Living Standards and Its Indicators

Living standards and its
indicators
Comparisons over time
•GDP
refers to the total market value of all final goods and services produced within
an economy over one year.
- “Final”: includes cost of all intermediate goods and raw materials
- “Produced”: value of output, not input  unsold goods produced in that year will also be
part of the economy’s GDP
- The higher the value of GDP, the greater the level of economic activity
- If GDP increases from one year to another, the economy has expanded
- Calculation of GDP:
1. Output approach (direct): Nominal GDP (GDPt) = , where t represents the year, Pt and Qt
represents prices and quantities of all final g/s produced in that year
2. Expenditure approach (indirect): GDP = C+ I + G + X - M
3. Income approach (indirect): GDP = W + R + I + P
GDP Vs GNP
• GDP: what is produced within the boundaries of the economy
• GNP: who produced the g/s. Formal definition: the market value of all final g/s
produced by (factors of production owned by) the citizens of the economy over a
year
• GNPt = GDPt + [net factor (property) income from abroad]t, where
net factor (property) income from abroad = factor (property) income from
abroad - factor (property) income to abroad
Subtract all incomes earned by fop earned in the economy that is due to foreign owners
Add all income earned overseas by fop that is due to local owners
Nominal GDP vs Real GDP (Over time)
•• Recall:
nominal GDP in each year is valued at the prices prevailing within each year  when
measuring changes in GDP over time, need to use real GDP so that prices used to value output of
each year are those that prevailed in an arbitrarily selected base year*
• The base year can be either one of the 2 years or any year before or after the years in question
• Real GDPt = , where t represents current year, o represents base year; Po represents prices
prevailing in base year and Qt represents quantities of all final g/s produced in current year
• Measuring real GDP change over a year:
• Only use real GDP to measure economic growth, not nominal!

Real GDP per capita
• Real
GDP per capita measures real GDP per person in the economy
• Real GDP per capita =
• Higher real GDP per capita  purchasing power per person is higher  higher
material SOL
Limitations of real GDP per capita
• Assumes increase in real GDP is divided among the population in a fair manner. However, most countries
face varying degrees of income inequality  Need to consider Gini Coefficient to measure the extent of
inequality in income distribution
o Gini coefficient ranges from 0-1, with 0 meaning perfect equality in income distribution and 1 indicating perfect
inequality.
o Singapore’s Gini coefficient: 0.43  relatively even distribution of income, but a far cry compared to Scandinavian
countries’ 0.25
• GDP does not take into account non-marketed g/s and g/s in the shadow economy  underestimate the
true value of output  the extent of underestimation matters, esp when comparing country’s ec
performance and SOL using real GDP per capita values from 2 years that are far apart
• Does not take into account composition of g/s produced: if the increase in national output is due to an
increase in the amount of capital goods produced rather than an increase in the amount of consumer g/s
consumed, the material SOL may not rise
• Ignores the non-material aspect of SOL
Alternative indicators of SOL
• Common examples include (but not limited to): Infant mortality, Life expectancy,
PSI, Average number of hours in a workweek  stress levels, Crime rates
• Notable example: Human Development Index (HDI)
o Takes into account life expectancy, education and GNP
Is material SOL or non-material SOL more important?

- Depends on stage of development of country
- Poorer countries: basic needs not fulfilled, higher income that improves material
SOL more important
- Richer countries: basic needs already met, non-material aspects of SOL more
important
Other macroeconomic indicators of SOL
• Unemployment rate: eg rising real GDP per capita + rising unemployment rate 
although real NY is rising, it is only benefitting those who still have a job, the
unemployed are worse off
• BOP: eg CA surplus usually suggests that a country is exporting more  g/s
produced in the year are not channelled to improving the material SOL of the
citizens but rather foreigners’
Comparisons over space
• Account for currency differences  convert to common currency eg USD
• Account for population differences  GDP per capita
Rank Country/economy Nominal GDP per capita (USD)
14 USA 49,965
28 Hong Kong 36,796
Q1: Does the average American earn more than the average Hong Konger? Yes
Q2: Does the average American have a higher purchasing power and therefore
higher material SOL than the average Hong Konger? Not necessarily
Per capita PPP GDP
• Purchasing Power Parity (PPP) takes into account price differences
• First, PPP exchange rate is calculated based on the average prices of a large
basket of goods (there are limitations to this but not important to know them)
• Second, the GDPs of each country are converted to a common currency eg USD
• Third, PPP GDP is divided by the populations of each respective country to give
per capita PPP GDP
• Lets compare the data again:
Rank Country/economy Nominal GDP per capita (PPP USD)

7 Hong Kong 51,946
8 USA 49,965
2009 A Level Q5
Economic measures of the Singapore economy for 2007 indicate the GDP was
S$243 billion. The current account on the balance of payments was S$59 billion
in surplus.
(a) Explain how you might use GDP and balance of payments data to measure
the performance of the economy. [12]
(b) Assess whether these economic indicators are the best measures of
economic performance and standard of living in Singapore. [13]
(a) Explain how you might use GDP and balance of payments data to measure the performance of the economy. [12]
Introduction:
• Strong economic performance = able to achieve the 4 macroeconomic objectives to a
large extent
• GDP and BOP data examine how well these objectives have been achieved, primarily that
of economic growth, with potential links to other indicators such as employment and
inflation
Main:
• How GDP is used to measure economic performance
• How BOP is used to measure economic performance
Conclusion:
• BOP data can be used to gauge the performance of the external sectors of the economy
• Since BOP data feeds into the components used to compute GDP data, the latter can
then be used as a measure of an economy’s overall performance
GDP Data
• GDP is often used as an indicator for NY of an economy

o Definition: total market value of all final g/s produced within a country in a given time period
• GDP = C+I+G+(X-M)  expenditure approach

• Countries with sustained economic growth rate are considered to have strong
economic perf and this can be measured using real GDP data
• Economic Growth = (Real GDP2 - Real GDP1)/(Real GDP1) x 100%
• Increases in GDP brought about by higher level of production and o/p would
imply more factors of production like labour are employed  better utilisation of
resources  lower rate of unemployment  hence GDP rise is indicative of
strong economic perf
BOP Data
• Definition of BOP data: receipts from and payments for all international
transactions of a country with the rest of the world over a period of time
• Transactions categorised into: Current Account and Financial Account
• BOP surplus (receipts > payments) vs BOP deficit (payments > receipts)
• Favourable BOP position: no large/persistent deficit
• Generally, BOP surplus is indicative of good ec perf because it implies that a
country is living within its means without the need to draw on its reserves/incur
external debts
BOP Data
• BOP surplus on the Current Account could be due to surplus on the BOT in g/s 
implies that domestic g/s are maintaining their export competitiveness in
overseas mkt  economy is structurally sound and performing well externally
• X>M  NX increase  increase AD  increase NY  Economic Growth  level
of employment increase, further reinforcing the strength of the economic
performance
• BOP surplus on the Financial Account, in particular FDI, is an endorsement of the
level of investors' confidence in the macroeconomic stability of the country eg
price stability and strong economic growth
BOP Data (optional)
• Temporary deficit in BOP is not necessarily undesirable eg temporary CA deficit

might have resulted from a growing, rapidly industrialising economy which
imports machinery and raw materials for production
• The finished goods can be subsequently exported and BOP and other
macroeconomic indicators will improve in future
• Hence, the use of BOP data needs to look at the surplus/deficit in terms of: size,
persistency and underlying causes
(b) Assess whether these economic indicators are the best measures of economic performance and standard of living in Singapore. [13]
Introduction:
• GDP and BOP data help to infer the standard of living of a country over time
• GDP and BOP data sufficient as baseline indicators, but alternative interpretation and measures are
needed to form a more holistic view of the economic performance and SOL in Singapore
Main:
• Thesis vs Anti-thesis: GDP and BOP as measure of ec perf
 Basis for assessment of how well GDP and BOP measure ec perf: Nature of SG
 While these data are well recognised to provide a robust measurement of economic performance, there exist
situations which call for further examination of their underlying causes or consequences
• Thesis vs Anti-thesis: GDP and BOP as measure of SOL (1-2 MWB + 1 NMWB)
 SOL refers to the level of well-being of a typical individual/HH within SG
 MWB: qty of g/s avail to an individual in a particular year
 NMWB: qly of life eg environmental and socio-economic factors
 Higher SOL = MWB + NMWB improve
Conclusion: Stand
GDP as measure of economic performance
Thesis: GDP is a good measure of economic performance in SG
• From (a), GDP is a commonly used indicator of economic performance in terms of
EG and its effect on Nt
• This is based on assumption that real GDP is used instead of nominal GDP data 
better reflection of economic performance as it eliminates the effects of inflation
Anti-thesis: Limitations of GDP in measuring economic performance
• Increase in GDP implies economic growth
• Rapid rate of economic growth  rate of obsolescence of production methods,
machinery and labour skills increase as well  structural unemployment and
other negative consequences like widening income gap
• Trade-off between economic growth and structural unemployment
BOP as measure of economic performance
Thesis: BOP is a good measure of economic performance in SG
• Assume in 2007 SG BOP surplus in the CA was due to BOT surplus  Since BOT is a key indicator
of X competitiveness, BOP is a good measure of the strength of the external sector of the
economy
• [EV]: This is especially so given SG's BOT figures are achieved without assistance from
distortionary effects of protectionist measures or currency manipulation in an attempt to
undervalue the S$ to boost NX
• Positive FDI figures also show investor confidence in stability of the economic performance in
terms of price stability and EG
Anti-thesis: Limitations of BOP in measuring economic performance

• BOP position is a composite of the economy's perf in Current and Financial Accounts  need to
look at trend data which reflects the relative size and change in the subcomponents of each
account to give a better assessment
• Changes in the size of the composition of BOP cannot be reflected by the BOT data  eg
contribution from key indicators like BOT and FDI have been reduced, butcompensated by
increase in the more volatile short term capital flow  overall BOP position may not change but
economic performance has worsened
GDP as a measure of SOL
Thesis: Real GDP per capita is a good measure of SOL
• Definition: market value of final g/s produced within a country over a period of
time after adjustment for changes in prices and population
(a) Why real (not nominal) GDP?
 Takes into account effects of changes in price levels  can determine that increase in GDP is
due to increase in actual output and not due to increase in GPL only
(b) Why per capita?
 Takes into account changes in size of population  better reflect the MWB of an average
Singaporean
 SG: relative slow rate of growth in population  likely that the increase in GDP will outpace
population growth  larger output p can be shared across the population  average person
better off
• However, increase in real GDP per capita does not always equate to increase in
SOL since GDP essentially only measures the material aspect of SOL
Anti-thesis: Limitations of GDP in measuring SOL
GDP data does not take into account:
1. Income distribution
• High real GDP per capita =/= income is evenly distributed amongst Singaporeans
• Higher GDP figure could be due to higher level of income earned by a minority group of people
while the majority do not see an improvement in their SOL  Information on GINI coefficient is
required
 GC indicates how evenly distributed the GDP is amongst the population. The higher the GC, the more uneven the
distribution
[EV]: SG’s GC has been worsening over the past decade despite increases in real GDP per capita*.
Globalisation and policies adopted in pursuit of EG  widening income gap. Lower-skilled
workers face structural Unt/depressed wages as influx of FW are in direct competition for their
jobs vs High-skilled workers see an increase in the demand for skills and thus higher wages.
Hence, SOL may not have increased for the majority despite increase in GDP
Anti-thesis: Limitations of GDP in measuring SOL

GDP data does not take into account:
2. Composition of GDP
• Production =/= consumption  Whether increase in GDP will lead to increase in material aspect
of SOL depends on the composition of (i) Consumption vs Capital goods and (ii) timeframe of
analysis
• [EV]: If increase in GDP is concentrated in the production of capital goods, this only improves
SOL in the future but not in current period, since the amount of consumer g/s did not increase
3. NMWB
• Increase in GDP achieved at the expense of leisure time, work-life balance etc
• SG: deterioration of quality of NMWB experienced in terms of competition for use of public
amenities, over-crowding on transportation system.
BOP as a measure of SOL
Thesis: BOP is a good measure of SOL
• Eg SG's BOP surplus arises from positive balance in BOT  increase NX and AD
 increase NY by a multiple  create more job opportunities  increase
employment  increase in income allows HH to consume more g/s  increase
MWB
• SG's BOP surplus also implies that there is no need to draw on foreign
reserves/increase foreign debt to finance deficit
o If debts were to be incurred to finance international spending, this would translate to
higher interest burden to service the debt and reduce future SOL of Singaporeans
• BOP surplus also contributed to a strong S$  prevents imported inflation and
ensure the purchasing power of S$
Anti-thesis: Limitations of BOP in measuring SOL
• Similar to GDP data, BOP data only measures material aspect
Conclusion/synthesis
• In comparison to BOP, real GDP per capita is a more useful and complete
indicator of economic perf and MWB of SG
• To accurately measure SOL, GDP figure should be complemented with the use of
alternative indicators eg HDI, which informs abt NMWB
Specimen Paper CSQ2
(a) What was the approximate change in the value of the Russian rouble in
terms of US dollars between 25 September 2014 and 23 March 2015? [2]
• The
rouble depreciated by approximately 55%
• X 100% = 54.7% 55%
(b) Explain, with the help of a supply and demand diagram:
(i) How the collapse of the Russian rouble resulted in a decline in the value of
the currencies of the ex-Soviet republics (Belarus, Azerbaijan and Moldova) [2]
• The depreciation of the Russian rouble caused Russian exports to be cheaper in terms of FC, thus
increasing the qtydd of exports from Russia as can be seen from Extract 4 (“suddenly cheaper
Russian-made goods increases the imports by ex-Soviet republics, eroding their trade balances”).
Consumers in these ex-soviet republics will sell their domestic currency (ex-soviet currencies) in
exchange for the Russian rouble in order to buy the exports from Russia. As such the supply of
the ex-soviet currencies will increase from S0 to S1 as shown in Figure 1, thereby causing the
currencies of the ex-soviet republics to depreciate from E0 to E1 against the Russian rouble
(i) How the collapse of the Russian rouble resulted in a decline in the value of
the currencies of the ex-Soviet republics (Belarus, Azerbaijan and Moldova) [2]
Alternative answer:
• The depreciation of the Russian rouble caused imports into Russia to be more expensive in
terms of Russian rouble, thus decreasing the qtydd for imports. Since consumers in Russia
buy less imports now, they will buy less of the ex-soviet currencies causing the demand for
the ex-soviet currencies to fall from D0 to D1, leading to a fall in the value of their currencies
from E0 to E1
(ii) How the rise in Ukraine’s benchmark rate of interest is expected to affect
the value of Ukraine’s currency [2]
• Ukraine’s currency is expected to appreciate. The higher interest rate in Ukraine

relative to other countries will attract large inflow of short term capital (hot money)
into Ukraine due to higher expected rate of returns, thereby increasing the demand
for Ukraine’s currency from D0 to D1 wrt Fig 3 above. As such, the value of Ukraine’s
currency increase as seen from the appreciation of currency from E0 to E1
(c) Explain the factors which are likely to determine the impact of the rise in
the Swiss franc on hotel bookings in Switzerland [6]
• The rise in the Swiss franc will cause an increase in the price of hotel bookings in Switzerland for
foreigners in FC, which results in a fall in the qtydd for hotel bookings. The magnitude of this fall
is in turn dependent on the PED for hotel bookings, the ec conditions of the country, as well as
the objectives of the hoteliers in Switzerland
1. PED for hotel bookings
• PED measures the degree of responsiveness of qtydd of g/s in response to a change in price, c.p.
• Wrt Extract 5, Switzerland’s hotels “have not reported mass cancellations but have seen a
slowdown in bookings”, suggesting that the increase in price of hotel bookings has led to a less
than proportionate fall in qtydd
• DD for hotel bookings in Switzerland is likely to be price inelastic due to the lack of close
substitutes. Despite the rise of gig economies such as Airbnb, the variety of amenities provided
by hotels limits the substitutability of hotels for alternative forms of accommodation. This lack of
close substitutes means that a rise in the price of hotel bookings is likely to result in a less than
proportionate fall in qtydd for hotel bookings
Cont’d PED for hotel bookings:

• Alternatively, from Extract 5, “Switzerland was never cheap and is now even
dearer” suggests that holidays to Switzerland are expensive and often regarded
as a luxury by the average income households as a holiday trip to Switzerland
takes up a large proportion of their incomes. This means that the demand for
hotel bookings in Switzerland is likely to be price elastic, thus the rise in prices of
hotels will translate to a more than proportionate fall in the qtydd for hotel
bookings in Switzerland
2. Relative economic conditions of Switzerland to other countries  determines

the extent of fall in qtydd for hotel bookings caused by the rise in price due to the
rise in Swiss franc
• Eg if foreign countries experience relatively higher EG than Switzerland, as
suggested by “the American economy is growing at a decent rate” in Extract 6, it
means that they are experiencing a greater increase in purchasing power which
may increase the demand for a holiday to Switzerland, thereby increasing the
demand for hotels in Switzerland. This will hence negate the fall in qty of hotel
bookings from the rise in Swiss franc
3. Objectives of the hoteliers

• Quantity for hotel bookings may not have fallen
• Eg if the aim of hoteliers is to maximise the number of bookings, they may
decide to keep the hotel room rates fixed in a FC such as USD and accept a lower
revenue in Swiss franc (since the price received in Swiss franc would be lower due
to the appreciation of the Swiss franc)
• As such, the quantity for hotel bookings may remain unchanged
(d) Discuss whether the problems faced by economies experiencing
depreciation in their currencies are more serious than those faced by economies
experiencing appreciation in their currencies [8]
Problems faced by economies experiencing depreciation:

• When an economy’s currency depreciates, the external value falls. Depreciation can be
caused by either a fall in demand and/or a rise in supply of the DC.
• If the fall in demand of DC is due to fall in export competitiveness of a country which
causes a fall in the demand for exports, this can result in a fall in EG
• As such, investors will be reluctant and cautious about investing in a country whose e/r
is depreciating, especially if the depreciation is persistent and huge.
• This fall in investment will compound the problem of falling AD (due to fall in export
competitiveness) which will cause a more severe multiple fall in national income via the
reverse multiplier process
• This fall in investment will also cause a fall in the productive capacity of the economy,
thereby limiting the increase in potential growth
Cont’d Problems faced by economies experiencing depreciation:

• Depreciation will also cause the price of imports in DC to increase and the qtydd will
fall less than proportionately assuming that the demand for imports is price inelastic
esp for a country which has no natural resources.
• This will increase import expenditure and increase the COP of domestic firms which
rely on imports for raw material, thereby leading to cost push inflation
• Firms may respond to this increase in COP by passing some of the costs to consumers
in the form of higher prices.
• Furthermore, firms may choose to hire fewer workers so as to hold costs down in
order to economise on their use of labour  rise in level of unemployment  higher
fiscal costs for the government since there is a fall in tax revenue collected + might
have to pay out more unemployment benefits
Problems faced by economies experiencing appreciation:

• An appreciation of the DC will cause exports to be more expensive in FC which
cause a fall in the qtydd for exports. The price of imports will be cheaper in DC
which will cause a rise in the qtydd for imports
• Assuming MLC is satisfied, NX will fall and hence AD will fall, thereby causing a
multiple fall in income via the reverse multiplier process  lower SOL for
individuals
• Due to fall in real output, firms will cut production and hire fewer workers,
leading to higher unemployment especially in the exports sector
• The rise in import expenditure and a fall in export revenue will also worsen the
Current Account in the BOP of a country
Evaluation:
1. Extent of the problem depends on the country’s credit rating
• If a country has high credit rating, it is less likely for it to experience a loss in investors’
confidence in its currency when the currency depreciates. Hence, the fall in I may not be to a large
extent
2. Depends on the nature of the economy
• Small open economies tend to be more import-reliant due to a lack of natural resources. Hence,
they will have to import more factor inputs than large and resource-rich economies. Therefore,
imported inflation due to depreciation is a greater concern for small open economies vs large
resource rich economies which can benefit from depreciation as their exports become more price
competitive instead
• Furthermore, small economies have small domestic market  highly dependent on foreign
investment for growth since the base of indigenous investment cannot bring about sustained
growth. Thus, a fall in investment due to depreciation can be more serious for these economies
Evaluation:
3. Appreciation can send a signal to potential investors that the economy is doing
well, hence due to the positive outlook of the economy, the increase in investment
may be able to offset the fall in (X-M), thus the problems of appreciation might be
less severe than those of depreciation
(e) Discuss why the US Federal Reserve decided to adopt a different monetary
policy from that adopted by the ECB and the BoJ, and consider which
approach is more likely to be successful [10]
• The choice of monetary policy by a Central Bank is determined by the prevailing

economic conditions. Thus, different economic conditions such as differing rates
of EG and rates of inflation will affect the different monetary stances of the
Federal Reserve, ECB and BoJ
Increase interest rate in the US
• As a measure to bring the economy out of its financial crisis, the Federal Reserbe
embarked on an EMP in 2008. Now, the economy is showing good progress
through its decent growth rates, which prompted it to “stop its asset purchases
and push up interest rates” as a measure to remove the monetary stimulus to
prevent a possibility of demand-pull inflation
Cont’d Increase interest rate in the US

• An increase in i/r will increase the cost of borrowing which increases the opportunity
cost of consumption which thereby decreases consumption expenditure
• Increase in i/r also reduces investment expenditure as projects which were previously
viable becomes unviable since the cost of investment is now higher than the internal
rate of return
• In addition, increase in interest rate will lead to short term capital inflow which will
lead to an increase in the demand of USD  appreciation of USD which means prices
of exports in FC is more expensive and prices of imports in USD is cheaper. Assuming
MLC is satisfied, NX will fall
• Combined fall in consumption, investment and NX  AD falls and potential rise in
prices can be contained/mitigated
Cont’d Increase interest rate in the US

• This measure is likely to be successful in the US to a large extent since C and I take
up a large proportion of NY due to large population
• However, the US government may need to increase i/r gradually as the recovery
of the economy is still slow
• A sharp increase in i/r may bring about negative impacts on the economy as EG
may be compromised
Decrease interest rate in Eurozone and Japan:

• Japan and Eurozone are facing risk of/are already experiencing deflation  could be due to low/falling AD
in the countries due to slow recovery from previous crises or continued pessimism of the consumers and
investors
• As a response, ECB and BoJ adopted quantitative easing, an unconventional MP which involves the Central
Bank buying LT financial assets in order to inject a pre-determined qty of money into the economy thereby
decreasing i/r.
• The fall in i/r will lower the cost of borrowing and consumers will find it cheaper to borrow to finance their
big ticket items and the opportunity cost of consumption will also decrease, encouraging them to consume
• Investors will find it cheaper to borrow to finance their investments and this will increase investments. The
ST capital outflow caused by a fall in i/r will lead to an increase in SS of DC, which causes the e/r to
depreciate
• With depreciation in e/r, prices of exports in FC decrease and prices of imports in DC increase. Assuming
MLC is satisfied, NX will increase
Cont’d Decrease interest rate in Eurozone and Japan:

• Combined increases in C, I and NX  increase AD and NY by a multiple
• Increase in real output  firms increase hiring of workers  fall in unemployment
• [EV]: However, in order for the decrease in i/r to be effective to bring about
actual growth and decrease unemployment, firms and households must be
willing to borrow and invest and consume so that C and I can increase. The
outlook remained bleak due to several major economies in the Eurozone
continuing to be plagued by growing national debt problem which caused
potential investors to be skeptical about the economic recovery. Little borrowing
will take place as these stakeholders adopt a wait-and-see approach. As such,
the decrease in i/r may not be successful to a large extent
Evaluation:
• The choice of MP implemented by the CB depends on the prevailing ec condition
of the country.
• In the US, a steadily growing economy due to recovering consumers/investors’
expectations and previously low i/r to stimulate the economy will mean that a
reversal of the policy could be effective
• On the other hand, the implementation of QE in Japan and Eurozone implies the
ineffectiveness of conventional MP as the economy may be in a liquidity trap
where there is little/no room for i/r to fall further. As such, QE is unlikely to bring
about significant change in AD and EG and hence the policy is less successful in
Japan and Eurozone
Cont’d Evaluation:
• The interest elasticity of investment affects the degree of success of the different
MP. If investment is interest inelastic, the change in i/r will result in a less than
proportionate change in the level of investment  i/r policy ineffective
• The investment level in the US might be relatively interest elastic since
indigenous investment is likely to take up the bulk of investment level (large size
of US population)  level of investment will be more responsive to the change in
i/r, rendering the i/r policy more successful
• Also, while the decrease in i/r will bring about a depreciation which may help to
stimulate NX, with 18 countries in the Eurozone sharing the same currency, these
countries have effectively lost the ability to manipulate their e/r to stimulate NX.
Cont’d Evaluation:
• Besides, due to the large number of countries in the Eurozone, a common i/r
policy may not help since different countries may face different and varying
degrees of problem  decrease in i/r ineffective
• Therefore, the i/r policy US Federal Reserve adopted might be more successful
compared to ECB and BoJ
Internal and external
economies and diseconomies
of scale
IEOS and IDOS
• IEOS allow firms to experience increasing returns to scale at lower o/p
levels  cost savings that a firm enjoys when it increases o/p
• IDOS cause average costs of production to increase as o/p increases
• Net effect on IEOS and IDOS determine whether LRAC curve slopes
upwards or downwards
Technical EOS*
Cost savings arising from production process, examples below:
• Specialisation and division of labour: when a firm’s o/p level increases, it has to
employ more workers. However, with a larger no. of workers, the firm can re-
organise workers in a way that allow each worker to specialise in a different task
 increased labour productivity arising from the familiarity of repeated tasks,
time saved from not having to change tools/locations within the factory to
perform each task (assembly line method of production)
• Non-divisible inputs: As o/p increases, machines become use in a more optimal
fashion  higher productivity  lower AC
• Container principle: larger containers tend to be cheaper in terms of AC per vol.
since surface area, which is proportional to the amount of materials used,
increases less than proportionately than the volume that these containers carry,
AC falls when firm has to produce and store more of its goods
Marketing EOS*
• When o/p is large, firm has to buy more inputs for its production process
• This gives firm the added bargaining power to bring down price of these inputs
they pay to suppliers
• Lower input price  cost of producing an additional unit (MC) falls  average
cost of production (AC) falls
• Eg buying goods from supermarkets is cheaper than buying from a small store
outside. Why? Because supermarkets acquire their goods in bulk and can pass on
the cost savings to us
Financial EOS
• Large corporations typically have more assets and greater stability (i.e. less likely
to go bankrupt)  lower borrowing costs from banks
• Because banks incur a lower risk, particularly default risk, when lending money to
large companies compared to small ones
Managerial EOS
• Similar to technical EOS arising from non-divisible inputs except now the non-
divisible input is not a machine but a manager
• Eg a small clothing store requires a store manager, and a larger store still only
requires one store manager  by selling more units of clothing, cost of having a
manager does not necessarily increase proportionately
• Similarly an area manager can oversea a particular geographical region  no
need to employ an additional area manager
Economies of scope
• By producing a wide scope of products, firms enjoy cost savings from sharing
overheads such as advertising costs, distribution costs and managerial costs
across various product lines
• Eg Apple sells iPhones, Apple Watch, Macbook, Airpods  costs of R&D in
developing new operating systems, advertising costs, distribution costs and costs
of operating service centres can be shared across these different products vs a
company who solely sells smartphones like HTC: higher AC than Apple
Technical DOS
• Arises from over-specialisation

• If the production process is divided into too many small parts, each worker’s role
may become repetitive and boring  fall in productivity
• If workers cannot perceive importance of their role to the quality of the final
product, they are also less likely to be as diligent in performing their assigned
tasks properly
Managerial DOS*
• Occurs when too much bureaucracy exists  productivity and efficiency is lost as
managers of different departments vie for the same promotion or work towards
sabotaging the efforts of one another  increase AC (shown along upward
portion of LRAC curve)
External EOS and DOS
• IEOS = cost savings due to expansion of firm itself vs EEOS = cost savings due to
expansion of industry as a whole  downward shift of entire LRAC curve
• At the same time, if the industry size grows beyond a certain point, AC will rise for
all firms due to EDOS
EEOS
• As more firms enter the industry, they collectively demand for factor inputs of the
same kind  supplier of factor inputs produce more units and enjoy IEOS  part
of cost-savings passed on to firms in the industry  lower COP i.e. LRAC falls even
if they did not alter output
• Sharing of infrastructural costs. Having one firm in a particular industry means
that any infrastructure must be built by that firm  costs borne. If more firms
enter the industry, costs can be shared eg retail park in Tampines where Courts,
Ikea and Giant Hypermarkets are situated next to one another provide free
shuttle service from MRT stations  cost of providing this service shared by three
firms  lower AC
2015 A Level Q3
(b) Discuss whether government intervention is always needed when a
firm dominates the market. [15]
(b) Discuss whether government intervention is always needed when a firm
dominates the market. [15]
Introduction:
• Government may intervene when a firm dominates the market due to concerns
over economic efficiencies (allocative inefficiency, productive inefficiency) and
over equity concerns
• However, GI may not be needed in instances when the dominant firm is able to
reap economies of scale (EOS), engage in r&d etc
Main:
• Thesis: GI is always needed
• Anti-thesis: GI is not always needed
Conclusion/synthesis
Thesis: Government intervention is always needed when a firm
dominates the market
1. GI to address allocative inefficiency
• AE occurs when society produces and consumes a combination of g/s that allows it to attain the
greatest level of satisfaction and maximises its welfare. In absence of externalities, P=MC
Monopoly with market dominance

• Assuming the monopolist's objective is profit maximisation, the monopolist will choose to
produce output Qm (refer to Fig 1) where MR=MC and charge a price Pm
• However, socially optimal level of output is Qs, where MSB=MSC as societal welfare is maximised
at this level of output. Hence, at Qm, there is under-allocation of resources since Pm>MC 
allocative inefficiency and DWL
2. GI to address productive inefficiency
• Productive efficiency is achieved when firms in an economy are producing the
maximum level of output possible by choosing the least cost combination of inputs
 any point on the LRAC (shows the lowest AC of producing any given level of
output in the LR)
• The monopoly is capable of achieving PE, however in reality, it often does not
produce on its LRAC since market dominance implies that it does not face
competitive pressure to keep costs low
• May result in complacency and lax cost controls such as overstaffing, overspending
on overheads etc  inefficiency and wastage of resources and yet continue to make
supernormal profits in the LR if high BTE exist in the industry + contextualize with
licenses/patents
• The higher cost of production would be in turn be passed on to consumers as higher
prices  reduce consumer surplus
• Due to high BTE, the monopolist is often able to earn supernormal profits in the
LR
• By restricting output and charging consumers higher price, income is being
redistributed from consumers to producers
• In contrast, consumers are charged with MC of producing the good in PC
industry where each firms only earns normal profits in LR  more equitable
distribution of income
• The monopolist's profits are usually not evenly distributed because corporate
stock ownership tends to be concentrated largely in the hands of the higher-
income groups/redistributed to the top management in the form of bonuses
Anti-thesis: GI is not always needed
1. IEOS
• Monopoly is able to reap significant IEOS
• Wrt Fig 2, if production is undertaken by PC market, then the market will achieve
equilibrium where market demand DDpc intersect supply curve SSpc with a price
of Ppc at the profit maximising level of output Qpc
• If a monopolist enjoys significant IEOS, it will have a substantially lower MC
(MCm) and may even charge a lower price Pm and produce greater output level
Qm, thus increasing consumer surplus
Cont’d IEOS
• Natural monopoly eg Sing Power's provision of utilities services: IEOS so
substantial that the LRAC may continuously decline over the entire range of
market demand  AC is lowest when a single firm supplies the entire market
• Hence, the government has allowed only 1 firm to provide this service rather
than many firms operating at smaller levels of output which leads to duplication
of resources and higher costs incurred
2. Innovation
• Monopolist is able to retain supernormal profits in the LR due to existence of
high BTE  financial ability to carry out R&D
• Strong BTE in the form of patents/copyrights  ensure that fruits of r&d efforts
will be protected and higher profits will not be competed away  incentive for
monopoly
• There might also be a need for a monopolist to strengthen BTE through
innovation to further lower production costs or to further improve products, esp
if there is threat of competition (or contestability) in the market
• Hence, GI not required if R&D leads to the development of improved products
and consumers' welfare is improved as a result
• Improvement in tech will also lead to greater productive capacity of the
economy and contribute to economic growth in the LR
Synthesis
• [EV]: Given the above analysis, GI may not always be needed when there is
market dominance as there are benefits associated with it.
• Type of GI should be carefully considered to ensure that the benefits that comes
with substantial EOS can still be reaped.
• GI in the form of introducing competition into the market might erode the firm's
dominant position. However, it might not be advisable to do so if a single large
firm can supply the good to the entire market at a lower cost and hence offer
consumers lower price eg for natural monopolist. Instead, government can
intervene using price regulations like MC pricing to ensure that AE is achieved.
• Using the case of natural monopoly, the monopolist will have to charge a price
equal to its MC. At this price, it will ensure that it produces at a socially optimal
output level and AE is hence restored. However, the government would also have
to compensate the firm through a subsidy as the monopolist sustains an
economic loss and may have to go out of business in the LR unless subsidised.

Living Standards and Its Indicators

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Living Standards and Its Indicators

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Living standards and its

• Only use real GDP to measure economic growth, not nominal!

Is material SOL or non-material SOL more important?

Rank Country/economy Nominal GDP per capita (PPP USD)

• GDP is often used as an indicator for NY of an economy

• GDP = C+I+G+(X-M)  expenditure approach

• Temporary deficit in BOP is not necessarily undesirable eg temporary CA deficit

Anti-thesis: Limitations of BOP in measuring economic performance

Anti-thesis: Limitations of GDP in measuring SOL

• Ukraine’s currency is expected to appreciate. The higher interest rate in Ukraine

Cont’d PED for hotel bookings:

2. Relative economic conditions of Switzerland to other countries  determines

3. Objectives of the hoteliers

Problems faced by economies experiencing depreciation:

Cont’d Problems faced by economies experiencing depreciation:

Problems faced by economies experiencing appreciation:

• The choice of monetary policy by a Central Bank is determined by the prevailing

Cont’d Increase interest rate in the US

Cont’d Increase interest rate in the US

Decrease interest rate in Eurozone and Japan:

Cont’d Decrease interest rate in Eurozone and Japan:

• Arises from over-specialisation

Monopoly with market dominance

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