of different currencies and crossing international borders
Theory of comparative advantage: produce good at lower
opportunity cost than another country
Sources
Differences in factor endowments that can change over
time
Differences in technology
Dynamic comparative advantage
Advantages of trade
Greater world output and higher consumption of goods and
services (possible at previously unattainable levels)
Reduction in unit cost of production: EOS, countries gain
experience over time
Stimulate economic development and growth: enlarge market,
increase competition in home market
Facilitate transfer of technology and ideas: increase efficiency
of production economic growth, help developing countries
leap frog stages
Promotes beneficial political links
Benefits consumers: more choice and higher satisfaction
levels, lower prices compared with local products, better
quality products
Dynamic gains from trade: gains grow larger over time
Disadvantages of trade
Unfair competition and dumping / unnecessary government
subsidies
Over dependence on other countries
Import harmful goods
Terms of trade: rate at which country exchanges its exports for
imports
Factors
Change in demand conditions: population, income,
availability of substitutes
Change in supply conditions: technology, depletion of
natural non-renewable resources
Consequences of change in TOT
Change in BOT and SOL: dependent on PED of exports
and imports, cause of change, responses that follow
Reallocation of resources
Change in consumption patterns

88

89

2. Barriers to Trade
Natural
High transport costs raises COP and lowers relative
efficiency
Lack of mobility of factors
Increasing COP due to LDMR beyond certain level of output
Other market imperfections: imperfect information and
market conditions may not specialize to extent that theory
suggests
Artificial: protectionism
Tariff: custom duties imposed on imports of goods and
services by government
Depends on PED of imports and how much foreign
suppliers are willing to absorb may not protect
domestic producers, just a source of government
revenue
Cuts volume of imports improve BOT exchange rate
appreciates exports more expensive abroad reduce
exports in the long run
Non-tariff: import quotas
Greater certainty of protection since revenue earned by
foreign suppliers may not be as badly affected as tariff
Export subsidies: cash grants by government to local
producers
Reduces COP sell more of good at prevailing price
May induce complacency
Drain on government funds
Foreign exchange control: government control over sale and
purchase of foreign exchange
Financial quotas, charges made on people purchasing
foreign currencies
Malaysia used this method to recover from 1997 Asian
financial crisis
Difficult to enforce and might result in black market for
foreign exchange
Works
best
in
communist
countries
because
government monopolises money conversion
Others: embargo, trade agreements, international cartels
New protectionist measure: technical specifications and
standards which discriminate in favour of domestic
producers
Administrative regulations regarding import procedures
to delay and reduce volume of imports

90

 Voluntary export restraints (VER): exporting country

voluntarily reduces its exports under threats of all-round
trade restrictions eg. US automobile industry vs. Japans

91

3. Arguments for Protectionism

Economic
Protect infant industry eg. Singapore had protective duties
covering ~300 items in 1960s
Difficult to identify currently unprofitable industries that
might acquire comparative advantage in the long run
Difficult to decide when industry can be independent of
protection
Encourage inefficiency
Reduce BOP deficits
Dependent on PED of imports and exports
Need to look at root causes
Invite retaliation reduced exports reduced total
volume of world trade
Prevent unfair trade practices
Dumping distorts market justifiable
If consumers benefit in the long run from lower import
prices not justified
Diversify economic structure
May not support theory of comparative advantage
Pattern of comparative advantage can change over time
naturally (discovery of new raw materials) / through
deliberate policies
Protect mature industries
Trade unions
Misuse of resources since protectionism will not increase
total employment
Retaliation
Protect against low-wage foreign labour
Rejection of theory of comparative advantage
Could shut down industries and divert resources to more
productive ones
Consumers denied opportunity to buy from cheaper
source benefits of trade lost
Increase domestic production: counter-cyclical measure
Increase government revenue
To be effective, should be imposed on goods which are
price inelastic
Retaliation
Retaliation
Unhealthy for word trade and ineffective
Distort and reduce differences in comparative
advantage
Welfare loss
92

Misallocation of resources: firms unnecessarily retained

Difficult to remove protectionist measures once in place
Other industries may demand for protectionism
Better alternative: stimulate export competitiveness by
increasing AS

Political
Essential to produce on military weapons in case of crisis
subsidies industry to ensure continuous supply eg. US 1980s
semiconductor industry for high-tech weaponry vs. Japans
Nation poorer but value of national security higher
Trade as weapon of foreign policy eg Gulf war: US imposed
trade sanctions against Iraq
Social
Subsidise agricultural sector to avoid further depletion of
population in rural areas / prevent further rural-urban
migration to overpopulated cities
Restrict import of harmful goods

4. Tariff Diagram

Loss in
consumer surplus
=a+b+c+d
a becomes producer surplus, c become tax revenue, b + d becomes
deadweight loss
Consumption effect:
- Reduce consumption from OQ4 to OQ3
- Reduce consumption of imports and switch to domestically
produced substitutes
- Pay extra amount (P2 P1)
- Consumer surplus falls

93

Production effect:
- Expand production from OQ1 to OQ2
- Increase revenue
- Producer surplus increases
Government revenue effect:
- Receives as tax revenue extra amount paid by consumers for the
imported quantity

94

Explain the theory of comparative advantage. [10m]

Introduction
Comparative advantage: specialize based on lower opportunity cost
less of the other good foregone
Body
Assumptions: 2 countries 2 goods, no transport costs, constant
returns to scale: LRAC remains constant
Assume USA and China each has 20 units of resources, initially use 10
units to produce each good
Table 1: Before specialization
Cars

Textiles

USA
100
60
China
5
10
Total
105
70
USA: CA in production of cars give up less textile
China: CA in textile give up less cars

Opportunity
Cost
1C: 0.6T
1C: 2T

USA devotes 1/10 more to car, China complete specialization.

Table 2: After specialization
Cars
USA
110
China
0
Total
110
World output increases

Textiles
54
20
74

Terms of trade: mutually beneficial 0.6T < 1C <2T 1C traded for 1T

USA exports 10 cars, gets 10 textiles
Table 3: After trade
Cars
USA
100
China
10
Total
110

Textiles
64
10
75

Gains from trade: higher level of consumption

Conclusion
Comparative advantage gains from trade, more choices, increase
growth
Limitations of CA: relax assumptions

95

To what extent does the theory of comparative advantage

explain the pattern of trade between Singapore and the rest of
the world? [15m]
Introduction
Singapores constraints lack of natural resources; small
geographical size and population human capital our only resource
Singapores relative strengths good geographical location
Our constraints and strengths determine where our CA lies
Pattern of trade: type of exports and imports of goods and services
Body
A) Yes
Type of exports
1970s
1980s

1990s
and
beyon
d

CA
Labour-intensive industries:
Cheap, unskilled and surplus
labour
Move towards higher-end
Capital-intensive industries:
products and electronic
More educated workforce and
products; moving towards
improved technology
services like banking and
Loss of CA in labour-intensive
finance, tourism
industries to countries like
Malaysia and Indonesia which
have huge labour force
Electronics, pharmaceuticals,
High value-added, knowledgetelecommunication
intensive, technologyequipment, disk drives,
intensive industries:
integrated circuits
Highly qualified labour force,
Services: banking and finance, r+d infrastructure
tourism, educational hub,
Continue to lose CA in
medical hub
manufacturing industries to
countries like China and India
Textiles and simple
manufactured products

Type of imports
Imports: consumer items,
food, raw materials, capital
goods for development and
infrastructure building

Lack of CA
Lack of natural resources
especially lack of land for
agriculture and to support
huge export base

96

B) No, there are other factors

Trade based on world demand
CA only gives rationale for trade but countries try to augment
and develop CA in industries with world demand
For country to develop and provide opportunities for its population
of diverse talents, needs to have spectrum of industries
Diversification to reduce negative consequences of overdependence
Desire not to rely on foreign supplier for essential goods
National pride / security eg. Newater
Re-exports

97

Discuss whether protection

specialization. [13m]

offers

any

advantages

over

Introduction
Protectionist measures
Advantages of specialization based on CA: gains from trade,
increase X economic growth, wider choice, EOS fall in LRAC
competitive prices, efficiency in resource allocation in the world,
welfare gain if world price cheaper than domestic price
Body
Infant industries
Rationale: NIE, reasons of economic diversification impose
quotas / tariffs allow new industries to grow and develop
EOS
SR implications: applies for all reasons to protect as long as
use quotas / tariffs
Society: DWL
Consumers: increase price
Other firms (some extent): increase COP if good
protected is important input eg. steel
LR implications
Grow enjoy EOS lower LRAC lower price of exports
able to compete internationally BOT improves if
demand is price elastic increase in total revenue from
exports increase exports increase NY/N
If do not grow
If government subsidizing waste of resources could
have been used elsewhere education / healthcare /
develop infrastructure
Consumers and society continue to suffer from
inefficiency higher prices
Shut down massive retrenchment
Summation: To the extent that infant industries grow.
However, the infant industries normally do not grow and may
become
inefficient
due
to
government
subsidies.
Protectionism cannot be long term.
Inefficient industries
Eg. US steel industry, textile: slap tariffs / quotas on Chinese
textiles / imported steel allow inefficient firms to eventually
be able to be more efficient develop new technology / adjust
cost structures
Eg. steel affects COP in many other industries eg. housing,
cars cost-push inflation affects domestic market and
erodes export competitiveness
98

 Summation: protect jobs in inefficient industries but more jobs

lost elsewhere eg. car industry
Alternative solution: develop CA in new industries: capitalintensive, technology-intensive, services, training

99

Dumping
Foreign country selling goods below its actual COP local
firms driven out eventually foreign country gains monopoly
power
Difficult to ascertain if it is dumping / country really has CA in
production of these goods Chinese textile + abundance of
cheap labour
Could be baseless accusation
Solution: force firms to be more cost-efficient (dont protect),
training (subsidise firms for training), subsidise r+d
Economic diversification
Reduce over-dependence on a few key products / industries
Eg. Zambia: copper exports what if world demand falls
Balance of trade deficit value of imports > value of exports
Eg. US huge trade deficit USA consumes a lot, including on
imports breed further inefficiency
Alternative solution: increase interest rates encourage
people to save + discourage consumption
LR: high C low S low investment affects productive
capacity low LRAS (inefficiency)
National security
Eg. steel war weapons

Conclusion
If country protects, other countries retaliate world inefficiency

100

Explain the rationale for free trade and discuss the extent to
which FTAs are beneficial. [25m]
Introduction
Free trade based on CA lower opportunity cost ratio gains from
trade
FTA remove tariff and non-tariff barriers in theory in practice eg
Singapores FTAs also include investment
Development
A) Expounding theory of CA difference in factor endowments
Assumptions
3 tables
Summation: gains from trade, increase choice / increase societys
welfare, increase economic growth and SOL
B) Are FTAs beneficial
On trade
Increase X k increase NY / N associated benefit of largescale production EOS fall in LRAC able to price goods
more competitively may improve BOT
Singapore: small domestic market
China: may not be as dependent on X revenue because
people are getting more affluent. C increase can sustain itself
based on internal economy
Cambodia / Vietnam: NIEs because people are poor
But increase X demand-pull inflation when near / at FE
price of exports increase volume of exports may affect BOT
NY falls affects economic growth
Inflation
Access to cheaper consumer goods + raw materials / inputs
fall in COP fall in price of exports X increase may increase
BOT
Fall in COL extra savings can be used to buy domestic goods
increase C / NY
Price of consumer goods
Sdom

Pw

Ddom

10

30

101
50 Quantity of consumer
goods

102

a+b = welfare gain

a: production effect, inefficient domestic firms forced to
reduce output from 30 to 10
b: consumption effect: increase C from 30 to 50
From diagram, firms forced to be more cost-efficient cut
costs in order for profits not to be eroded since P is at Pw
Trade creation / diversion
Creation: increase volume of trade from high-cost producer
to low-cost producer increase welfare of people
Diversion: from low-cost non-member to high-cost member
away from optimum allocation of resources
Draw diagram to illustrate effects
Jobs: increase in X increase N
But loss of CA forced to restructure move towards CA
structural unemployment
Outsourcing firms benefit by relocating increase BOT
increase GNP
But cost jobs in previous country
On FDI
Outward investment to China from Singapore
Increase investment increase productive capacity increase
AS
Increase investment increase AD increase N / NY
Transfer of technology
Useful for NIEs lack wealth / local entrepreneurs eg.
Singapore depends on MNCs
But footloose
But local firms cannot compete
Others
Vulnerability to external shocks due to over-dependence
recession / imported inflation
Interdependence: economies become intertwined eg. USA
recession Singapore recession, worldwide food prices
increase

Conclusion
Possibility of unequal gains
Singapore
More ST capital outflow to China but LT profits increase
GNP
Loss of jobs as companies go to China
Shifted focus to capital-intensive / technology-intensive
focus on services
103

 Gain education: Chinese students come here to study

104

USA
USA spend a lot because lost CA in lots of goods need
to buy more imports worsen trade deficit less
savings less investment reduced productive capacity
India
Demand for capital goods
Summation
FTA: macroobjective increase NY increase SOL, fall in price
increase BOT
Trade creation > trade diversion

*FTA means freer trade no restrictions among countries vs. free

trade, so arguments similar, only difference is trade creation / diversion

105

To what extent can economies benefit from globalisation?

[25m]
Introduction
Globalisation free movement of goods and services, capital, labour
Economic integration: FTA, customs union
Development
A) Goods and services
Trade based on CA gains + EOS
Poor NIEs + Singapore (small domestic market) increase X
increase NY / N increase SOL
Access to cheaper goods
Consumer goods lower COL
Raw materials Singapore / Hong Kong
Capital goods for infrastructure Cambodia / Vietnam
increase societal welfare + potential growth
Draw in free trade diagram and illustrate gains
Trade diversion vs. trade creation: diagram
Loss of CA eg. USA steel and textile industry, Europe car industry
but restructure and move towards new CA
Inter-dependency eg. USA affect China / India
Over-dependency due to CA and complete specialization thats
why countries tend to partially specialize / diversify their economies
Effect on prices imported inflation
Tariffs due to protectionism: draw in diagram
B) Capital (associated technology) FDI (inward and outward)
Receiving country
Increase inward investment increase AS / AD increase NY /
N
Growth of local supporting industries
Transfer of technology
Footloose may cause massive retrenchment if suddenly
leaves
Local industries cannot compete lack of SMEs
Source country
SR: loss of jobs
SR: outflow of capital
LR: restructuring
LR: More companies internationally increase GNP
LR: Create jobs

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C) Labour
For LDCs, provide jobs for labour cheap
May be SR exploitation but vs. no jobs
Eg. Vietnam inflation ~19% - lower income wage rise < price
rise
Free flow of labour influx of foreign workers depress wages in
jobs where supply elastic (abundant supply of manual workers) no
skills
Eg. Singapore / EU influx of workers into UK
Solution: provide training
Brain drain
Inequity issue
Manual workers wages fall
Skills demanded globally increase demand for work
increase wages for skilled jobs
Dual economy
Caters to international market people grow richer
Caters to domestic market people do not really get
richer

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Discuss the opportunities and threats of globalisation for

Singapore and other Asian economies. [12m]
Globalisation: high degree of freedom of movement of goods and
services (trade), capital, technology (MNCs) and talent (labour)
1) Globalisation and free trade
Opportunities
Export revenue and higher rate of economic growth
Increase in X k increase N / NY
Increase M of capital goods / raw materials eg. Vietnam /
Cambodia / Singapore
Threats
Competition causes countries to lose CA
Singapore lost CA in labour-intensive industries in mid80s to NIEs like China and Indonesia
SR: structural unemployment
LR: efforts may pay off if country realizes CA in new
industries
Singapore shifted to capital-intensive then knowledgeintensive
Specialisation and over-dependency on few major products
If some countries adopt protectionist measures, trading
partners could be adversely affected
Interdependency of countries
Economies of major trading partners take a slide,
countries will be affected eg. 911, US recession
2) Presence of MNCs and out-sourcing
Opportunities
Influx of MNCs in Asian countries helped their economies grow
Creation of jobs and contribution to GDP
Transfer of technical know-how
Outsourcing eg. UK IT companies phone service operations to
India
Threats
Fear of over-dependency: MNCs footloose if pull out, adverse
effect on jobs and economic growth
Dearth of local firms
3) Influx of talent
Increase quantity of resources shift PPC outwards
But cheap foreign labour wages in city fall lower income

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Consider the effects, other than on the general price level, of

Singapores changing tax structure.
A) Inflation
Effect of increased reliance on indirect taxes definite inflation
shift in SRAS
Increase indirect taxes increase COP for all firms fall in AS
fall in NY (contractionary) + rise in GPL cost-push inflation
BOT may worsen (depending on PED)
Effect of decreased reliance on direct taxes may or may not have
inflation shift in LRAS and AD
Fall in direct taxes C/I increase AD increase NY increase
(growth) / N increase if near / at FE: demand-pull inflation (a
little may be desirable because increase output) BOT worsen
(depending on PED)
Lower income taxes income / substitution effect may
increase incentive to work increase AS increase NY fall in
GPL BOT improves
Lower corporate taxes increase I increase NY fall in GPL
BOT improves
Singapore: keep / attract talent increase efficiency
Attract MNCS increase FDI increase AD (increase N) and increase
AS (increase productive capacity)
B) Equity
Income taxes (direct) progressive higher the income, the higher
the percentage to tax reduce income gap
Indirect taxes regressive lower the income, the higher
percentage to tax increase income gap affects poor more
Cost-push inflation increase COL affects poor more
Lower direct taxes increase income gap because rich pay
proportionately less (usually reduce the percentage tax of rich
more)
Corporate taxes fixed at 18%: neither progressive or regressive
C) Tax base
Increase indirect taxes widens tax base better to rely on due to
ageing population increase number of dependants / decrease in
size of labour force
Decrease direct taxes: on working population and firms
D) Ability to evade
Indirect taxes: difficult to evade
Direct taxes: can evade but not in Singapore (jailed) can underdeclare
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Policies to remedy Singapores recession

Recession in Singapore: externally induced: fall in X
1. Fiscal Policy
Increase G to reduce business costs + training need to subsidise
firms and training grants
Fall in COP + increase productivity increase LRAS fall in
GPL price of exports fall volume of exports increase
Evaluation: buy only if they recover from recession
But increase G to boost increase in NY limited effect in Singapore
Small k need huge increase in G
Prudent
Why not increase G on public works
Limited land
2. Monetary Policy
Why not policies to directly increase X with exchange rate
management
Short run solution: depreciation of S$ - price of exports fall in
foreign dollars volume of X increase
Government prefers soft option
Price of imports increase in S$ - import all raw materials COP
increase goods more expensive
Long term policy stance: gradual and modest appreciation of S$ price of imports lower for S$ - import raw materials more cheaply
COP falls prices more competitive
Modest: small increments export competitiveness not
drastically eroded in the immediate period
Gradual: firms can have time to adjust their cost structures
find ways to be more cost-efficient
Deals with cost-push inflation
3. Other Ways
Explore new markets through trade missions and signing of FTAs
reduce over dependence on a few trading partner
Long term measure
Conclusion
Fall in X is beyond our control
Measures can only be long run or interim ones

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Evaluate methods the Malaysian government might use to slow

down import growth and increase new export business.
A. Slow down import growth
Devaluation weaken ringgit
Price of exports fall in foreign currency volume of exports
increase total revenue from exports increase
Price of imports in ringgit increase volume of imports fall
total expenditure on imports fall
BOT improves
Depends on price elasticity of demand for X and M Malaysia
demand for imports of capital goods could be price inelastic
COP rises
Can only be short term if Malaysia needs to import capital
goods and raw materials
Persistent devaluation can lead to loss of confidence in
economy
Tariff tax on imports price of imports rise volume of imports fall
total expenditure on imports fall
Increase in COL
Deadweight loss to society
Retaliation
Contractionary policies: interest rate rise investment and
consumption falls AD falls k fall in NY fall in demand for
imports
Malaysia may have small multiplier
Malaysian firms may want to buy capital goods
Malaysia still developing, cannot afford to have fall in rate of
growth
Use only if overheating
B. Increase new export business
Subsidies to export firms
COP falls increase AS GPL falls price of exports fall
Inefficiency, burden on government and taxpayers
FTA / Trade missions to new countries increase X k increase NY
Reduce over dependence on just a few major trading partners
Takes time long term
Firms may not want to take the risk uncharted territory
businessmen may be risk averse
Supply-side
Education and training increase productivity increase LRAS
fall in GPL price of exports fall
Best measure, yield results in the long run

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To be considered successful, an economy needs to achieve

low unemployment, low inflation and stable economic growth.
How far DYA with the statement? [12m]
Anti-thesis
Healthy BOPs especially open economy macro objective
Equity in distribution micro objective
Efficiency in resource allocation micro objective
To be considered successful, an economy needs to achieve
low unemployment, low inflation and stable economic growth.
Explain this statement. [12m]
A) Low unemployment success [any 2 well-discussed]
Maximise use of resources reduces loss of potential output due to
unemployment
Burden on government
Less tax revenue collected
More unemployment benefits
Increase budget deficit, opportunity cost less for other areas
healthcare, education
Singapore: GST offset package, growth dividends, Singapore
shares, one-off rebates
Low unemployment people have jobs higher C fuels growth
Social problems crime rates social unrest loss of man hours +
deters investment (confidence)
B) Low inflation success [internal and external]
Internal: stimulates output, induces confidence, increase investment
due to certainty, increase FDI, encourages savings increase
investment in the long run
External: BOT improves [PED]
C) Stable economic growth success [any 2 well-discussed]
Sustained growth: actual and potential growth: increase AD and As
continual increase in SOL
Confidence increase investment + FDI good macroeconomic
management of government
Why unstable growth undesirable
AD keeps increase may cause overheating demand pull
inflation increase COL + affects BOT instability
If economy lapses into recession: negative growth hardship
fall in SOL

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Conclusion
Brief mention of other criteria for success
Conflict between growth and inflation: relentlessly pursues growth
demand-pull inflation: stable growth vs low inflation
Which criteria most important: low inflation price stability
Singapore

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Discuss whether fiscal policy is the most effective way for

Singapore to sustain a successful economy. [13m]
Introduction
Sustainable + stable growth + low inflation one of the keys to
sustainable growth
Development
A) How FP works to attain growth
Increase G + decrease T increase AD k increase NY
K brief + diagram
Evaluation
Size of k small k huge leakages high savings / M need
huge increase in G prudent: budget surplus
Small C / I by domestic firms need export revenue policies
should target X
Crowding out: increase G financed by borrowing from public
increase interest rate crowd out C/I/X
May not need to borrow huge reserves reserves can
be depleted
More concerned about fall in X
Time lag: recognition, implementation, response
Small shorter time lag
Taxes unpredictable effect on C/I k works only on the extra
disposable income that is spent
Expectations: pessimism / optimism
Fall in direct taxes rely more on indirect taxes (GST)
(increase COL) regressive increase income gap
B) Summation: FP in Singapore limited role
If economy weakens (fall in GDP) usually due to external factors
like fall in X eg. 911 US recession policies should target X
Policy exchange rate management sustainable growth
Gradual and modest appreciation of S$
Price of imports fall in S$ - check imported inflation (low
inflation) + Singapore depends a lot on imported raw
materials lower COP LT able to price competitively stable
growth BOT increase (PED)
Price of X increases in immediate period
Gradual: Singapore firms to find other ways to reduce cost
Modest: not to totally erode export competitiveness
Supply-side policy: education and training, welfare benefits, taxation
incentives

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Conclusion
FP in Singapore limited effect on Ad, serves as supply-side measure
to increase NY over long term + exchange rate management to
boost long term export competitiveness

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In the fourth quarter of 2004, Singapores unemployment rate

rose to 3.7%. Discuss whether supply-side policies are the best
way of achieving full employment in Singapore. [25m]
Introduction
Full employment: natural (frictional) rate of unemployment (some
structural)
Cause for concern (very briefly): if structural severe, if cyclical
Development
A) Supply-side
Education and training Budget 08
Schools and vocational institutes gear Singapore workers for
the challenges of new economy grants, scholarships, places
in university focus: biomedical increase employability
Subsidise firms for workers training Skills Development Fund
upgrade skills reduce structural unemployment
Life-long learning knowledge can become obselete
constant upgrading of skills reduces prospect of being
structurally unemployed
Long term and may not yield results
Increase employability and attracts MNCs
Welfare benefits
Singapore no unemployment benefits reduce frictional
unemployment
Forced to upgrade skills reduce structural unemployment
Reduce power of trade unions
NTUC: government body harmonious relations no labour
unrest: attracts investment (FDI)
NWC: wage recommendations wage increase < productivity
increase keep COP low
Increase employability of workers
B)

Policies to deal with cyclical unemployment: fall in AD

Supply-side structural, cannot solve cyclical
FP: increase G, decrease T but small k, external factors
Exchange rate management
Recession due to fall in X: depreciation / appreciation
Depreciation: price of exports fall immediate solution but
Singapore cannot afford to price of imports increase COP
increase later price of exports increase (growth cannot
sustain)
Singapores choice: gradual and modest appreciation (long
term solution)

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Conclusion
Increase G on education and training + taxation incentives supplyside policies effect on AD and some effect on cyclical
unemployment limited role in Singapore due to small k

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Why Singapore does not use interest rate policy

Very dependent on overseas funds small
Eg. if Singapores interest rate falls to curb recession hot money
outflow - $ in Singapore banks fall MS falls interest rate increase
no control
Discuss interest rate only if not Singapore
Problems with exchange rate instability
Exchange rates determined by
Trade and investment between trading partners
Speculation
Government management / manipulation of exchange rate eg. buy
US bonds to keep USD up
1) Trade
Affects business planning: need for certainty to forecast profits
Eg. If S$ depreciates
Price of Singapore exports fall in foreign currency volume of
exports increase
Price of imports increase in S$: dependent on raw materials
(same for developing countries which need capital goods)
Eg. If S$ appreciates price of exports increase in foreign currency
affects export earnings
2) Investment
Persistent depreciation loss of confidence in economy fall in
investment
3) Developing countries
Foreign loans in US$ denomination if your currency depreciates
pay back more in your countrys $

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