(2013) 8823 H1 Econs Paper CSQ 1 Suggested Answers by Mr Eugene Toh (A Level Economics Tutor)

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a. World commodity prices increased in both periods 2000 - 2005 and 2005 - 2010. [1m]

Prices increased more significantly between 2000 - 2005 as prices increased by around 54% as compared to 2005 - 2010 where prices increased by around 43%. [1m]

There were brief periods where prices decreased in both periods, but for 2005 - 2010, there was a sharp decrease in prices in 2009 of around 41%. [1m]

b. For spending on food as a proportion of disposable income to have fallen considerably, either spending on food has decreased or disposable incomes have increased. It was mentioned in Extract 1 that food prices have seen relatively stable, low inflation, 

which suggests that food prices have been going up. With food being demand price inelastic due to a high degree of necessity, an increase in price will result in a less than proportionate fall in quantity demanded, which will result in expenditure on food increasing.

For spending on food as a proportion of disposable income to have fallen considerably, it must be due to an increase in disposable incomes and such an increase in disposable incomes must have significantly outpaced increased spending on food. 

c. Demand factor

Increased demand from India and China could be attributed to rising income levels which would increase the purchasing power of consumers resulting in an increase in demand for food and other commodities from DD0 to DD1. At the initial price P0, the quantity demanded would exceed quantity supplied, putting upward pressure on prices until it reaches P1.

Supply factor

The increase in production of biofuels would have resulted in a decrease of supply of

land available for the production of food. This is since the production of crops for biofuels is in competitive supply with production of crops for food. The reduction of supply of land available for the production of food will increase the price of land used for production of food, which decreases the supply of food from SS0 to SS1. At the initial price P0, the quantity demanded would exceed quantity supplied, putting upward pressure on prices until it reaches P1.

d. Possible consequences for exporting country

The imposition of such limits can reduce the export revenue for the exporting country.

This will lead to a fall in (X-M). Given that AD = C+I+G+(X-M), this will result in a fall in AD from AD0 to AD1, which can result in a multiplied decrease in real national income from Y0 to Y1.

Possible consequences for the world economy

As the supply of commodities available on the world market decreases, this will increase prices of commodities. As many commodities are used as key factor inputs in the production of many goods and services, this will result in an increase in the cost of production for such goods and services. As a result, SRAS will decrease, reflected by a leftward shift from AS0 to AS1. This causes general price levels to increase from P0 to P1 while real national income will fall from Y0 to Y1. The world economy will likely see higher global inflation and a fall in global incomes.

ei The act of ‘strictly curbing investments’ can be done through contractionary fiscal policy 

such as increasing corporate income taxes or contractionary monetary policy through increasing interest rates. Since AD = C+I+G+(X-M), curbing investment spending will result in a fall in aggregate demand from AD0 to AD1. General price levels will then fall from P0 to P1, reducing demand pull inflation, if the economy was operating at full or near full employment level.

eii. Tightening government spending

One way that the government can control inflation is by decreasing government spending. This can happen through the government reducing spending on public infrastructure projects such as roads, rail links, schools and hospitals or reducing direct government hiring in civil service positions.

As AD = C+I+G+(X-M), a decrease in government spending (G) will reduce AD from AD0 to AD1, bringing about a fall in general price levels from P0 to P1.

Appreciation of the currency

The government can also appreciate the currency through MAS’s exchange rate based 

monetary policy where the currency is guided towards a modest and gradual appreciation.

A stronger SGD makes imported goods like food such as eggs, chickens, vegetables, meat and fish cheaper.

At the same time, a stronger SGD also makes imported raw materials like oil cheaper, reducing cost of factor inputs and thus cost of production falls, shifting SRAS rightwards from AS0 to AS1, reducing cost push inflation.

A stronger SGD also makes Singapore exports more expensive in foreign currency terms, reducing demand for Singapore exports. As demand for Singapore exports fall, (X-M) falls. Since AD = C+I+G+(X-M), there will be a fall in AD from AD0 to AD1, resulting in a fall in general price levels from P0 to P1, addressing demand pull inflation.

Comparing relative effectiveness

Given that tightening government spending addresses only demand-pull inflation and not 

cost push inflation nor imported inflation, tightening government spending is not considered to be extremely effective in addressing key causes of inflation in Singapore.

A stronger SGD through the appreciation of the currency can address all three types of inflation that SIngapore can be susceptible to, but also has the repercussions of decreasing export competitiveness.

This is a key reason why Singapore chooses to adopt a modest and gradual appreciation of the Singapore dollar as opposed to an outright appreciation.

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