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Q.91 labour-productivity-and-macroeconomic-goals

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  • 1. (a) Explain the four macroeconomic goals of a government. [10] (b) Discuss whether increasing labour productivity in Singapore would achieve macroeconomic goals. [15] (a) The four macroeconomic goals of a government are high economic growth, low unemployment, low inflation and a balance of payments equilibrium. High economic growth will lead to a rapid rise in the standard of living. Economic growth is an increase in real national income or real national output over a period of time. Although there is no standard measure of the standard of living, it is commonly believed that the welfare of the people depends to a large extent on the amount of goods and services available for consumption and this is directly, though not perfectly, related to national output. High economic growth will also help the economy achieve full employment and will put the government in a good position to redistribute income from high income groups to low income groups. Low unemployment helps the economy avoid the adverse effects of high unemployment. Unemployment is the state of the economy in which some workers are not employed in the production of goods and services. High unemployment will cause the economy to lose a large amount of output. It will cause a large number of people to lose their income. Further, if the unemployed remain unemployed for a long period of time, they may lose their skills and knowledge. When unemployment is high, the employed will lose some of their income in the form of pay cut. High unemployment will cause firms to lose a large amount of profit. When unemployment is high, the government will lose a large amount of tax revenue. High unemployment will lead to a high crime rate, high divorce rate, high suicide rate and social unrest. Low inflation helps the economy avoid the adverse effects of high inflation. Inflation is a rise in the general price level over a period of time. Monetary economists, however, define inflation as a sustained rise in the general price level and refer to a oneoff rise as a price shock. When inflation is high, nominal interest rates will not fully compensate for the rise in the general price level which will reduce the amount of goods and services that can be purchased with any given amount of savings. When inflation is high, domestic goods and services may become relatively more expensive than foreign goods and services. If this happens, net exports will fall. Since high inflation tends to be less stable, firms will find it harder to estimate the costs and revenues of investments when inflation is high which will lead to a decrease in investment expenditure. High inflation will lead to a high menu cost and a high shoe-leather cost of inflation. A balance of payments equilibrium helps the economy avoid the adverse effects of a persistent balance of payments disequilibrium. The balance of payments is a record of all the transactions between the residents of the economy and the rest of the © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  • 2. world over a period of time. A persistent balance of payments deficit, which occurs when money outflows persistently exceed money inflows, may lead to adverse consequences such as high imported inflation, high cost-push inflation, falling national income, rising unemployment or rising foreign debt, depending on the exchange rate system. A persistent balance of payments surplus is also undesirable because if the surplus had been used to purchase imports, the standard of living would have been higher. In conclusion, macroeconomic problems will occur if macroeconomic goals are not achieved. Therefore, the government should implement policies to ensure that this does not happen. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  • 3. (b) Labour productivity refers to output per hour of labour. The question on whether increasing labour productivity in Singapore would achieve macroeconomic goals can be discussed in terms of the effects on the aggregate demand and the aggregate supply. Increasing the labour productivity in Singapore will lead to an increase the aggregate supply which may achieve macroeconomic goals. Aggregate supply is the total supply of goods and services in the economy over a period of time. An increase in the labour productivity in Singapore will lead to a fall in the cost of production. Further, to increase the labour productivity in Singapore, the government needs to increase the productivity of labour and the productivity of capital which will lead to an increase in the production capacity. When this happens, the aggregate supply in Singapore will rise. When the aggregate supply in Singapore rises, the national income will rise which will lead to higher economic growth. In the above diagram, an increase in aggregate supply (AS) from AS0 to AS1 leads to an increase in national income (Y) from Y0 to Y1. Since national income is equal to national output, the increase in the national income of Singapore will lead to a rise in the demand for labour resulting in a fall in unemployment, assuming the size of the labour force remains the same. The increase in the aggregate supply in Singapore will lead to a surplus of goods and services and hence a fall in the general price level (P) from P0 to P1. However, if the aggregate demand in Singapore is rising, which is the normal state of the Singapore economy, the general price level will rise at a slower rate which will lead to lower inflation. Lower inflation in Singapore may make Singapore’s goods and services relatively cheaper than foreign goods and services. If this happens, the net exports of Singapore will rise which will lead to an improvement in the current account and hence the balance of payments. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  • 4. Increasing the labour productivity in Singapore may lead to an increase the aggregate demand which may achieve macroeconomic goals. Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports. In an attempt to increase the productivity of labour and the productivity of capital in Singapore, the government may set up more educational institutes and research institutes which will lead to an increase in the government expenditure. Further, the investment expenditure in Singapore may increase if the government incentivize firms to invest in efficient production technologies. If these happen, the aggregate demand in Singapore will rise which will lead to an increase in the national income resulting in higher economic growth. In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to an increase in national income (Y) from Y0 to Y1. When aggregate demand rises, firms will employ more factor inputs to produce more output and hence pay more factor income to households. Household income and hence consumption expenditure will rise. Due to the increase in consumption expenditure, firms will employ even more factor inputs to produce even more output and hence pay even more factor income to households. Household income and hence consumption expenditure will rise further. Therefore, the increase in aggregate demand will lead to a larger increase in national income and this is commonly known as the multiplier effect. Increasing the labour productivity in Singapore may not achieve macroeconomic goals. The increase in the aggregate demand in Singapore will lead to a shortage of goods and services and hence a rise in the general price level resulting in higher inflation. When the national income of Singapore rises, the imports will rise which will lead to a deterioration in the current account and hence the balance of payments. Investment expenditure and government expenditure are small components of aggregate demand in Singapore. Therefore, the increase in the aggregate demand and hence the national income of Singapore may be not be significant. Further, the increase in the government expenditure in Singapore incurred to increase the labour productivity may © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  • 5. lead to a persistent budget deficit. If this happens, the Singapore government debt may reach a critical level which may lead to a sovereign default resulting in a fall in the national income and hence a rise in unemployment. In the final analysis, to achieve the four macroeconomic goals, the Singapore government must achieve a sustained increase in aggregate demand and aggregate supply. To the extent that labour productivity can be increased continually to achieve a sustained increase in aggregate supply, it is an effective policy. This is particularly true in Singapore in view of the small land area which leads to limited room for increasing the amount of labour. However, due to the limited effect of this policy on the aggregate demand in Singapore, the government should complement it with policies that will boost aggregate demand. Given that the Singapore economy has a small domestic sector, trade policy such as signing more free trade agreements to increase exports can be effective for increasing the aggregate demand. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek

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