JC Economics Essay Balance of Trade & Macroeconomic Policies Model Answers
For a small and open economy, the balance of payments (see SG’s BOP data here.) is one of the more important macroeconomic objectives of Singapore. The BOP summarises the transactions between Singapore and the rest of the world (ROTW), many changes in the global and international economy may affect a country’s Current Account and Capital & Financial Account.
here, we are only concerned with the Current Account
In the H2 Econs Syllabus (Code: 9757), the BOP and exchange rates are considered the external macro econs objectives. And in Year 2021, cos of the striking off of the CLT, there are very important indeed for Macro Econs.
(In some countries, exchange rate is not considered an macro goal. Why?)
The following question (with full length sample answers) demonstrates how the balance of trade (BOT) in the Current Account (part of BOP) is affected, and S’pore’s policies options in tackling such an issue.
The USA current account deficit widened sharply in the fourth quarter of 2014 and was the largest since 2012.
Source: Reuters March 2015
(a) Explain the main reasons that can account for the widening USA balance of trade deficit in her current account. 
(b) Discuss whether Singapore would tackle a worsening balance of trade balance differently from USA. 
JC Economics Essay – Current Account & Balance of Trade (BOT)
Suggested Answer Part (a)
Define Balance of Payment (BOP), and and Current Account (CAcc)
Acknowledge that the current account comprises the following accounts:
Visible Trade Balance (Good or Tangible balance)
Invisible Trade Balance (Services or Intangible balance)
Net Income Flows (Primary Income or Net Factor income From Abroad)
Net Current Transfers (Secondary Income or Unilateral Transfers)
Both Goods and Service Trade Balance from the Balance of Trade (BOT)
Reasons can be catergorised into 2 types: Reasons affecting BOT or trade balance (Visible and Invisible Trade Balance) and other components (Income Flows and Current Transfers)
Factors impacting the Trade Balance (Visible + Invisible Trade Balance)
1. Relative inflation rate
Domestic costs and prices in the US may rise faster than costs and prices abroad thus exports will be relatively more expensive than those of competitors abroad and imports will be relatively cheaper compared to the domestically produced goods. This leads to a rise in the demand for imports and a fall in the quantity demanded for exports, The increase in import expenditure would depend on the cross elasticity of demand (CED or XED). The greater the XED value, the higher will be the increase in import expenditure. The change in export revenue would also depend on the price elasticity of demand for exports, where a price elastic demand for exports would lead to a decrease in export revenue. The increase in import expenditure and decrease in export revenue would hence result in a fall in level of (X-M) a widening US trade balance deficit.
In fact, due to quantitive easing (QE) carried out by the US’s Federal Reserve, this may result in higher domestic inflation rates compared to trading partners, that increase the price of US exports and make the imports relatively cheaper.
(Qn: Is the point on imports and the use of XED necessary?)
2. Relative Incomes (Relative higher economic growth rate)
A rise in national income of US relative to other countries, especially major trading partners such as the Eurozone economies would raise the country’s Imports relative to its exports. This is especially since the Eurozone economies have been hit by slow growth/recession in the aftermath of the Greece crisis. As US Income Increases, the demand for imports as a form of form of consumption good will increase, resulting in the worsening of the trade balance and hence the current account of the balance of payments. This is especially so if the marginal propensity to import for the US is high. Alternatively, income elasticity of demand (YED) for imports can be used to explain the trade deficit. The higher the YED, the greater will be the percentage change in demand for imports given a percentage change in income. This would lead to a greater increase in import expenditure.
3. Long-Term Changes in International Trading Patterns
Over time the pattern of imports and exports are likely to change as . consumer tastes and preferences change, the nature and quality of goods change, and also technology changes
Indeed, globalisation and the prevalence of outsourcing due to technological advances has seen manufacturing activities migrating to lower cost and more innovative countries such as China. US’s goods are thus becoming less competitive and exports less attractive compared to other countries’ goods. Thus the decrease in export revenue would lead to a widening BOT deficit.
4. Deterioration in Terms of Trade
The terms of trade (TOT) is defined as the quantity of imports that can be exchanged for one unit of the country’s exports, and is given by the ratio of the export price index to the import price index. A decline in a country’s terms of trade means that the country would earn less from its exports relative to its expenditure on imports, assuming quantities remain unchanged. It will thus be more likely to experience a trade deficit and therefore a current account deficit.
In the case of USA, the income elasticity of demand of US’s exports (such as high end computers) tend to be higher relative to US’s imports (basic electronics) This means that during the global recession that accompanies the Global Financial Crisis, there is a deterioration of US’s terms of trade and assuming price inelastic demand for imports and exports, this lead to a widening BOT deficit.
(Qn: Is this point on TOT a strong factor?)
5. Relative Productivity
US productivity may lag behind that of other countries, especially when compared to its Contextualisation trading partners. Labour productivity is measured by output per labour input (cost of labour) Productivity in the US could be falling relative to other countries due to poorer skills of its workforce. This is true especially when compared to other developed countries. The weak US educational system, which is hampered by structural rigidities ( most obvious examples are labour market rigidities and tax disincentives) and lack of funding that has reduced the productivity of the average US worker. In this case, the country’s exports become less competitive relative to other countries and its domestic goods and services may also be less competitive compared to imports from other countries, thus leading to a widening the BOT deficit.
6. Persistent overvaluation of the country’s currency (US currency appreciation)
The US dollar could be overvalued relative to its actual purchasing power parity level due to its attractiveness as a reserve asset, use as an international currency or speculative demand. Despite concerns about the stability of the US political system and its huge national debt, the US currency is often seen to be a safe haven, which increases the demand for the currency. ⇒ appreciation. in US$.
The US dollar could also be overvalued due to other countries such as China, devaluating /depreciating their own currency that makes the US dollar overvalued. The overvaluation of the currency makes the country’s exports less competitive relative to other countries, thus widening the BOT deficit.
(Note: US demand for export is price elastic due to many Subs ↑ P , qty demanded fall by more than proportionate. Also more than PEDM > 1 as many thing are produced in USA.)
(Note: high PED value ⇒ trade value to worsen considerably (Marshall-Lerner Condition or MLC is fulfilled. For 9757 syllabus, it is sufficient to just highlight that demand for exports price elastic or PED x> 1))
Provide a simple analysis of the significance of the different reasons for the current account deficit.
A-level Economics Tuition teacher’s Comments:
1. Qn focuses on BOT only. If focuses on entire Current Account, then following point will also be valid:
2. Factors affecting other components of current account
a) Net Income Flows
Net income flows from abroad consists of: labour income (of resident households received from non-resident employers or paid by resident employers to non-resident workers), rent, interest, profits and dividends received from or paid to the rest of the world..
In the US, there are many companies that have invested abroad such as Apple and they have been reluctant to repatriate their profits back to the US and have chosen to re-invest the profits generated into the economies overseas due to more opportunities overseas.
b) Net Current Transfers
This comprises transfers of money from one country to another not in exchange for goods and services, and which do not involve transfer of ownership of fixed assets. United States of America currently has a huge migrant population (both legal and illegal), especially from Mexico and the other Latin American countries. The remittances back to their home land constitutes a significant outflow and contribute to a widening current account deficit.
US provides aid to many countries (both military and economic) and recent humanitarian aids (e.g. Ebola epidemic in Western Africa) have increased the transfers outflow.
3. General Comments:
Candidates generally provided theoretical answers that are both lacking in rigour and contextualisation. Answers are thus generally short and only 1 page long due to time constraints. As a result, many candidates achieve only a low L2 mark.
Most of the candidates did not provide consideration of the context of US in 2014 and factors used did not directly address the issues of hand. There was also a minority where the candidates provide factual inaccuracies, such as the US being the world’s largest exporter of crude oil, to support their analysis. There is a significant group of candidates who also believe that there are many Chinese migrant workers in US which is not factually accurate. This points to a lack of www general knowledge of candidates which is alarming.
Also, many A-Level Econs students restrict their analysis to the worsening balance of trade to price factors only. Others did not have insufficient rigour in their analysis without use of economic concepts to support their points. Elasticity concepts should have been used in examining the effects of the different changes. Some candidates were unsure of the components that made up the current account and a minority went on to confuse components in capital and financial Account with those in the current account.
5. Structure & Organization:
A minority of candidates tend to do a listing of the different factors affecting current account deficit rather than concentrating analysis on 3/4 key factors. There are also a small number of candidates who chose to break up the components of current account for analysis rather than focusing on key factors. For instance, candidates chose to analyse either the fall in export revenue or increase in import expenditure independently when candidates should be focusing on underlying causes such as relative inflation, etc, which affect exports and / or imports.
Candidates are not using the proper terminology to explain changes in rate. Instead of using correct terms like “appreciate” and “depreciate”, candidates used words like “increase” and “decrease” instead.
Candidates should also note the proper terms in analysing elasticity concepts. For example, “demand for exports is price elastic” instead of “exports is elastic” or “Price elasticity of demand for exports is high” instead of “Price elasticity of demand for exports is price elastic” A minority of the candidates did not understand the significance of the word “relative” when examining changes in income and prices. This is especially important in the analysis of prices, where it is the relative prices that result in changes in the demand for imports and exports. A minority of the candidates are still confused in the use of quantity demanded and demand when explaining changes in exports and imports.
H2 Part A Econs Essay Mark Scheme:
Level 3 (7-10) :Excellent knowledge of significant and relevant economic theories and concepts throughout analysis
– Analysis is accurate, precise, logical and well-elaborated (Depth)
– Highly relevant and appropriate use of contextualised examples relevant to the US (Depth)
– Excellent coverage/scope of concepts (Breadth) with examination of at least 3 reasons for the widening current account deficit Accurate use of economic terminologies (Phrasing) to examine current account deficit
Overall structure and organisation
– Logical, coherent and systematic flow of idea
-Strong and meaningful linkages between ideas
Level 2 (5-6): Some knowledge of significant and relevant economic theories and concepts in analysis
– Analysis is largely accurate, precise, logical and elaborated.
– Example(s) may not be highly relevant and appropriate to the US
– Limited coverage / scope of concepts
– Some inaccuracies in the use of economic terminologies, but does not contain major errors
Overall structure and organisation
– Ideas may not flow in a logical, coherent and systematic way
– Ideas may not be meaningfully linked
Level 1 (1-4): Economic theories and concepts are largely irrelevant
– Statements fail to express an understanding of economic concepts
– There is little evidence of economic analysis
– No relevant and appropriate use of examples
– Essay contains significant inaccuracies in terminologies, concepts and/or diagrams
JC Economics Essay – Balance of Trade (BOT) Policies of SG & USA
Part (b) Suggested Answers:
Brief examination of the similarities and differences of US (large, less open economy) versus Singapore (small, open economy)
Note that there are two types of policies to deal with a worsening current account balance:
a. Policies to deal with a worsening trade balance
As trade (both visible and invisible) is often the largest component of the current Account, policies to deal with a worsening trade balance will be most significant in dealing with a worsening current account balance. For policies dealing with trade balance, there are 3 types of policies Expenditure reducing policies: contractionary fiscal/monetary policies, Expenditure switching policies protectionist and free trade policies: exchange rate policy, , as well as Supply side policies.
Expenditure switching policies: These policies aim at changing the prices of foreign goods relative to domestic goods so as to: switch the expenditures of domestic households from foreign goods to domestic goods to reduce imports switch the expenditures of foreign households from goods produced abroad to goods produced at home to increase export
Thesis: Singapore would tackle a worsening current account balance in a similar manner as the US
1. Supply-side policies (to increase productivity/quality of products)
In an increasingly globalised and competitive world, both the US and Singapore face the need to increase productivity make their exports competitive. Increasing home productivity through research and development and improvement in technology lowers costs and increases the supply of goods. The countries can also put more resources into research and development (R&D) to create more unique and innovative exports that will have a price inelastic demand.
These will not only help to cater for the home demand, and hence reduce the demand for imports; it will also help in increasing the supply of goods for exports. This measure is unlikely to be objectionable since it does not “unfairly” disadvantage any other country in the process. Increasing productivity can also lead to economic growth. (illustrate through increase in SRAS and/or LRAS in AD-AS diagram).
2. Free Trade Policies – Export Promotion
The government may encourage and provide support to exporting-industries by giving tax incentives, granting subsidies, providing useful services like providing information regarding conditions abroad; also organising and financing exhibitions and trade fairs in the foreign markets.Signing free trade agreements or FTAs also help
For both US and S’pore, can pursue free trade policies as a way to increase the export revenue. However, the assumption is that import expenditure remains the same. However, considering that free trade policies may also increase flows of imports and import expenditure, its effects on dealing with a worsening current account deficit is uncertain.
Anti-Thesis: Singapore would tackle a worsening current balance differently from the US
1. Differences in the use of supply-side policies (SSP)
Both SG and USA rely on the use of supply side policies to increase export competitiveness but the two countries may differ in the adoption of specific policies due to differences in context and nature of their economies. Singapore already has a competitive tax system (with low corporate and income tax rates) [Market Oriented policies] and can thus rely on interventionist policies to increase productivity and improve export competitiveness. Singapore also faces the lack of big companies with the size and cleft to benefit from economies of scale thus one of the supply side measures employed by Singapore is to encourage small medium enterprises (SMEs) to scale up through mergers and internationalise. E.g. 2015 Budget measures.
This is different from the US where are generally large enough to exploit economies of scale and focus on external markets. US may choose to focus on having a competitive tax system and on other market-oriented policies, especially considering the relatively high tax rates in the US. In addition, due to US’s large size and contrasting economic environment in different parts of the US, it will be difficult to enact interventionist policies, especially if funding is required as the US is already running budget deficits.
2. Contractionary Fiscal Policy (Expenditure reducing policy)
Reduction in government expenditure and/or increase in taxes to reduce aggregate expenditure. Reduction in government expenditure: For example, a decrease in operating expenditure, such as decreases in bonus to government workers (reduces G), decreases transfer payments (reduce C).Increase in taxes: For example, an increase in corporate income tax, which reduces after-tax profitability of investment (reduces I), an increase in personal income tax, which reduces disposable income (reduces C).
Only USA can to use contractionary fiscal policy to influence aggregate demand and the national income of the country. USA is likely to rely on restrictive fiscal policy especially since the country is running huge budget deficits and has high national debt and the increase in taxes and/or reduction in government expenditure will help restore fiscal balance and confidence in the US economy.
Whether expenditure reducing policies such as fiscal policy will be used depends on the state of the economy/economic conditions. If both the US and Singapore are in a period of recession/slow growth, both countries are unlikely to sacrifice economic growth in order to deal with the current account deficit. Economic recovery in US as pointed out by the robust US consumer spending thus the US might consider the use of contractionary policies as part of expenditure reducing polices. Economic growth in Singapore may remain weak and the Singapore government may not want to pursue contractionary policies due to its negative effects on growth and employment.
Differences in composition of economy and size of multiplier (k): The Singapore economy is external oriented and (X-M) comprises around 400% of the economy. Singapore also has high leakages due to high MPM and MPS and thus the size of k will be small compared to the US which has a low MPM and MPS. However, the high MPM in Singapore means that there will be a significant reduction in import expenditure with every decrease in national income.
(Note: Students may discuss the use of contractionary FP as Anti-inflationary measures (under Expenditure Switching policies) deal with the prices of domestically produced goods such that relative inflation rate is lower and thus increase the price competitiveness of exports (price elastic demand) as well as reduce the appeal of imports (link to XED)]
Differing use of other policies to improve trade balance
In terms of policy choices, there will be differences in what the US and implement due to the differences in the nature of their economies.
Contractionary monetary policy (MP)
Contractionary MP can be carried out through a rise in interest rates, stricter hire purchase regulations, or more constraints on bank lending, which can dampen spending (C and I). Singapore does not make use of traditional monetary policy due to the ineffectiveness of controlling interest rates in an open economy where capital flows in and out of the country easily. The Open Economy Trilemma also means that the country would choose management of exchange rate rather than interest rate management. This is unlike the US, which is able to use monetary policy to influence consumption (C) and investment (I) effectively.
Depreciation or devaluation will make the exports cheaper (in foreign currency) and the imports more expensive (in home currency). This is key policy that SG will use but not by the US due to the Open Economy Trilemma, where the US would focus on the use of an independent monetary policy, which will be important in a country with a large domestic market (to influence C and I) and open capital flows.
With currency depreciation in S’pore,
For a weaker ER: fall in Px in terms of foreign currencies ↑ DD for exports → demand for Singapore exports are price elastic (availability of substitutes from competitors such as Korea and Taiwan)→ more than proportionate ↑ export revenue in domestic currency
For a stronger ER : ↑ PM in terms of domestic currency →→ Qty DD of imports less than proportionate (PEDm <1)→→ ↑ import expenditure in domestic currency
According to the Marshall-Lerner condition, as long as the sum of price elasticities of demand for imports and exports is greater than one (i.e. IPEDx + PEDMI > 1), a depreciation of the exchange rate will lead to an improvement in the balance of trade.
Limitations: Singapore is an import reliant country thus currency depreciation though it will help to improve the trade balance, will also worsen import price-push inflation such that it will lead to an eventual increase in the price of exports, especially with the high import content in the exports.
Protectionism – Import restrictions
Import tariffs, quotas and/or exchange controls may be used to restrict imports. This will help to improve the current account balance by curbing import expenditure Singapore, a small and open economy relies heavily on imports for necessities and raw materials and do not have the scope to carry out import restrictions compared to the US. US is less reliant on imports and have enacted protectionist policies such as Buy America during the 2008/2009 crisis. Furthermore, as a trading hub, such a policy would conflict with the objective of free trade and bring about problems such as retaliation as well as a reduction in consumer welfare and a loss in allocative and productive efficiency. US, being a larger economy with greater bargaining power against its trading partners, it is more likely to use protectionist measures as a temporary measure to improve its trade balance.
*Nature of Economy: Due to open nature of Singapore’s my, Singapore is more to these external oriented policies such as change rate policy compared to US, which will the domestically oriented policies such as FP.
Balance of payment position of both countries: US of America is likely to suffer from a current account deficit while Singapore is still experiencing a current account surplus, hence the choice and magnitude in which the policies are carried out will be different. .
Part B Essay Mark Scheme:
Level 3 (7-10)
Analysis is accurate, precise, logical and well elaborated with discussion of at least 3 policies, including supply side policy, with highly relevant and appropriate use of examples contextualised to US and Singapore Excellent coverage/scope of concepts (Breadth) with policies not confined to dealing with the worsening trade balance but deals with other components of the current account Balanced viewpoint that covers both US and Singapore in terms of similarities and differences in policy measures.
Accurate use of economic terminologies (Phrasing)
Overall structure and organisation
Logical, coherent and systematic flow of ideas; Strong and meaningful linkages between ideas
Diagrams are accurate, well labelled and are well-referenced Diagrams are of a reasonable size and appropriately placed
Level 2 (5-6)
Content: Analysis is largely accurate, precise, logical and elaborated with discussion of at least 2 policies but examples may not be highly relevant and appropriate to the context of USA and Singapore
Limited coverage of concepts to only deal with the worsening trade balance ; Analysis contains an attempt of a balanced viewpoint of similarities and/or differences but may not be well developed or is generally one sided -but well developed
Some inaccuracies in the use of economic terminologies, but does not contain major errors
Overall structure and organisation
Ideas may not flow in a logical, coherent and systematic way; Ideas may not e meaningfully linked
Diagrams are mostly not well labelled and referenced to in the essay, may contain some inaccuracies
Statements fail to express an understanding of economic concepts
There is little evidence of economic analysis
No relevant and appropriate use of examples
Essay contains significant inaccuracies in the use of economic terminologies, concepts and / or diagram
Evaluation (E2: 3-5m): Able to provide a good judgement and comparison of policies and their effectiveness in US and Singapore; Able to challenge assumptions, understand limitations of each policy;
(E1: 1-2m) Unexplained judgement, and/or judgements not supported by economic analysis
Remarks from our JC Economics tutor:
1. US is a relatively Large and Less Open (LLO) economy.
– Consumption is about 60-70%
– Multiplier Size
(small vs. large values)
– Absolute size
(small vs. large economies)
2. If also includes entire Current Account, then require other policies to deal with income flows and current transfers
a) Net Income flows: To encourage income inflows and discourage income outflows. countries can consider providing incentives and creating investment opportunities to encourage foreigners to reinvest their profits, dividends and interest in the country and for residents to consider repatriating their returns from overseas to invest in the domestic economy.
Singapore has also provided many incentives and investment opportunities that are coordinated by government agencies such as Economic Development Board, and with a small domestic economy, may find it difficult to create more incentives and opportunities, unlike the US.
b) Net Current Transfers: To reduce remittances from foreign workers/expatriates back to their home countries, countries can restrict the hiring of foreign workers/expatriates or impose restrictions on the ability of the workers to remit money back to the home. countries. Both US and Singapore depend on foreign workers/expatriates to complement local workers and enhance economic growth and thus face transfer outflows due to remittances of foreign workers However, Singapore with an aging population problem, has a higher dependence on the foreign workers/expatriates and may have problems imposing restrictions on them.
Criteria in the use of policies by USA and Singapore Depends on the component in current account that is causing the current account deficit (May be different in US compared to Singapore)
Economic conditions in the 2 economies: Whether both countries are experiencing economic growth. If both countries are experiencing strong growth, expenditure reducing policy is possible. If both US and Singapore are experiencing recessions, expenditure reducing policy would be inappropriate.
3. General Comments:
Answers provided are generally too short for a 15 mark question, with many candidates having time management issues to complete the question. Thus, there are varying lengths in terms of answer as well as rigour in analysis thus the marks vary with a wide spectrum from L1 to L3.
The varying rigour in the answers reflect the different level of preparation done by the candidates for the question. Most of the candidates did not provide rigour in their analysis of policies, without the use of diagrams to provide meaningful analysis or make use of economic concepts such as price elasticity concepts to enhance the level of analysis. Even for Econs pupils who use diagrams to support their analysis, many of them failed to provide proper labels, especially for the AS curve, with many failing to label the diagram.
Almost all the candidates did not consider the use of policies to deal with other aspects of current account such as income flows, to improve the current account balance. Most of the candidates only consider the differences in choice of policies between US and Singapore and did not consider the similarities. Some candidates did not realise the workings of the Open Economy Trilemma means that an economy open to capital flows, cannot simultaneously pursue a monetary and exchange rate policy. Failure to consider the trilemma by candidates will not result in any mark penalties. Some candidates provided policy suggestions that are contradictory to the objective of improving the trade and current account balance. Many of them focused analysis on the secondary effects rather than focusing on the primary effects thus leading to ineffective policies. For example, some candidates focused on the use of expansionary monetary policy with the aim of increasing investment to increase productive capacity to improve export competitiveness. However, this will be a reverse of any expenditure reducing/switching policy which deals more directly with a trade deficit.
Some candidates explain that an expenditure reducing policy will be ineffective for Singapore due the presence of a large marginal propensity to import (MPM) and thus withdrawal, and thus the change in national income will be small. However, the presence of a large MPM also means that for every decrease in national income, there will be a large fall in import expenditure as well. Quite a considerable group of candidates also preferred to do a description of the differences between the economies of US and Singapore at the beginning of their essay instead of using the point to support the choice of policies in their analysis.
A minority of candidates instead of focusing on resolving the worsening current account balance look to policies to improve capital and financial account instead as a countermeasure to improve overall balance of payment balance. This is not directly answering the issue at hand.
5. Structure/ organisation / Phrasing:
Although it should be clear that the question requires a comparison of policies between the US and Singapore, some candidates chose to examine the context of US and Singapore separately in their analysis. Moreover, some are confused about the use of supply side policies and explain them as expansionary fiscal policy instead.
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Sample Essay Questions List:
Micro: Elasticity Concepts | Externalities | Oligopoly |
Macro: Demand Side & Supply Side Policies | Exchange Rates | Globalisation