Key Economic Goals

Microeconomic Goals
1) Efficiency in resource allocation - Allocative Efficiency - Productive efficiency 2) Equitable income distribution - Income distribution should be less unequal to ensure people can afford basic necessities (E.g. Shelter, Food, Education & Healthcare.)

Done by:

Jia Haopu

Macroeconomic Goals
1) Economic growth and high Standard Of Living(SOL) - Aims to increase output of goods and services. (Ceteris paribus, economic growth ensures that on average, a resident can enjoy a higher standard of living. 2) Low Inflation - Economic growth should be coupled with low inflation to ensure economic competitiveness, sustained economic growth and a higher SOL. 3) Reduce Unemployment (Full Employment of Resources) - The economy should aim to achieve full employment to ensure that scarce resources are fully utilized. - Unemployment is largely related to social stability. (Crime rates etc.) 4) External Stability - This is reflected in a stable exchange rate with a healthy Balance Of Payments (BOP). - A stable exchange rate reduces uncertainty, which promotes international trade and economic growth.

Economic Growth
Definition: Economic growth refers to actual and potential growth. It can be achieved by increase in AD &/or AS. Actual Growth is the increase in national output actually produced for a given period of time, measured by percentage increase in real GDP. (AD shift rightwards, AS shift downwards.) Potential Growth is the increase in productive capacity of the economy for a given period of time through an increase in resources and/or increase in efficiency of which resources are used. (Represented by AS Outward shift)

Benefits from Economic Growth

a) b) Higher Material Living Standards More goods and services available for consumption. Easier to redistribute income ad help poor A rapidly growing economy can affords to be more generous to the disadvantaged. Rise in NY provides govt. with more funds for policies to alleviate poverty. c) Increased savings and Investment - NY increase absolute savings increase. - Marginal Propensity to Save (MPS) increases with higher income levels as people start to consume increasingly less out of extra income. - With increase in absolute savings increase in supply of loanable funds interest rates fall in long run greater incentive for firms to invest greater capital expenditure potential capacity increase. d) Decrease Unemployment - Economic Growths creates jobs since increase in NY increase in AD firms increase production to keep up with increase market demand employ more workers.

Costs of Economic Growth

a) Current Opportunity Cost - Resources have alternative uses. To achieve higher rate of economic growth, resources are used to produce capital goods instead of consumer foods, compromising current material living standards. b) Inequality of Income Distribution - Growth propagates inequality in income distribution within a country. Main beneficiaries are rich people who have savings that enable capital accumulation and gain from investments. c) Environmental Costs - Higher rate of growth Higher costs on environment. - Growth encourages creation of artificial needs and consumers tend to buy unnecessary things which leads to wastage of resources. - Natural resources are rapidly depleted. - Pollution arises.

Causes of Weak/Negative Economic Growth

a) b) c) Lack of Aggregate Demand AD must keep in pace with AS in order to absorb the goods produced, or else economy will lie idle. Low rate of Investment Lack of capital accumulation affect productive capacity affect potential growth. Low Savings Rate To have more funds for investment, a low savings rate is needed, especially when in lack of FDI. (Low income, low interest rates, Erosion of traditional virtues of saving, Increase in social security, Expectations of future inflation, High income tax.) d) Lack of Natural Resources - Affect inputs in the production of goods and services. - Increase in natural resources increase in AS. (However, whats most vital is entrepreneurship.)
e) f) -

Poor Human Capital Quantity and Quality of workforce. (E.g. skilled labour) Efficiency of workforce (Labour productivity) Lack of Technological Advancement R&D increase efficiency Affects cost of production.

In the long run, the education system improves quality of human capital, but in the short run, reduces labour force.

g) External Shocks

h) -

Governmental failure in economic policies. E.g. Too high interest rates) May lead to recession. (E.g. Oil prices rocket.) Political Situation Corruption Political Instability

Consequences of Weak/Negative Economic Growth

a) b) c) Unemployment and Lost Output Lower Savings and Consumption Lower Investment and Long term Growth

(Opposite of Benefits)

Inflation
Definition: Inflation is a situation where there is a sustained increase in the general price level.

Causes of Inflation Demand-Pull Inflation - Caused by persistent increase in AD. (Usually associated with a booming economy.) - As AD increase, the economy s spare capacity is sued up gradually and it approached full employment. Labour and raw material shortages make it difficult for firms to expand production to meet rising demand. Thus, if AD continues to increase, it will lead to a higher inflation.

Cost-Push Inflation a) b) c) d) e) Caused by rising production costs during periods of low unemployment. (Factor production) Wage-push Inflation Profits-Push Inflation With higher costs of production, market forces push the prices up in order to achieve higher profit. Inflation due to price increase in raw materials Import-Induced Inflation Structural Inflation

Consequences of Inflation
Uncertainty: Affects cost of production for local/external firmsaffects cost of productioninvestment. Misallocation of resources. Deterioration of BOP Domestic inflation increase price of exports, thus affect the country s economic competitiveness in the global market (goods appear more expensive) decrease in exports. - This also makes imports appear relatively cheaper increase in value of imports exports less than imports BOP deteriorates may result in debt over a long period. 4) Depreciation of country s currency - Inflation will lead to deterioration of BOP due to fall in quantity demanded for country s exports by foreigners. - At the same time, greater demand for imports leads to an increase in supply of local currency to buy foreign exchange to pay for its imports supply of local currency increases/demand falls currency depreciates. 5) Fall in real value of savings (disposable income) 6) Arbitrary redistribution of income (real income) - The poor are more affected by increased price levels as compared to the rich, since their income is largely spent on necessities while the rich may save up the excess income. 7) Shoe-leather Costs - Time and effort wasted as people try to minimize their holdings of money. (Inflation reduces value of money) 8) Menu costs - Cost constantly revising price lists, tags as well as catalogues. Increase in opportunity cost. 1) 2) 3) -

Unemployment
Causes of Unemployment Frictional Unemployment Structural Unemployment Cyclical Unemployment Result of Market Imperfections: Due to recession. Firms unable to sell a) Imperfect Knowledge their current level of output cut - Ignorance of available jobs down on production reduce b) Geographical Immobility employment. Consequences of Unemployment 1) Output loss to Economy 2) Negative Impact on government budget (Unemployed do not pay tax) 3) Increase in Social Instability: crime rates, depression, child abuse, divorce, suicide.

Balance of Payments (BOP)

Definition: The record of a country s international transactions between its residents and the rest of the world over a period of time.

Causes of BOP deficit Current account deficit (exports less than imports) 1) Cyclical factors: change in NY and inflation rate. 2) Structural factors: Changes in Tastes and preferences. 3) Exchange rate: Economic competitiveness (Goods more expensive as exchange rate rises) 4) Government policies: Protectionism 5) Terms of Trade 6) Random Factors (disasters and stuff)

Capital & Financial Account Deficit 1) 2) 3) 4) Expected Rate of Return (Subsidies,tax) Investment COP Relative Interest rate Expected exchange rate movements Exchange control Regulations

Consequences of Persistent BOP Deficit

1) Rise in external debt 2) Fall in national output and employment (through AD) 3) Unemployment in Domestic Economy (due to loss in FDI)

Consequences of Persistent BOP surplus

1) 2) 3) 4) 5) Depression of Domestic SOL Country producing more than it can consumecountry is enjoying a lower living standard than it could. Inflation (Injection of AD through the circular flow of income multiplier effect) Retaliation Other countries retaliate though import controls in order to reduce the deficit. Dutch disease Effect Employment opportunities create more jobs due to increasing FDI (capital account surplus)

Fiscal Policy
Definition: Fiscal policy is the deliberate management of government spending and taxation designed to influence the level of economic activity in order to achieve the economic goals of the government.

ECONOMIC GOALS IN FISCAL POLICY

Microeconomic 1) To achieve a more efficient resource allocation. 2) To achieve a more equitable income distribution. Macroeconomic 1) 2) 3) 4) To smooth out the ever-present fluctuations in economic activity To promote economic growth To push the economy closer to full employment without inflation To maintain price stability

Rationale: According to Keynes, private consumption and investment expenditure are based on self-interest. While this can provide economic growth, it may result in excessive inflation or serious unemployment. Thus, government action is necessary to achieve or maintain the economic goals of the government. Fiscal Policy Tool The Budget In order for the government to carry out its microeconomic and macroeconomic functions, the government carefully plans its expenditure and raises its taxes and other revenue during the process of drawing up its annual budget. The annual budget is a major instrument on economic management. Budget deficits and surpluses are deliberately planned (discretionary fiscal policy) to impact the economy.

SOURCES OF GOVERNMENT REVENUE

1. Taxation

Taxes are compulsory payments made by individuals or firms in the private sector to the government without any services rendered in return. It involves a transfer of funds from the private sector to the government.

2. Sale of Goods and Services, including: a) State Enterprises fees from postal, telecommunications and public utilities services earnings from commercial and industrial undertaking, state trading. b) Investments in Securities by the Government Investment Corporation of Singapore (GIC).

c) License fees and fines

littering fines.)

(E.g. marriage license, hawker s license, and

TAXATION
Direct Taxes Direct taxes are taxes on income and wealth paid direct to the government. The burden of such taxes is usually borne by the person or company paying the taxes, i.e. direct tax cannot be passed on to others. Impact and incidence is usually on the same party and is not easily shifted. [Main direct taxes in Singapore are personal income taxes and corporate taxes.] Impact of taxation refers to the person, company or transaction on which a tax is levied. The party is responsible for handing the levy to the tax authorities. Indirect Taxes Indirect Taxes are taxes on expenditure or production of goods and services. They are called indirect taxes because although the producers are legally liable to pay the taxes to the Government, it is often the consumer who will bear the burden of the tax. The impact and the incidence may not be on the same person. [Main indirect tax in Singapore is Goods & Service Tax (GST).

Incidence of taxation refers to the eventual distribution of the burden of the tax (shows how tax burden can be transferred from one party to another.) Proportion of tax burden borne by buyers and sellers depends on relative elasticities of demand and supply of the good. Average tax rate (ATR): the proportion of total income paid in taxes. [Total Tax Payable/Total Income] Regressive Tax a) Tax rate decreases as income increases. (Smaller proportion from rich) E.g. Indirect taxes on goods and services especially on necessities since poor spend more on necessities.

TAX STRUCTURE
Marginal Tax Rate (MTR): the proportion of additional income paid in taxes. [Change in Taxes paid/Change in income] Proportional Tax - Tax proportional to income E.g. Corporate Tax.

Progressive Tax a) Tax rate increase as income increases (Larger proportion from rich) b) Takes into account ability to pay c) Helps reduce income disparity.

ECONOMIC EFFECTS OF DIFFERENT TYPES OF TAXES

1. Production a) Incentive to work (Labor Supply) - High income taxes, especially progressive types, will encourage absenteeism and discourage overtime work. It may reduce labor supply, production and income. - Changes in labor supply depend on relative strengths of income and substitution effects of tax: Income Effect: With higher taxes, people cannot afford to have same amount of both leisure and goods/services as before. Thus, they sacrifice some of each by cutting their consumption and working more. The more they work, the less they have to cut down on their consumption. Higher taxes encourage people to work more. Substitution Effect: With higher taxes, an hour s work buys less consumption than before, but it still involves the sacrifice of an hour s leisure. Conversely, an extra hour taken in leisure now involves smaller sacrifice in consumption. Higher taxes encourage people to work less.

The net effect is uncertain. (Depends on commitments) E.g. Debt/Children b) Incentive to take risk (Enterprise) - Entrepreneurs earn profits, a reward for risk taking. Higher corporate tax rates reduce after-tax profits, hence taking away a larger part of the reward for risk-taking. Affect Investment - Tax incentives to encourage entrepreneurial firms (start-up firms). Important due to the high degree of capital mobility and competitive corporate tax rates in the region. 2. Resource Allocation - Tax incentives e.g. tax deductions for local R&D will influence allocation and production of goods & services. - Taxation may also influence supply of labor E.g. high progressive income tax may trigger an outflow of talent to countries where taxes are lower. - Indirect Taxes like GST raise prices and increase the number of tax accountants and other administration staff needed by firms to comply with these taxes.

3. Savings - Heavy progressive income taxes, high capital transfer taxes and wealth taxes reduce the ability and willingness to save. This in turn will reduce the pool of loanable funds available for capital formation (investment). 4. Investments - Lower corporate tax could increase the financial capital available for investment. For example, a corporate tax cut will increase the profitability of firms and therefore increase the level of investments. (There are many other factors) - At the same time, tax cuts may increase government budget deficit, causing government to borrow more pushes up interest rate reduces private investments (crowding-out-effect). Thus, overall effects of corporate tax is uncertain. 5. Inflation - Indirect taxes levied on goods & services increases prices of goods and hence cost of living workers demand higher wages if such demands are met, price will rise even further, resulting in an inflationary spiral. - On the other hand, increasing direct taxes reduces disposable income and thus aggregate demand, thus prices fall. (Thus, indirect taxes are inflationary while direct taxes are deflationary.)

Types of Fiscal Policy

Discretionary Fiscal Policy a) Expansionary Applied when economy is operating below full employment. There is a need to stimulate AD to get the economy out of recession. A budget deficit (G >T) can be planned by either increasing G and/or T. b) Contractionary This is used to close an inflationary gap, or during periods of excess demand and inflation to curb AD. The government plans a budget surplus (G<T) by reduce G or/and increase T. Non-Discretionary: Built in Stablisers

Limitations of Fiscal Policy

1) 2) 3) a) Size of Multiplier (Leakages) Time Lag Crowding Out Effect Domestic Investment: Decline in private expenditures as a result of an increase in government spending. Assuming the government does not finance an increase in its budget deficit by increasing money supply, it will have to borrow money from non-bank private sectors competing for scarce funds with private sector raises interest rate reduction in investment by private firms. b) Open Economy: When there is expansionary fiscal policy, domestic interest rates rise.