(a) What are the determinants of consumption expenditure in Singapore?
[10]
(b) Discuss whether an increase in the consump...
payments on national debt will lead to an increase in disposable income. The disposable
income of Singapore usually change...
(b)
The effects of an increase in the consumption expenditure in Singapore on the
economy can be discussed in terms of the...
run, assuming the net investment is initially positive. Therefore, the aggregate supply in
Singapore will rise more rapidl...
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Q.75 consumption-and-singapore

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Q.75 consumption-and-singapore

  1. 1. (a) What are the determinants of consumption expenditure in Singapore? [10] (b) Discuss whether an increase in the consumption expenditure in Singapore is desirable for the economy. [15] (a) Consumption expenditure is the expenditure made by households on goods and services. When discussing the determinants of consumption expenditure in Singapore, it is useful to distinguish between induced consumption and autonomous consumption as they have different determinants. Induced consumption is the part of consumption that depends on disposable income. Induced consumption is positively related to disposable income. In other words, an increase in disposable income will lead to an increase in induced consumption and vice versa. The consumption function shows the consumption expenditure of households at each disposable income. An increase in induced consumption can be shown by an upward movement along the consumption function. In the above diagram, an increase in disposable income (Yd) from Yd0 to Yd1 leads to an upward movement along the consumption function (C) resulting in an increase in consumption expenditure (C) from C0 to C1. The effect of an increase in disposable income on consumption will depend on the marginal propensity to consume. Given any increase in disposable income, the larger the marginal propensity to consume, the larger the increase in consumption. The marginal propensity to consume in Singapore is small due to the high savings. Disposable income could increase due to several reasons. For instance, disposable income will increase when national income increases. A decrease in direct taxes such as personal income tax and corporate income tax, or an increase in transfer payments such as unemployment benefits, social security benefits and interest © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  2. 2. payments on national debt will lead to an increase in disposable income. The disposable income of Singapore usually changes due to a change in the national income. Autonomous consumption is the part of consumption that does not depend on disposable income and is determined by consumer confidence, the wealth of households, interest rates, expectations of price changes, the availability of credit and the distribution of income. An increase in autonomous consumption can be shown by a vertical upward shift in the consumption function. In the above diagram, a vertical upward shift in the consumption function (C) from C 0 to C1 leads to an increase in consumption expenditure (C) from C0 to C1 at the same disposable income (Yd0). Autonomous consumption could increase due to several reasons. In Singapore, the major determinants of autonomous consumption are consumer confidence and the wealth of households. For instance, the Singapore economy is rather export-dependent due to the small domestic sector. Therefore, a strong external economic environment of Singapore will lead to a rise in consumer confidence which may result in a large increase in consumption. Singaporeans hold a larger proportion of their wealth in the form of properties. Therefore, a property bubble in Singapore will lead to a large increase in the wealth of households which may result in a large increase in consumption. Although interest rates, expectations of price changes, the availability of credit and the distribution of income also affect consumption in Singapore, they are minor determinants. For instance, interest rates in Singapore are low and the general price level is generally stable. Therefore, they rarely change substantially. In conclusion, consumption expenditure is a small component of aggregate demand in Singapore. Therefore, the Singapore government is not concerned with controlling consumption expenditure to maintain the good health of the economy. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  3. 3. (b) The effects of an increase in the consumption expenditure in Singapore on the economy can be discussed in terms of the effects on the balance of payments, the national income, unemployment and the general price level. An increase in the consumption expenditure in Singapore will lead to an increase in the aggregate demand and hence the national income. 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 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, an increase in aggregate demand will lead to a larger increase in national income and this is commonly known as the multiplier effect. Since national income is equal to national output, the increase in the national income of Singapore due to the increase in the aggregate demand 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. An increase in the consumption expenditure in Singapore may strengthen business sentiment which will lead to an increase in the investment expenditure. An increase in the investment expenditure in Singapore will lead to an increase in the aggregate demand and hence the national income. Further, when the investment expenditure in Singapore rises, the production capacity will rise more rapidly in the long © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  4. 4. run, assuming the net investment is initially positive. Therefore, the aggregate supply in Singapore will rise more rapidly in the long run. Aggregate supply is the total supply of goods and services in the economy over a period of time. When this happens, assuming the aggregate demand in Singapore is rising, which is the normal state of the Singapore economy, the national income will rise more rapidly, unemployment will be lower and the general price level will rise less rapidly. An increase in the consumption expenditure in Singapore will rebalance the economy towards a greater dependence on the domestic sector. When this happens, the Singapore economy will become less susceptible to external demand shocks and hence more stable. Although an increase in the consumption expenditure in Singapore can be desirable for the economy, it can also be undesirable. An increase in the consumption expenditure in Singapore will lead to a deterioration in the balance of payments. The balance of payments is a record of all the transactions between the residents of the economy and the rest of the world over a period of time and is made up of the current account and the capital and financial account. Since a fraction of the increase in the consumption expenditure in Singapore will be made on imported goods and services, the current account and hence the balance of payments will deteriorate. 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. In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to a rise in the general price level (P) from P0 to P1. This is especially undesirable if the Singapore economy is over-heating. The increase in the national income and the general price level in Singapore will lead to a deterioration in the balance of payments. When the national income in Singapore rises, the imports will rise. Further, the rise in the general price level will make Singapore’s goods and services relatively more expensive than foreign goods and services resulting in a decrease in the net exports. Therefore, the current account and hence the balance of payments of Singapore will deteriorate. In the final analysis, an increase in the consumption expenditure in Singapore is likely to bring about more benefits than costs to the economy. To the extent that an increase in the consumption expenditure in Singapore leads to an increase in the investment expenditure, economic growth will be higher both in the short run and in the long run. Although inflation in Singapore will be higher in the short run, it will be lower in the long run. However, due to the culture of thrift in Singapore, any increase in the consumption expenditure is unlikely to be significant. Further, consumption expenditure is a small component of aggregate demand in Singapore. Therefore, the effect of an increase in consumption expenditure on aggregate demand is likely to be small in Singapore. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek

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