(2018) A Level H2 Econs Essay Q4 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

(2018) A Level H2 Econs Paper 2 Essay Q4

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4. In April 2016, Singapore’s Finance Minister Mr. Heng Swee Keat, announced that in the fiscal year 2016, total government expenditure is expected to be S$5.0 billion (7.3%) higher than the previous year.  
 Source: Singapore Budget, accessed 3 August 2016 
 
Assess whether an increase in government expenditure, such as that announced in the 2016 budget, is likely to have a significant impact on Singapore’s economic performance. [25]

 Explain how economic performance is measured & what is ideal 

  1. Low and stable inflation – 2% or less 

  2. Sustained / sustainable / inclusive growth – Moderate growth at 2% - 3% that can be sustained, without negative repercussions e.g. on the environment or, worsening of income inequality 

  3. Low unemployment rate – Near or at full employment rate at around 2% 

  4. Healthy balance of payments – Balance of payment / trade surplus position 

 

Theoretical / potential impacts that government expenditure may have on Singapore’s economic performance 

  1. Increase in government expenditure à increase AD à increase RNY via multiplier process à higher economic growth 

  2. Increase in government expenditure à increase AD à increase RNY via multiplier process à firms produce more output à hire more factor inputs including labour à fall in unemployment 

  3. Increase in government expenditure à increase AD à GPL increases if economy is operating at full / near full employment à higher inflation 

  4. Increase in government expenditure à increase AD à increase RNY via multiplier process à increase disposable incomes of consumers à increase spending on goods & services à increase import expenditure à worsen current account position à worsen BOP position 

 

Factors affecting whether impacts will be significant 

Crowding out effect 

  1. Crowding out effect can occur if the government has to borrow to finance an increase in government expenditure.  

  2. Increased demand for loanable funds à higher interest rates.  

  3. Higher interest rates à less investments become profitable (use MEI to illustrate) à fall in Investments à fall in aggregate demand (which offsets part of the increase due to the increase in government expenditure) 

  4. Singapore does not borrow to finance increases in government expenditure due to a prudent fiscal policy over the years, building up sizable reserves 

  5. Impact on economic growth will thus be significant ; will not be affected by crowding out effect 

 

Resource utilization level 

  1. If economic is operating at full employment level, any increase in AD caused by an increase in government expenditure will result in demand pull inflation instead of an increase in real GDP growth 

  2. Singapore has been operating at near full employment level since 2010, with unemployment rates steadily between 1.9% to 2.5% 

  3. There is a possibility that overheating will occur, in which then, the increase in government expenditure may not have a sizable impact on economic growth but having an impact on prices instead. 

 

Size of the multiplier 

  1. The size of the impact that any increase in AD would have on real national incomes (and therefore economic growth) is to an extent dependent on the size of the multiplier, denoted by k 

  2. K = 1/mpw where mpw = mps + mpt + mpm (elaborate) 

  3. Given mandatory CPF scheme in Singapore, mps is high, and due to Singapore lacking natural resources, mpm is high as well 

  4. K is therefore small in Singapore 

  5. The small multiplier size may mean that the impact that an increase in government expenditure on real national incomes may be smaller compared to countries like United States 

 

Size of increase in government expenditure (as a % of total government expenditure and as a total % of GDP) 

  1. A S$5billion increase is sizable when we take it as a % of total government expenditure since we are told that it is a 7.3% increase from the previous year 

  2. We do not, however, have adequate information to see the size of this increase relative to real GDP. 

  3. In year 2020, the COVID-19 cumulative fiscal stimulus package announced by end May amounted to S$92.5b which was stated to around 19% of Singapore’s GDP.  

  4. The 2016 increase in spending would pale significantly in comparison with that in 2020. 

  5. In usual years, the government adopts a prudent fiscal policy and avoids significant increase in government expenditure to maintain a reasonable budget position which would likely mean that a S$5billion increase may not be considered to be a significant increase. 

 

Evaluation & conclusion 

  1. Given the prudent nature of our fiscal policy, and the small multiplier, an increase in government expenditure like that announced in 2016, would unlikely have a significant short-term impact on Singapore’s economic performance.  

  2. There will be no significant boost to economic growth but neither will there be significant negative repercussions on inflation. 

  3. Given the focus of our government expenditure is usually on improving the long-term supply side potential of the economy through infrastructure development and improving business capabilities – there will most likely be a long-term positive impact on economic growth. 

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