Session 2 - 2012 Promos Essays 3 4

8/11/2019 Session 2 - 2012 Promos Essays 3 4

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P-CubeSession 2


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Todays objectives

1. Understand the 2 practice questionsrequirements

2. Common errors for the 2 practice que

3.Review of sample essay


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2012 Promos essay

question 3

Discuss the extent to which economic growth is lik

the rate of inflation in Singapore. [25]


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Dissecting the question

Discuss the extent to which economic growth

to affect the rate of inflation in Singapore. [

Actual and potenti

Causes of inflation demand pull & cost pus


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Schematic plan (3)

Introduction

BodyThesis Explain the impact of

economic growth on inflation

AG worsens inflation

PG helps mitigate inflation

Anti-thesis rate of inflation is

other factors

1. Cost push inflation

2. Governments policies

Synthesis & Conclusion relate to Singapores trend of healthy growth


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Common mistakes

Avoid these mistakes

Economic growth leads to increased consumptimpor ts hence impor t price push inflation

Appreciation of S$ to counter demand pull inf

Use ML condition whenever the discussion is abalance


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Extra Practice - TYS 2010

When there are large increases in the prices of oil and othproducts, they are usually expected to lead to rising inflatio

the worlds economies.

Discuss the extent to which these factors are likely to affof inflation in Singapore. [25]


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2012 Promos Question 4

(a) Explain how firms determine their level of investm

capital goods. [8]

(b) Discuss how far an increase in the level of invest

Singapore can help to achieve economic growth

unemployment. [17]


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(a) Explain how firms determine their le

investment in capital goods. [8]

How method, processwhat - factors


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Comparison

Last sessions question

Explain the most significant causes of increase in inve

Singapore. [10]

This sessions question

Explain how firms determine the level of investment

goods. [8]


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Schematic plan (4a)

Introduction

Body

Explain MEI and how level of I is determine

(Lecture 11)


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(b) Discuss how far an increase in the level of in Singapore can help to achieve economic gro

low unemployment. [17]Actual & potenti

Cyclical, structural, frictional

Whats investment? Cons


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Schematic plan (4b)

Introduction

BodyImpact on Economic Growth

Explain how increase in investment help EG (AG & PG)

Explain the extent as to investment will raise AG & PG (magnitImpact on unemployment

Explain how increase in investment help reduce cyclical and structural un

Explain the extent as to investment will reduce unemployment

Synthesis & Conclusion Investment is extremely impor tant in Sg as a k

and creation of jobs


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Common mistakes

Avoid these

Hot money flows are investments


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Question 3

Discuss the extent to which economic growth is likely to affect the rate of inflation inSingapore.

Examiner's Comments for Question 3

Overall performance for the questionApproximately 40% of the cohort chose Question 3 over Question 4 for the essays inSection B. The average mark for this question was the best out of the 4 essayquestions: 13.1 / 25 (D grade).

It is heartening to note that despite this question being an unstructured 25 markquestion it attracted many candidates, from which the best script scored 21/25. Thisproved that students should not always instinctively shy away from such types ofquestion.

The responses to this question showed that in general students could recognize that thereference to economic growth and inflation is an indirect reference to demand-pullinflation. Most also recognized that in Singapore, the main sources of inflation areCOST-PUSH in nature. Many did also make references to policies as an importantfactor in influencing the rate of inflation.

Overall, most answers were well-structured with at least satisfactory explanations ofdemand-pull and cost-push inflation with illustrations, addressing the relevant causes ofinflation, as required by the question. Most answers fall in Level 2 band as the analysiswas found somewhat lacking in depth and/or scope.

However, there are concerns over essay writing skills. The details are provided underspecific comments. A simple yet effective technique that is lacking is to adopt anapproach or style that fits well with the context and nuance of the question. Forinstance, since this question requires students to discuss the extent a goodstyle/approach would be one that addresses this issue to what extent squarely andhead-on such as Economic growth will affect the rate of inflation to the extentinflation is demand-pull and actual growth outpaces potential growth. In other words,the clear and explicit reference to EXTENT as an integral part of the analysis makes allthe difference to the quality of the answer.

There is still general weakness in evaluation skills and consequently there were few 34marks for evaluation awarded. Many provided conclusions that were vague or which didnot address the issues in the question directly.

In general every student should make the effort to learn to write an L3 quality essay witha GOOD FACE:F Good Focus

A Good Analysis


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C Good ContextualisationE Good Evaluation


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Conceptual Issues

1. Actual Growth is the increase in GDP per capita? This is wrong as GDP per capita isa measure of SOL not growth!

2. Economic Growth leads to more consumption of imported goods hence causeimport-cost push? This line of reasoning is erroneous because:

o Conceptually import COST push refers to an AUTOMONOUS increase in prices(ie inflation that is not related to higher demand) e.g. oil and fuel costs rising duenot to more demand from Singapore but other reasons e.g. OPEC restrictiveactions; geo-political tensions in the gulf states; etc. Some argued that oil pricesrose because of higher demand from China etc. Thats true. But, from theperspective of Singapore, it is still imported cost push since it not Singaporesdemand that causes the price of oil to rise but China.

o

Singapore is a price taker in the international market for imports. Thus, it is toofar-fetched to say that we have the power to increase the prices of oil or foodwhen they are imported into Singapore. Of course once they are imported intoSingapore, subsequent increase in domestic demand due to affluence isdemand-pull and no longer cost-push.

3. Foreign worker policy to buffer against demand-pull inflation?The almost ubiquitous reference to the so-called labour buffer policy deservesclarification as to its origins. The original idea was to allow into Singapore a pool offoreign workers to buffer the economy against retrenchment affecting the localworkforce. In the event of any contraction of the economy, the axe will fall first onforeign workers. It is not meant to buffer against demand-pull inflation.

4. Singapore appreciates its currency to slow down demand-pull inflation?One must realise that the primary objective of MAS gradual and modestappreciation of S$ is to keep out imported inflation. The strong S$ policy is meant tomaintain price stability in order to support growth (including export growth). Thus, tosay that it is used to slow down exports and economic growth in order to cool downthe economy may not be so relevant especially if export revenue is 2 timesSingapores GDP.

5. COE is an example of demand pull due to rising affluence?This may be deemed as a fallacy because the Singapore economy is currentlyslowing down yet the COE prices are soaring. So, rising affluence cannot be the realreason. The real reason is supply crunch initiated by the government to control roadcongestion. In fact, the COE rose because of the drastic cut-back of the supply ofCOEs implemented by the LTA.

6. Flexi-wage system is to counter inflationary pressures?


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There seems to be confusion between the flexi-wage policy and the performance-based wage policy (ie wage growth =productivity growth principle). It is the latter thatis used to control wage-push inflationary pressure and not the former.

7. Indiscriminate use of the Marshall-Lerner conditionThere is a tendency to use the Marshall-Lerner condition indiscriminately almostlike a knee-jerk reaction to any mention of export earnings or revenue. For instance,some wrote Export demand increases, if Marshall-Lerner condition holds, ADincreases Where is the fallacy? Marshall-Lerner condition applies only if there hasbeen a change in the exchange rates !! The original usage states that if thecurrency is devalued the BOT (X-M) will improve if the Marshall-Lerner conditionholds.

Diagram IssuesDo learn to draw AWEsome diagrams for the following:

o

Diagram to show Cost-push inflationo Diagram to show Overheatingo Diagram to show Sustained non-inflationary economic growth

(Refer to suggested answers for the AWEsome diagrams)

Inappropriate Abbreviations and TerminologyUse proper terms and spellings for the following:

o RNI [spelling = real national income]o Classical range [proper term = economy operating at full employment (Yf) or

LRAS]o Intermediate range [proper term = upward sloping segment of SRAS or

economy operating near to Yf or economy experiencing supply bottlenecks]o Inappropriate to describe the strengthening /appreciating the S$ as

contractionary monetary policy because the aim is not to slow down economicgrowth but to control import cost push inflation.

Contexualisation issuesScripts that wrote about Resilience package and Zero appreciation policies clearlydid not consider the context in which these policies were implemented. They arepolicies to counter a recessionary threat and therefore have no place for a questionwhose focus is on inflation.

Assessment Object ive: To test both causes of in flation and po licies to control in flation.

Basic structure

Introduction : Use KIA approach (refer to essay skills package)

A. Focus on Economic Growth and impact on rate of inf lat ionActual vs Potential economic growth : overheating (ie AG > PG)


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sustained non-inflationary growth (ie AG=PG)

B . Focus on Inflation unrelated to Economic GrowthCost push inflation

Import cost push inflation Other types of cost push inflation e.g. COE

C. Focus on Policies and impact on rate of Inflation- Key monetary policy gradual and modest appreciation of S$- Other poli cies

Conclusion : synthesis + stand

Suggested essay outline

INTRODUCTIONInflation is the sustained rise in the general price level. It is a measure of how fast the

general price level rises over time. Economic growth is one key factor that determinesthe rate of inflation. The extent to which economic growth contributes to the rate ofinflation will be discussed in this essay.

BODY

A. Economic growth can cause Demand-pull Inflation (Inflationary Growth)

Economic growth can lead to demand-pull inflation. This is a situation in which actualgrowth outpaces potential growth. Actual growth refers to annual increase in nationaloutput, whereas potential growth is the annual increase in the economys productive

capacity. This is likely to happen when the economy is booming and the economy is indanger of overheating

Singapore is heavily dependent on growth of exportsas exports are about 2 times ofGDP. Thus, any demand-pull inflation in Singapore would probably come from rising

export demand. Singapores GDP growth of 14.7% in 2010 was accompanied by risinginflation rate in 2010 (at 2.8%) & 2011 (at 5.4%). The rise in inflation rate may beattributed to the resurgence of export growth in 2010/11 period.

Moreover, demand pull inflationary pressures may also be caused by too muchliquidity in the economy. Aggregate spending could be bolstered by the availability ofcheap and easy credit. For example, demand for property is high despite a slowingeconomy because of the availability of cheap loans to finance the purchase of such

In boom times, demand-pull inflation can happen when the economy is experiencingrapid growth brought about by a rapid increase in one or more components of AD e.g.household consumption, business investment, government expenditure or net exports.In an economy operating close to full capacity, the in AD exerts an upward pressure onprices.


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assets. Demand for property has been boosted by low mortgage rates (ie interest ratefor home loans) easy financing (e.g. 50 year loan) as well as influx of foreign buyers. Infact, in recent times, rising housing accommodation costs is a major contributor toinflation in SG

Figure 1: Economy experiencing Demand-Pull Inflation

Economic growth may notlead to inflation when PG = AG (Non-inflationary

growth)

On the other hand, economic growth may not fuel higher inflation rates when the growthis non-inflationary in nature. Non-Inflationary economic growth is the situation wherepotential growth grows in tandem with the actual growth. In such instances, theeconomy will have adequate resources to meet rising demand for goods and services.Hence there is no upward pressure on prices to rise.

Explain demand-pull inflation with reference to Figure 1: An excessive/rapid rise in AD from AD0 to AD1will raise the real output marginally

from Y0to Yf1. This represents an increase in actual output or actual growth, without corresponding

increase in AS. This is the situation when the economy is operating near or at full-capacity.

Thus, rising AD leads to competition for resources, hence driving up business costse.g. wages, rentals, which in turn give rise to sustained rise in general price level inthe economy.

It results in inflationary pressures, GPL increase from P1 to P2.

ADo

AD1

P2

P1

AS

YfYo

GPL

Real NI


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This could happen when actual growth is accompanied by increased productivity.

Figure 2: Economy experiencing Non-Inflationary Growth

Evaluative comment:The benefits of such policies take time to kick in. However, in Singapore thegovernment is far-sighted and has implemented policies to continually raise productivityvia skills training, adoption of better technology; more efficient workplace managementpractices and R&D.

B. Cost Push Inflation mainly import-cost push

There are other possible causes of inflation in Singapore which are unrelated toeconomic growth. In fact, a perennial threat of inflation for Singapore comes fromimport-price push inflation.

Being a small and open economy with limited natural resources, Singapore isparticularly vulnerable to import-price push inflation. As the Singapore economy isheavily dependent on imported finished goods for consumption as well as importedintermediate goods for production, a hike in the prices of key consumption item such asfood and raw materials such as oil could lead to cost-push inflationary pressures. Forinstance, rise in both global oil and food prices have probably driven Singaporesinflation rate for 2008 to 6.6%, which was 3 times the inflation rate in 2007.

Cost-push inflation can be explained with reference to Figure 3 below:

Explain with reference to Figure 2 below:Economic growth may not lead to inflation when potential growth outpaces the actualgrowth. For potential growth to occur there would also have to be an increase in

potential output, AS shifts right to AS1. When AS shift rightwards together with theincrease in AD, output increases beyond Yfand price level stays at P1, achieving non-inflationary growth.


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Figure 3: Cost-Push inflation

AD

AS

AS1

P1

p

GPL

Real Output


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Higher Imported Food and Fuel PricesIf there is a hike in oil prices globally due to supply shocks (e.g. OPEC cutting quotas),oil will cost more to import. Since oil is a key resource used as fuel and energy in theproduction of many goods and services in SG e.g. higher bus fares; cab fares; electricitytariffs businesses are likely to pass on the cost to consumers. Assuming there is an

increase in the costs of production at all levels of output, the AS curve shifts upwards toAS1resulting in a higher price level at P1 and a lower equilibrium output at Y1.

Other forms of Cost-Push inflation threatGovernment policy in the form of taxes, fees, charges impact on business costs. A hikein these costs might also cause inflation.

GST: For instance, if firms face a rise in costs through indirect taxes, they usuallyrespond by passing some of the higher costs to consumers through higher prices. Theextent businesses could pass on higher GST to consumers would depend on the PED

of their products. The increase in Goods and Services Tax (GST) was increased in2008 from 5% to 7%. However, Increase in GST was implemented only on a fewoccasions. Hence, its impact on inflation rate is usually one-off. Moreover, in SG thegovernment give out GST off-set packages to cushion its adverse effects.

COE: On the other hand, government regulation of COE quota has to a large extentcaused a hike in COE prices which in turn raise private transport costs and fuel inflation.

C. Policies to mitigate inflation

The rate of inflation is also affected by policies implemented by the government to curbinflationary pressures.

Singapore uses the monetary policy in the form of Gradual and Modest Appreciation ofthe Sing$ to curb pressures arising from rising costs of imports. This is a key reasonwhy even when the SG economy grew in the last decade, inflation rate has beenrelatively low.

Appreciating the S$ will make imports relatively cheaper in terms of S$. For instance, ifthere is a hike in the price of imported oil priced in US$ by say 10% the cost of buyingimported oil in terms of SGD would have risen by 10%. However, to keep cost down,the government could appreciate the Sing$ by 10% against the US$. The appreciationof Sing$ effectively keeps the price of imported oil unchanged in terms of SGD.

However, recently, these policies dont seem to be working e.g in recent years inflationhit 4%-5% despite a slowing economy.


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C. Other pol icies may also mitigateInflation in SG

Singapore policy of linking wage growth to productivity gains puts a lid on wage-costpush inflationary pressures. This policy ensures that business unit cost remains thesame even when nominal wages rise. For instance, if a worker produced 10 units ofoutput per day and is paid $10, the unit cost of production is $1. If the workersproductivity rises and he can produce 20 units of output per day, the unit cost would stillremain unchanged even if he is paid twice as much

[Choose any 1 for elaboration]

1) Wage cost push inflation Wage cost push inflation has been reined in through two

key policies:

Linking wages to productivity (e.g. National Wage Council recommendations)


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Foreign manpower policyThe availability of cheap source of foreign workers has depressed wages especially forthe low-income unskilled workers.

Evaluative comments: The policy of tightening the influx of foreign workers is expected

to exert upward pressure on wages and business costs in the short run thus contributingto the rate of inflation

2) Profit-Push Inflationary PressuresIn theory, big firms or monopolies/oligopolies have pricing power due to their substantialmarket share. They could raise the prices of their product and services in order to boosttheir profitability. However, in SG, the government has put in place policies to regulatefirms with the potential to cause profit-push inflation e.g. monopolies supplying publicservices such as SMRT, SBS, PUB, telcos etc.

Other recent sources of Inflationary PressuresProperty cooling measures e.g. increase SS of public housing and private housing;rein in speculative demand, ABSD ( Additional Buyer Stamp Duty) set at 10%, the

Additional Buyers Stamp Duty (ABSD) is a formidable weapon against foreignerslooking to speculate in the local property market.

Conclusion:

Unlike other economies like China and India despite growing at a healthy pace theSingapore economy did not experience inflationary pressures due to overheating. Infact, the average 30-year historical rate of inflation for Singapore is 2.2%. This iscomparatively low by international standards. A key reason is due to the far-sightedcounter-inflationary policies implemented e.g. Strong Sing$ policy by the government.Thus it can be said that economic growth did not have a significant impact on the rate ofinflation in Singapore

L3 Upper (19-21)An excellent, theoretically sound, in-depth, balanced andcontextualized analysis covering ALL 3 aspects :

A economic growth and impact on rate of inflationB Impact on rate of inflation from factors unrelated to economic growthC - Policies and impact on inflation.


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Mid ( 17-18)A good in-depth, balanced and contextualized analysis

covering all 3 key aspects -A, B and C

Lower ( 15-16)A good in-depth, balanced and contextualized analysis covering at least 2 kaspects

A + B or A + C.

L2

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Upper (13- 14)A satisfactory in-depth and contextualized analysis covering at least 2 key aspectsA +B or A + C.

Mid ( 11-12)Satisfactory in-depth and contextualized analysis. However answer is lop-sid

covering aspect A + B ( but mainly imported cost push)

Lower (10-11)Satisfactory in-depth but mainly generic analysis covering only aspect A.

OrAn answer that attempts to cover all aspects but is too superficial + sketchy

L1Upper6 9

Answer shows some knowledge, but does not indicate that the meaning of tquestion has been properly grasped.

Basic errors of theory or an inadequate development of analysis may be evident.

L1Lower1 5

Answer is mostly irrelevant and contains only a few valid points made incidentain an irrelevant context.

E2 (3-4) Judgment based on economic analysisE1 (1-2) Mainly unexplained judgment


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Sample answer (adapted from John Yap 12S7B)

In Singapore, economic growth is usually associated with rising inflation as the AggregateDemand of the economy increases. This essay will explain whether and to what extent such agrowth would impact the rate of inflation in Singapore, taking into account possible governmentpolicies and intervention that may affect it.

When there is actual economic growth in the form of an increase in GDP and a subsequentincrease in output, a small and open economy like Singapore is likely to suffer from demand pullinflation. With our growth being mostly driven by an increase in exports due to an upturn in theglobal economy, the subsequent increase in AD (as most of Singapores exports, such aselectronics and refined oil, are normal goods with a positive income elasticity of demand)without a corresponding increase in productive capacity can lead to supply bottlenecks, and asproducers bid higher prices for factor inputs such as fuel and labour, a sustained increase in theGeneral Price Level is likely to result. In addition, growing affluence of our population wouldresult in an increased demand for normal goods such as housing and transport in the form ofcars, causing a huge percentage increase in our Consumer Price Index (CPI) as these 2components take up a large percentage of the CPI.

However, such effects only apply if there is little spare capacity in the economy as highlightedearlier. If productive capacity can keep up with the increase in AD, the economy can have non-inflationary economic growth that is sustainable. If the economy is way below full employmentequilibrium, for instance during the recession of 2008, economic growth is unlikely to lead tosignificant demand-pull inflation. The effects of this are shown in Figure 1, with the effects of anincrease in AD from AD1 to AD2 having little effect on General Price Level, while increases from

AD2 to AD3 when it is near or at the full employment national output can lead to demand pullinflation.

Moreover, there are other factors that can affect the rate of inflation. As a small and openeconomy, Singapore is highly vulnerable to import-price push inflation, as we heavily rely onimported inputs for production and consumption. When general price levels in other economiesincrease, the prices of the finished goods and inputs we import from them also increases. Whenprices of essential factor inputs like oil and food increase, like they did in 2008 (with oil reachingrecord highs of US$148 per barrel), the cost of production increases for producers and thusdecreases SRAS. Such an increase in general price level is unrelated to the increase in ADcaused by economic growth, though in a poor economic climate, it is less likely to occur due to


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reduced demand. As such, averting this kind of inflation may not be in conflict with increasingactual economic growth.

The rate of inflation is also affected by the government policies that are implemented to curb it.To curb demand pull inflation, we need an increase in potential economic growth where the AScan keep up with the increasing AD. To curb cost-push inflation, the government can move the

short and long run AS outwards by decreasing cost of production and improving productioncapacity. These policies are preferable to contractionary demand management policies, such ascontractionary fiscal (a decrease in government expenditure or an increase in taxes) ormonetary policy, as these come in conflict with the goals of both actual and potential economicgrowth, the latter because investment that is curbed might decrease the potential capacity of theeconomy in the long run.

As such, one policy that would affect the rate of inflation is the governments exchange ratepolicy. At present, the government practises a gradual and modest appreciation of the Sing$,decreasing the cost of imported inputs in terms of local currency and reducing production costs.This also additionally makes our exports more expensive in terms of foreign currency,decreasing the quantity of our exports, and ceteris paribus, net export revenue and AD, curbing

demand pull inflation as well as cost push inflation. However, this may cause our exportcompetitiveness to suffer in the long run, causing this policy to be in conflict with the goal ofeconomic growth, so the government needs to continue to explore areas of Singaporescomparative advantage and diversify our export sector to ensure economic growth is notcompromised.

In addition, policies that improve the productive capacity of our economy, such as long-runsupply side policies, could improve potential economic growth and decrease general pricelevels. Such policies that are currently carried out by the Singaporean government, such aseducation and retraining under the SPUR scheme in 2009 and the subsidising of courses toimprove language and IT skills, would help to improve the skills of their workers and thus theirproductivity, decreasing the rate of inflation as AS continues to increase. In addition, our current

policies to encourage investment by creating a business-friendly environment through lowcorporate tax helps increase AD in the form of investment, and in the long run through theimprovement of productive capacity, AS, decreasing the rate of inflation.

Moreover, short-run supply side policies can decrease firms cost of production and help to curbthe rate of cost-push inflation. For instance, changing the size of the CPF wedge to reducebusiness costs without affecting disposable income (as the employers contribution is reduced),implementing schemes like the Jobs Credit Scheme in 2009 to reduce wage costs, as well asrebates on utilities and rental can all help reduce a firms costs. This will shift the SRAS curve tothe right, mitigating the impact of cost-push inflation. However, we must note that most of thesemeasures are short term as they can pose a burden to the government budget and impactworkers future standard of living. Ultimately, all these policies serve to cushion the effect of

inflation on our economy as we are still heavily dependent on external conditions due to ouropenness.

In conclusion, while actual growth is often associated with demand-pull inflation, the state of theeconomy, the presence of cost-push inflation, and governmental policies currently in place tomitigate inflationary pressures will also play key roles in affecting the extent to which the rate ofinflation is altered. The Singaporean government should thus try to pursue a multi-prongedapproach so as to ensure actual growth and potential growth are in tandem to allow for non-inflationary economic growth.


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Sample answer (adapted from Eunice Phua 12S66)

Economic growth is defined as the growth is real national output of an economy and it consistsof both actual growth and potential growth. Depending on the type of economic growth, theimpact on the rate of inflation will vary. Inflation can be categorized into demand-pull inflationand cost-push inflation.

For actual economic growth, which means a growth in real national output, due to the increasein aggregate demand by factors like consumption (C), investment (I), government spending (G)and net exports (X-M), it could potentially lead to demand-pull inflation, but this depends on theextent of economic growth.

Referring to Figure 1, when there is economic growth and aggregate demand (AD) increasesfrom AD1 to AD2, general price level will increase from P1 to P2. However, as the shift in AD is stillin the intermediate range of the aggregate supply curve, the inflationary pressure is notsignificant. If, however, aggregate demand due to economic growth increases by a large extentto AD3 and there are supply bottlenecks because the economy is at tight capacity and producershave to compete with other factors of production, the rate of inflation will be significant asgeneral price levels will increase to P3. This is evident in the context of Singapore where there isan optimistic outlook and to meet rising levels of aggregate demand, where there is an

unplanned decrease in stocks and firms hire more factors of production to increase the supply,there may be competing factors of production which causes the firms to be unable to meet risingaggregate demand and hence cause an increase in price. For example, there is a housingshortage in Singapore now because the rise in aggregate demand for housing is significant anddespite the government efforts for build-to-order flats, the great economic outlook due toeconomic growth has caused inflationary pressures on the housing market . (comments: Toimprove on this example, the student should indicate that housing is a major contributorto CPI.)


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However, economic growth also leads to increase in investment and government spending. Thismeans that there will be an increase in capital formation by firms who may invest in long-termproductivity measures, leading to a rise in potential growth. Government spending on socialinfrastructure such as telecommunication networks or investments in technology like the fibrebroadband will similarly increase the productive capacity of an economy. If aggregate supply(AS) shifts in tandem with AD, non-inflationary growth can be achieved. This is seen in figure 1

as AS shifts rightwards from AS1 to AS2. Even if demand were to increase to AD3, general pricelevels will maintain at P4 and the rate of inflation will not be high. Therefore, it is believed that inthe short-term, economic growth may lead to demand-pull inflation if there is excessive rise inaggregate demand. However, in the long-term, if AS shifts in tandem with AD, demand-pullinflation will not be drastic.

As for cost-push inflation, which consists of import-price push inflation, wage-push inflation, tax-push inflation, profit-push inflation, economic growth could possibly increase cost-push inflation.

For import-price push inflation, economic growth in Singapore is unlikely to result in import-pricepush inflation as the prices of imported raw materials and goods are dependent on the state ofthe economy in the other country. However, if economic growth occurs in countries which

Singapore imports goods from, a rise in cost of imported goods can lead to inflation inSingapore as Singapore is a small and open economy and is especially dependent on importedgoods for survival.

Wage-push inflation may result. This is because as inflationary pressures set in due to demand-pull inflation, for example the shifting of the demand curve from AD1 to AD3 as seen in figure 1,workers may demand for higher wages to meet the rising cost of living. Hence, initial demand-pull inflation can exacerbate cost-push inflation. If higher wages are demanded without acorresponding increase in productivity, it can lead to an increase in the cost of production,causing further inflationary pressure on the economy due to economic growth. Furthermore, dueto supply bottlenecks as less efficient resources have to be employed to meet the rise indemand, the cost of production will increase.

In Singapores context, however, wage-push inflation is unlikely to occur because Singaporelacks strong trade unions to demand for higher wages. In addition, the National Wage Councilalso gives recommendations on the income of workers, hence preventing a rise in wageswithout a corresponding rise in labour productivity. Thus, actual economic growth will not causewage-push inflation and this aspect is not of concern.

In addition, economic growth should not lead to tax-push inflation as this is caused by a one-time increase in tax rates like GST.

However, profit-push inflation, a subset of cost-push inflation, is likely to result during economicgrowth. This is especially so in imperfect markets where the barriers of entry are high and

producers increase the prices of their products more than what is necessary to cover their risein costs. Hence, general price level increases more than proportionately. Fortunately, in thecontext of Singapore, profit-push inflation may not result from economic growth as markets inSingapore are usually perfectly competitive (comments: Too sweeping, but it is true thatgovernment encourages competition.) and the government adopts deregulation and preventsmonopolies from happening. Even in the case of transport where there may be an oligopolybecause of the existence of only two companies, the government ensures that profit-pushinflation will not occur by intervening to ensure that transport fares are kept at a reasonableprice.


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In conclusion, actual economic growth can lead to demand-pull inflation in the short-term.However, coupled with potential economic growth, the rate of inflation can be mitigated andreduced in the long-term. It is essential that the government and firms work hand in hand toincrease potential economic growth in tandem with actual economic growth. Efforts in researchand development like the $16.1 billion that the government invested to make Singapore a

research and development hub is necessary to reduce inflation. In addition, the productivecapacity of an economy can be enhanced by improving the quality of the labour force likereeducating workers through the Skills Programme for Upgrading and Resilience (SPUR). Thiswill ensure growth in the productive capacity. Retraining is hence necessary for workers to bebetter equipped with the necessary skills set.


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Question 4

(a) Explain how firms determine their level of investment in capital goods.

(b) Discuss how far an increase in the level of investment in Singapore can help to

achieve economic growth and low unemployment.Examiner's Comments for Question 4Overall performance for the question

Approximately 60% of the cohort chose Question 4 over Question 3 for the essays inSection B. The average mark for this question was 12 / 25 (E grade).Part (a)This question is meant to test the technical competency in explaining the basicdeterminants of investment from the perspective of the firms. Thus, technical accuracyis required in explaining the process involved in making investment decisions ratherthan just the determinants per se. From the responses it was evident that there were

several misconceptions regarding the concepts and the process. On hindsight, thisquestion served as a good diagnostic tool in surfacing technical and conceptual issuesassociated with investment decision making which students should do well to check ifthey have any misconceptions (refer to specific comments below). Having said that, itwas heartening to note that there were a handful of scripts which did provide aconceptually clear explanation and thus gained an L3 score.Get the focus rightThe focus of the question is on how firms determine. In other words, it is about theprocess involvedin decision making rather than just determinants per se. Looking at itfrom this perspective, the starting point has got to be the motive for investment. Firmsare assumed to be profit-maximisers hence to ensure that their investments areprofitable they have to find the so-called optimal or equilibrium level of investment giventhe prevailing rate of interest. Hence the focus is on the derivation of the optimal levelof investment(MEI=r). At this level of I, firms are expected to maximize profits.

Get the analysis rightLooking at the responses here is a list of misconceptions which need to be cleared up:

Misconception orConceptual ERRORS

Conceptually Correct

(1) Fall in i/r will lead to a fallin MEI or expected rate of

return Higher cost of borrowing

(r ) will lead to lower ratesof return (m)

Econ Principle: The MEI is derived independentlyof i/r.Therefore the conceptually correct analysis shouldbe:A fall in i/r will lead to higher level of investment asmore marginal units or additional units ofinvestments become profitable at lower interestrates.

(2) An important determinant of An important determinant of Investment is interest


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MEI is interest rate rate.

(3) If m is high theinvestment is profitable. Ifm is low the investment is

unprofitable.

If r is high the investmentis unprofitable and if r islow the investment isprofitable.

.

Got to make a clear conceptual distinction betweenProfitability vs Profitable.MEI (m) is a measure of the rate of profitability. But,

it must not be confused with profitable investment.Whether an investment is profitable would dependon the relative values of m and r. If m>r, theinvestment is profitable. However, if r>m theinvestment is unprofitable. For instance if m =5%and r =8%, it can be said that despite a return orrate of profitability of 5% on the sum of capitalinvested, the firm would end up with a loss of 3%since the funds it need to borrow to invest cost 8%and hence the investment is unprofitable.

Part (a) - Assessment objective: to test the concept of MEI (refer to lecture notesPg 11.15)Basic StructureIntroduction: KIA approach (refer to essay skills package) Investment in Capitalgoods

A. Focus on derivat ion of MEI or m.

The lower the interest rate the higher the level of investment ie more marginalor additional uni ts become PROFITABLE to undertake.

B. Focus on derivation of the optimal or equilibrium level of investment

MEI = r ruleAt any given r, the optimal level of I is where m=r. ie th is is the point whereadditional units of investment is no longer profitable.

Conclusion :Firms will invest so long as it is profitable.

Suggested essay out line to part (a)

Introduction

What are Capital Goods? Capital goods are investment or producer goods such as machines,tools and equipment used by firms or businesses to further production and not for consumption.Example: Firms such as airlines will need to invest in new equipment such as aeroplanes.

Body

A. Derivation of the MEI


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Firms are profit-driven business enterprises. The decision to invest in capital goods isbased on whether these investments are going to be profitable. Since investmentdecisions have to be taken even before the investment actually bears fruit, firms have tocompute/estimate returns based on projections of future revenue and operatingcosts for every additional unit of investment. This concept is known as the Marginal

Efficiency of Investment (MEI).

The MEI can be defined as the expected rate of profitability or returns on anadditional unit of investment. The key factors that determine the MEI are businessoutlook/expectation, corporate taxes, technology and the cost of capital asset.


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The MEI Curve or Investment Demand CurveThe investment decision process can best be explained with reference to Figure 1:Firms such as airlines will need to evaluate the expected rates of return of all theirpotential investment on capital goods (e.g. purchases of new aeroplanes) and rankedthem in descending order of profitability. With this process, the firm is able to derive an

MEI schedule or curve as shown in Figure 1.

B, Derivation of the equilibrium or Optimal level of InvestmentThe firm will need to find the optimal or best level of investment. The optimal level is theprofit-maximising level of investment. In theory, this is achieved at the level ofinvestment where the MEI (m) is equated to the current level of i/r (r): m = r

Figure 1: Determination of Optimal level of autonomous investment

With reference to Figure 1:In making investment decisions firms typically have to weigh the benefit against the costof each additional unit of investment. This is best illustrated with an example.

Assuming the current interest rate (r ) is 20%.The firm is better off not proceeding with all additional units of investment that yields anMEI of below 20%. This is because if the firm were to borrow the funds to invest from abank at an interest rate of 20%, the investment would be unprofitable. However, if thefirms were to use their own accumulated surplus or savings for investment, theopportunity cost incurred would be greater. The firm would be better off leaving its fundsin a bank to earn a higher rate of return.

On the other hand, if additional units of investment yield an MEI of more than 20%(e.g. 25%), it would be profitable for the firm to proceed to invest since the expectedrate of return more than cover the cost of borrowing the funds for investment or theopportunity costs of using the firms own accumulated savings.

It can be seen that if m>r, every additional unit of I adds to the firms profits. Converselyif r>m, every additional unit of I causes the firm to incur a loss. Hence, it stands to


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reason that the ideal or optimal of investment is reached when m=r or the yield from thelast unit of investment equals the cost of borrowed funds. With reference to figure 1, if ris 20%, the optimal level of investment is I1. At this level of investment, the firm will beable to maximize all potential net returns from investment in capital goods.

Conclusion :To sum up, firms will invest as long as it is profitableto do so.

Level Descr iptors for Question 4 (a) MEIL3

(7-8)Upper 8: Excellent, coherent in-depth explanation of firms investment decisions(both A + B)Lower 7: Good in-depth explanation of firms investment decisions - both A + B

L2(4-6)

Upper 6: Satisfactory In -depth explanation of aspect A + BMid 5: Satisfactory in-depth explanation of only aspect ALower 4: Answer attempts to cover both aspects A and / or B but is too

superficial / sketchy / skimpy

L1(1-3)

Upper 3: Major errors / flaws with the use of the relevant concepts e.g.incorrectly drawn diagrams + major misconceptionsMid 2: Mainly descriptive answer e.g. vague reference to animal spirits withoutusing the MEI frameworkLower 0-1: Wrong focus e.g. multiplier analysis


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Part (b)

Generally this part was better answered than part (a). Most could address the issues ofgrowth and unemployment associated with increased level of investment but withvarying degree of success. The good scripts, however, could cover both key issues with

adequate scope and depth incorporating pretty impressive exemplification. The weakerscripts tended to be more descriptive and some instances went off focus, writing as ifthe question is about policies to promote investment. As with part (a) there were quite afew misconceptions that needed to be corrected (refer to specific comments below).Generally evaluation and conclusion were not very impressive.

Get the focus rightWrong focus - Keynesian fiscal stimulus or using a policy-based approach.

Get the analysis right

Misconceptions Conceptually correct(1) Higher I leads to lower C True, only if the economy is operating at the frontier ofthe PPC (ie Yf).

However, this is not true if the economy is operatingwith excess capacity (ie inside the PPC frontier orbelow Yf)

(2) Increase in potentialgrowth cause anincrease in output.

Potential growth increase the capacity to produce. Byitself it does not cause an increase in output. However,it does help to prevent overheating caused by an

excessive increase in spending or AD.

(3) Hot money flows is aform of Investment

Hot money flows are not investment in the context ofgrowth and employment. They are treated as financialflows or flow of funds. Investment refers to productionof capital goods.

(4) The K effect caused ADto increase by multiple ofthe increase in injection

The K effect caused real output or income to increaseby a multiple of the increase in injection. It does notcause AD to increase.

(5) Our growth is verydependent on externaltrade since X + M =400%.

But, M are withdrawals and hence does not lead to anincrease in AD.

In the context of growth, it is the EXPORTS or externaldemand that is relevant. Therefore it is better to say, Xconstitutes about 2 times of GDP and not 400% or 4times GDP.


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(6) InappropriateTerminologyIncorrect to use the termHuman investment

The correct term is investment in human capital ieeducation and training.

Diagram Issueso To illustrate K effects it is best to use Keynesian cross diagramo To illustrate overheating it is best not to shift the AS curve (ie show the supply

bottlenecks)

Part (b) To test 3 key conceptso Investment ( various forms such as FDIs, infrastructure and education and

skills training)o Economic Growth ( macro-goal)o Unemployment ( macro-goal)

Basic StructureIntroduction : KIA

A . Focus on level of Investment and Economic Growth

Thesis - Yes, increase in investment can help achieve economic growth(1) Actual Growth

Anti -Thesis However, extent depends ono State of economy - Problem of overheatingo Nature of economy export reliant economies + weak Ko Increased leakages/withdrawals e.g. Savings, taxes, imports

(2) Potential-Growth

Anti -Thesis - However, the extent depends on.o Other determinants of potential economic growth e.g. labour supply.


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B. Focus on level of Investment and low Unemployment

Thesis - Yes, increase in investment can help achieve low unemployment(1) Cyclical unemployment -Boost AD create jobs(2) Structural Unemployment - Retraining to match workers to available jobs

(3) Frictional Unemployment -Reduce search time

Anti -Thesis: However, increase in investment may not reduce/worsenunemployment

o Cyclical investment leads to overheating.o Structural investment in new technology e.g. automation, displacing workers;

jobless recovery; investment in new industries/sectors requiring new skills e.g.casino gaming; knowledge-based such as researchers.

o Frictional The abundance of jobs may prolong search period by making job-seekers more choosy ( spoilt for choice) or picky.

Conclusion Synthesis & Stand


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Introduction:Achieving economic growth and low unemployment levels are 2 key macroeconomicgoals of an economy. The extent an increase in the level of investment in Singaporecan help to achieve economic growth and low unemployment will be discussed in thisessay.

A. Thesis Yes, increase in investment can help achieve economic growth

Actual Growth

Any increase in I will result in real or actual growth if the economy is operating below itsfull capacity.

Fig 1 Increase in real or actual growth

With reference to figure 1: In the short run, increase in I e.g. private investment such asplant and equipment causes the I component of AD to shift rightwards. Given that thereis excess capacity (unused resources), this injection of autonomous spending into thecircular flow would trigger off a K effect resulting in a magnified increase in NI from Y1to Y2. In this instance, investment benefits the economy by boosting real output oreconomic growth and creating jobs. This is likely to be the case in times when theeconomy is experiencing a recession or cyclical downturn.

Anti -Thes is However, the extent depends on.

(1) State of the economy + Problem of overheating (nominal vs real growth)However, in the SR if the economy is already operating at near or full capacity (ie Yf),any further increase in I will lead to supply side bottlenecks & an over-heated economy,resulting in only nominal increases in national income.

With reference to figure 1 above: This is illustrated by the rightward shift of AD fromAD1 to AD3. As a result, prices rise from P to P1. The economy overheats and


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economic growth, if any is in nominal terms ie higher prices. There is no real economicgrowth if the economy is already overheating.

(2) Nature of the economy

Heavy reliance on external demand to drive growthIn Singapore, the main driver of growth is X (external demand). Export revenueconstitutes about 200% of GDP. Given such a high dependence, an increase in I isunlikely to offset a slump in exports during a global recession.

Evaluative comments: However, if investment is focused on improving productivity +innovation in the export sector it would help to make exports more competitive ( ieexport cheaper and better goods + services ) and help to spur economic growth andprovide jobs for the workforce and keep unemployment low.

Weak or small multiplier

An increase in I in a form of injection in autonomous expenditure might have a smallimpact on economic growth in Singapore because of her weak k effect. This is dueto our huge leakages in the form of high propensity to import as well as save.(Note: this does not mean that there is no impact and hence Investment does nothelp EG.)

(3) Increased leakages e.g. savings, taxes and level of importsAn increase in investment might not always lead to economic growth if it is offset byhigher imports, savings and taxes ie withdrawals or leakages. For example, the countrycould be spending more on imports due to rising oil and food prices or paying moreGST as result of higher expenditure on goods and services.(i.e we are questioning the ceteris paribus assumption)

Long Run Potential GrowthIn the long run, increase in investment adds to the productive capacity or potentialoutput of the economy. e.g. more factories, roads, airports, schools etc. Moreoverinvestment in better technology, training and skills upgrading raises productivity. This isimportant to sustain economic growth over time. Without I, AD might raise faster than

AS resulting in supply bottlenecks and overheating.


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Figure 2: Actual and Potential Growth

Increasing productive capacity shifts the vertical portion of aggregate supply rightwardsfrom AS1 to AS2. This allows the economy to grow without overheating ie achieve realgrowth without inflationary pressures. However, its impact is largely felt in the long runas it takes time for investment to filter through to expansion in productive capacity.

Moreover, if potential growth or productivity gains outstrip growth in actual output theeconomy could end up with excess capacity and unemployment of resources.

Anti -Thesis : Other determinants of Potent ial Economic Growth e.g. Labourshortages

Currently, Singapore also faces growth constraints in terms of labour shortages. This isexacerbated by declining fertility rates and ageing population. Hence there is a need todepend on the influx of foreign workers.

Evaluative comments:The lack of workers or labour crunch may make it difficult to attract FDIs as well asdiscourage investment by Small and Medium Enterprises ( ie small businesses)because of higher costs and lack of manpower. However such constraints can bealleviated (note: does not completely solve the problem) by investment in technology ie

automation.

B Low unemployment

Thesis - Yes, increase in investment can help achieve low unemployment

(1) Cyclical unemployment


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Cyclical unemployment arises when the economy has excess capacity or unusedresources including available labour. To put these unused or idle resources to work,more expenditure must be injected into the economy. Increasing the level ofinvestment can help inject more expenditure to stimulate AE or AD and hence createmore jobs for unemployed workers directly via higher demand for capital goods as well

as indirectly via higher demand for consumption goods triggered off by the multipliereffects.

(2) Structural UnemploymentIncrease in investment can help reduce structural unemployment if firms invest inretraining workers (investment in human capital) to fit into jobs that require new skillsinstead of retrenching them.

(3) Frictional UnemploymentIncrease investment may help to reduce frictional unemployment if it shortens thesearch period for a job that matches job-seekers expectations. For instance, job-

seekers in SG tend to shun jobs with low status, pay and unattractive workingconditions. If firms invest in better technology to raise productivity e.g. cleaning jobsthey can improve working conditions and give such workers better pay. Job-seekersmight see the job of a cleaner operating sophisticated cleaning equipment andmachines as cool. In this respect, it is easier for such firms to fill up existing vacanciesfor cleaners.


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Anti -Thesis: However , increase in investment may not reduce unemployment

o Cyclical type if increased investment is in new areas. Although more jobs arecreated, these jobs require new set of skills which are not possessed by localworkers. Hence these job vacancies may be filled by foreign talents.

o Structural type if there is no significant investment in retraining redundantworkers or jobs created use labour saving or capital intensive methods.Economic growth might even worsen structural unemployment if is driven byrestructuring of the economy with declines in sunset industries and investmentsin new industries e.g. casino gaming for which the workforce might lack relevantskills to fill up available vacancies. Also, investment in better technology such asautomation may cause workers to be displaced by machines.

Evaluative comments:However, in Singapore, the current situation is such that the introduction of

labour-saving technology is unlikely to worsen unemployment amongst theresident workforce. The impact is more likely to fall on foreign workers as firmsare encouraged to substitute the use of cheap foreign workers with technology inorder to raise productivity.

o Frictional unemployment might worsen if investment creates more jobs causingjob-seekers to be choosier in finding suitable work. In times when jobs areplentiful, the search period might be prolonged rather than shortened as job-seekers could afford to reject work that does not match their expectations, in thehope of finding the most suitable job offer.

Conclusion :Except for periodic bouts of recession due to external factors, the economy hasgenerally experienced healthy growth and low unemployment. This is due to asignificant extent on Singapores economic strategy of relying on investment as a keydeterminant to spur growth and create jobs. Investment or capital accumulation isespecially important for Singapore where growth is constrained by the lack of naturalresources and a large growing workforce. To overcome these natural constraints,Singapore has relied upon the constant injection of investment in the form of FDIs, goodinfrastructures as well as education and training not only to achieve growth but also toprovide new as well as better jobs for its resident population.


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Level Descriptors for Question 4 (b)

L3(10-13)

Upper 12 13: Excellent in-depth, balanced and contextualized analysiscovering both aspects (A + B)

Mid 11: Good in-depth, balanced and contextualized analysis covering bothaspects (A + B)

Lower 10: Good in-depth, balanced and contextualized analysis coveringmainly aspect A.

L2(6-9)

Upper 9: Satisfactory in-depth and contextualized analysis covering bothaspects A and B.

Mid-7-8: Satisfactory in-depth and contextualized analysis covering mainlyaspect A (ie mainly on issue of overheating)

Lower 6: Satisfactory but mainly generic analysis covering mainly aspect A, OrAn answer that attempts to cover both aspects A +B, but is generic, superficialand sketchy.

Cap at 7If approach used is based on Keynesian fiscal stimulus and its limitations forstimulating economic growth and employment in SG.

L1(1-5)

Upper 4-5: Answer contains major conceptual errors/flaws.

Mid 3: Descriptive approach

Lower 0-2: Mostly irrelevant/off focus

E2(3-4)

Judgement supported by economic analysis

E1(1-2)

Unexplained judgement


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4(a) - Sample answer (adapted from Zhong Zhenyu 12S6G)

Firms determine their level of investment in capital goods by comparing two indicators calledmarginal expectation of investment (MEI) and interest rate. MEI is the expectation rate of returnof investment of a firm. Interest rate is the measurement taken by the central bank to influencethe level of economic activities.

Firms will only invest in capital goods when they think the investment will benefit their profit. Thecapacity for investment mainly comes from the banks via borrowing. Interest rate decides howmuch the firms will return to the bank. If the MEI of a firms investment plan is greater than theinterest rate, then the investment plan will be viewed as profitable and be implemented.However, if the MEI is smaller than the interest rate, firm will not process the investment plan asit is not profitable.

From Figure 1, in a market of interest rate (r) at 20%, a firm originally plans an investment incapital goods of I1, and the MEIof the investment MEI1is 35%, which is higher than the interestrate (r) which is 20%. Therefore, as the investment plan is beneficial, the firm will increase itsinvestment in such a particular capital good to maximum its profit until the investment I1increaseto I0and MEI1 decrease to MEI0which is the equilibrium and the profit will all used for returningthe interests.

On the other hand, if the firm has an investment plan of I2, and the MEI is only 10% which is

lower than the interest rate, firm will decrease the investment in capital goods and may notprocess the investment plan or not borrow from the bank for investment.

For example, Nike want to invest in China to build up factories and its marginal expectation ofreturn is higher than the interest rate in the US, it will then borrow from the banks in the US toinvest in China as it is profitable. As the cheaper coat of production in China due to the cheaperlabor cost, the Nike will have high MEI of its investment in China.

MEI1

MEI0 (r)

MEI2

MEI

Investment

E2

E0

E1

20%

Figure 1: Investment of a firm


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In conclusion, the firms will determine their level of investment in capital goods based on thesize of their MEI to the investment plan and the interest rate of bank they borrow from.


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4(b) - Sample answer (adapted from Rachel Gan 12A10)

An increase in the level of investment in Singapore has both long term and short-term benefitswhich alleviates unemployment and achieves economic growth, as a culmination of bothpotential and actual growth, respectively. However, it is only helpful to the extent where it doesnot result in inflationary pressures and alleviates cyclical unemployment, neglecting frictionaland structural unemployment.

The short-term immediate impact of an increase in the level of investment in Singapore is that itachieves actual economic growth through the reduction of unemployment. Investment is acomponent of aggregate demand, hence when investment increases, so does aggregatedemand. A stimulation of the aggregate demand will result in a chain of induced consumptioncalled the multiplier effect, magnifying the increase in aggregate demand national income. Thiscauses a rundown on existing stock, causing firms to increase production of goods henceincreasing the use of factors of production like labor and hence reducing unemployment; as ADshifts from AD1 to AD2, national output increases therefore from Y1 to Y2, and the general pricelevel increases from P1 to P2.

As shown in Fig.1, an increase in the level of investment will cause aggregate demand toincrease from AD1 to AD2, causing an expansion and growth in the economy as national incomeincreases from Y1 and Y2. However, this increase in the level of investment is only helpful to the

extent that Singapore still has spare capacity. If aggregate demand is over-stimulated by a largeincrease in investment, shifting aggregate demand from AD1 to AD3, reaching the vertical rangeof the aggregate supply curve causing demand pull inflation from P1 to P3while not achievingsimilar economic growth as the economy is already at full employment, national income willremain stagnant at Y3.This risk of overheating is extremely pertinent to Singapore who alreadysuffers from other forms of inflation, and is close to full employment at a natural unemploymentrate of 3-4%. (comment: recognizes the context and apply it in an appropriate manner)

Fig.1 Diagram of Singapores Economy


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However, this negative effect is mitigated if the increase in the level of investment is towardsincreasing the productive capacity of the economy by bettering production practices, increasingthe level of technology or training workers to be more efficient by investing in higher qualitycapital goods. This however, is a long term impact, and will take time to implement and bearfruit, during which, the economy would be experiencing inflationary pressures. This increase inthe productive capacity of the economy shifts the aggregate supply from AS1 to AS2 hence

resulting in a fall of GPL from P3 to P4while still causing an increase in national income from Y3to Y4, resulting in the ideal sustained non-inflationary growth.

Another limit to the helpfulness of an increase in the level of investment is that it only reducescyclical unemployment by stimulating economic activity. However, an increase in the level ofinvestment leading to an increase in economic growth could worsen structural unemployment aswell if the investment was towards labour saving equipment, causing a retrenchment of humanlabor replacing it with capital equipment. Another means in which it aggravates structuralunemployment is if the economic growth due to the increase in investments causes sunsetindustries to decline. If for example, the growth led to a shift in the economic composition fromlabor intensive to capital intensive industries, this would cause greater occupational immobilityleading to greater structural unemployment. Also, frictional unemployment on the other hand is

worsened as with the increase in economic growth could in turn, lead to an increase in thenumber of jobs created hence resulting in a prolonged job search period since there are moreemployment options, lengthening the time between jobs.

In the context of Singapore, an increase in the level of investment, particularly a sudden greatincrease, is of great concern since Singapore is already encroaching upon operating at fullcapacity. Furthermore, as the worlds No.1 city with the best investment potential as per theBERI Institute, it is a realistic and pressing worry. On the other hand, Singapore does notexperience much frictional unemployment such that it is almost negligible and have measureslike JobDB.com to alleviate it. Also, structural unemployment is mitigated by measures such asSpring Singapore or the Skills Programme for Upgrading and Resilience aimed at retrainingworkers and increasing the productivity of the Singaporean workforce to cope with the changing

face of the global economy. Hence, since cyclical unemployment is the main form ofunemployment plaguing Singapore, an increase in the level of investment in Singapore wouldhelp to achieve low unemployment but while it would theoretically achieve economic growth,Singapore must ensure that actual growth occurs in tandem with potential growth to curb theexacerbating inflationary risks.


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Documents

Session 2 - 2012 Promos Essays 3 4