(2013) 8823 H1 Econs Paper CSQ 2 Suggested Answers by Mr Eugene Toh (A Level Economics Tutor)

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a. One macroeconomic consequence would be a fall in economic growth due to a fall in

real GDP.

b. Real GDP growth was 5.6% in 1990, but has since been decreasing, with a negative

real GDP growth rate of 1.2% in 2008. This suggests that incomes have been increasing at a decreasing rate and fell in real terms in 2008.

Inflation was at 3.1% in 1990 but has been low from 2000 – 2007 ranging between -0.7% to 0.1%. While a low rate of inflation is generally seen as favourable, economists generally prefer to see an inflation rate of 2% as it reflects a healthy and growing economy.

At 2.1% in 1990, the Japanese economy would likely have been at full employment level. This has increased to 4.0% in 2008 which is double that of 1990. There would likely be the presence of cyclical, structural and frictional unemployment. As 4.0% would likely still be close to full employment level – this is not yet concerning.

Lastly, current account balance has remained healthy as Japan consistently sees a current account balance surplus, and this has consistently been increasing, with a current account balance of US$44.1 billion in 1990 to US$156.6 billion in 2008.

Overall, Table 2 shows that the Japanese economy has seen slow growth, low rates of inflation and also increasing unemployment rates. Current account balance has been doing well.

c. A key determinant of investment is the cost and availability of credit. Due to the

collapse of the property market, which according to Extract 10, resulted in the banks making significant losses, it would likely be the case that the banks were either less willing to lend or less capable of lending. This would restrict the credit made available to firms for investments, which means that firms would find it harder to obtain loans for investments.

This would likely result in a fall in investments. Given that AD = C+I+G+(X-M), there will be a fall in AD from AD0 to AD1, resulting in a multiplied fall in real national income from Y0 to Y1 via the reverse multiplier effect, contributing to lower economic growth.

The fall in economic growth would create negative sentiments, which could further result in pessimism in investors investing, resulting in lower investments.

This would thus cause the economy to get stuck in a rut of low investment, low growth and low confidence’.

di     The reconstruction spending suggested in Extract 9 refers to an increase in

government expenditure by the government to rebuild/reconstruct buildings, housing, public infrastructure, and acts akin to an expansionary fiscal policy stance.

Since AD = C+I+G+(X-M), there will be an increase in AD from AD0 to AD1, which will result in a multiplied increase in real national income from Y0 to Y1.

The increased spending on capital goods by both the government efforts to restore public amenities will also increase the productive capacity of the economy post-earthquake. This will shift LRAS from AS0 to AS1, bringing about an increase in real national income from Y0 to Y1.

dii.   While the government reconstruction spending will increase government expenditure,

which is a component of AD, AD comprises of C+I+G+(X-M).

In extract 9, there is also a suggestion that there is weak business investment as well as a fall in exports. The fall in exports is attributed to a rising yen and faltering global growth. A rising yen makes Japanese exports less competitive while slowing global growth can reduce the demand for Japanese exports.

If export earning falls and investment expenditure remains stagnant, then the increase in Government expenditure can potentially be offset by a decrease in net exports (X-M). This can mean that the increase in AD, as previously mentioned, may not occur, and thus an increase in economic growth may not be certain.

ei.    Concept tested for this question is no longer required in the current 8843 curriculum.

eii.   The case for fiscal policy to achieve this change in saving and spending

         There are two ways that expansionary fiscal policy can achieve an increase in

spending.

Firstly, the government can directly increase government spending through increased hiring of civil servants or increasing spending on public works/infrastructure projects such as schools, hospitals, roads & public amenities. Since AD = C+I+G+(X-M), an increase in government expenditure will result in an increase in AD from AD0 to AD1 which will result in a multiplied increase in real national income from Y0 to Y1 via the multiplier effect.

Secondly, the government can also decrease corporate income taxes and personal income taxes. As corporate income taxes decrease, after tax profits increase, encouraging an increase in Investment spending. As after-tax disposable incomes increase, consumers will also increase Consumption.

Since AD = C+I+G+(X-M), an increase in both Consumption and Investment spending will result in an increase in AD from AD0 to AD1 which will result in a multiplied increase in real national income from Y0 to Y1 via the multiplier effect.

The increased incomes will result in consumers ‘spending more’.

The case against fiscal policy to achieve this change in saving and spending

An increase in incomes may not trigger consumers necessarily to increase spending.

They may instead opt to save the bulk of any increase in incomes as suggested in Extract 10 that Asian citizens are inclined to save rather than to spend.

Additionally, increasing government spending, should the government already experience persistent budget deficits, will increase the government debt which requires increased future interest repayments. This may not be sustainable in the long-run and imposes a fiscal burden on future generations who may have to pay higher taxes.

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