Economics Tuition Singapore A Level H2 H1 Economics Tuition – Essay Model Answer

Spending by Singapore-based MasterCard cardholders increased 12.4 percent to USD797.4 million in the first month of the Great Singapore Sale (GSS) this year (31 May to 30 June 2013) compared to the same period last year.

SUGGESTED ANSWER

Explain what consumption is:

• Consumption refers to expenditure by households on goods and services. Consumption can be induced by income changes (induced consumption) or influenced by non-income factors (autonomous consumption).
• A change in any one of the determinants will lead to a change in consumption expenditure; reflected in a pivoting of C and AE (if induced consumption changes) or a shift of C and AE (if autonomous consumption changes, or both a pivot and shift if both autonomous and induced consumption were to change.

Explain how income & non-income determinants affect consumption – support with examples relevant to “Singapore in recent years”

• Income

The Singapore economy has been enjoying a healthy average annual growth of 6% since 2000. As a result, the average income in Singapore has risen by 76% (real GDP per capita has risen from S$38,970 in 2000 to S$68,481 in 2013). The higher income would mean higher purchasing power for Singaporeans, thus greater ability to consume more goods and services, or to spend more on luxury goods and big-ticket items in addition to necessities. All these would result in a higher level of consumption expenditure.

• Wealth

Wealth refers to the value of assets, both physical (e.g. houses, cars, art pieces, etc.) and financial (e.g. shares, bonds, etc.), held by households at a particular point in time. A change in the value of assets will affect the purchasing power of households thus affecting their ability to consume. An increase in the value of financial assets can result from a global boom which improves the confidence in the economy thus prices of shares of companies will increase. With the increase in share prices, value of financial assets will increase leading to higher purchasing power. Individuals will thus increase consumption of goods and services.

Explain how an increase in consumption expenditure affects the economy (use AD/AS analysis or Y=AE approach)

• Increase in autonomous consumption à increase in aggregate demand (rightward shift of the AD curve) à possible change in the equilibrium level of national income and general price level.
• Whether an increase in consumption is desirable or otherwise will depend on various factors, e.g. state of the economy, nature of consumption (local or imported goods), and time period.
• Acknowledge that “increasing” consumption refers to a persistent/continuous increase in consumption, and not just a one-time increase or a sharp increase.

Short run impact (of increasing consumption) on the economy:

• State of the economy
• Singapore in 2009 when economy was below full-employment level à desirable
• At the original level of national output, there is excess capacity and thus unemployed resources. With an increase in consumption, aggregate demand will be greater than national output leading to unplanned inventory depletion.
• The decline in stocks will encourage producers to increase production in the next time period. Firms involved in the production to meet the increase in demand will employ more factors of production. The people employed will then spend part of their income based on their marginal propensity to consume and firms will produce more goods and employ more factors of production. This raises the income of another group of people and so on.
• However, each subsequent round of consumer spending becomes smaller as the increase in income generated becomes smaller. The process will stop when there is no further change in income. The change in national income will be a multiple of the autonomous change in consumption i.e. ∆Y = k.∆C where k is the value of the multiplier. Given that the economy is operating below full-employment, there will be an increase in output with no or little change in the general price level.
• Singapore in 2013 when economy was operating near full-employment level (unemployment rate was 2.1%) à not so desirable
• With the increase in AD, there is increased competition for the limited resources as producers increase output. Factor prices will increase leading to increase in cost of production, illustrated by the movement up along the aggregate supply (AS) curve.
• At the same time, higher prices would reduce the level of aggregate demand, illustrated by the movement leftwards along the AD curve. A new equilibrium is reached where the general price level (GPL) and national output are both higher. If the economy is at full employment, the increase in consumption will lead to a sharp increase in the GPL with no change in real national output though nominal output will increase.

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