JC Econs Essay Multiplier Process & Economic Crisis Model Answers
In Singapore, being a small and open economy, our 4 sectorial economy means there are large leakages. In addition, we have no natural resources, so we have to import practically everything we need. Therefore, the multiplier value is expect to be very small
A four-sector economy like Singapore economy has a smaller multiplier value whereas a two-sector economy has a large multiplier value
(a) Explain the multiplier process and suggest reasons for this difference in the size of the multiplier.
(b) Assess the possible effects of an increase in the marginal propensity to save on Singapore’s recovery from the recent global COVID-19 health and economic crisis.
JC Economics – Multiplier Process Explanation
The multiplier (k) measures the extent in which the national income will increase (decrease) when there is an increase (decrease) in autonomous spending. It is calculated as the reciprocal of the marginal propensity withdraw which is the sum of the marginal propensity to save (MPS), marginal propensity to import (MPM) and marginal propensity to tax (MPT). This essay aims to explain the multiplier process and how differences in the value of the marginal propensity to withdraw affects the size of the multiplier.
4 main points: Topic Sentence (usually involves the economic concept to be used)
Explain (the economic concept)
Exemplify (using examples) (“remember to answer the question)
1. Explain the multiplier process
To explain the multiplier process, we assume that a 4-sector economy which has plenty of idle. unemployed resources or excess capacity. The marginal propensity to consume is constant and equals 0.6 (MPC = 0.6) . We begin our analysis with an autonomous government injection of $10 billion on road building to stimulate economic activity.
The initial government spending of $10 billion will lead to national income expanding initially by $10 billion. The $10 billion spent on construction of roads will be used to pay the households employed by the firm. The households will then spend $0.60 for every dollar of increased income on consumption (i.e. MPC = 0.6) on domestically produced food and clothing. This will create an extra income of $6 billion for the domestic producers. The remaining $4 billion will be saved, paid as income taxes to the government, and spent on imported goods (i.e. withdrawn from the circular income flow).
This additional $6 billion represents income for households employed in the consumer goods industry who will further spend their additional income on consumption, based on the value of MPC=0.6.This further increases the national income, which can be seen in Table 1 below:
The rounds of increase in national income will continue until the stream of induced consumption fizzles out and no more additional incomes are created to be passed on within the circular flow. This happens when all the initial injection of expenditure has been withdrawn completely in the form of savings, taxes or import expenditure.
In Table 1, the multiplier effect stops when the sum of withdrawals equals exactly $10 billion, which is equal to the initial injection. We can see that the final change in national income is the product of the multiplier and the initial injection.
AY = k. ΔAE
K is also represented by k = 1/MPW, where the marginal propensity to withdraw (MPW) = MPS + MPT + MPM, denoting marginal propensity to save, tax and import , respectively.
2. Differences in MPW affects size of multiplier In a 2-sector economy, the only withdrawal would be savings, while in a 4-sector economy. withdrawals would include savings, tax and import. Thus, it is likely that the MPW in a 4-sector economy is larger than in a 2-sector economy, making the value of the multiplier smaller in a 4-sector economy like Singapore.
The marginal propensity to save (MPS) depends on various factors such as the social security system in the country. If government encourages savings, MPS will be higher. In Singapore, there is a national saving scheme whereby all working individuals have to make compulsory monthly contributions of a certain percentage of their income to the Central Provident Fund (CPF). This compulsory aspect of savings out of any increase in income, together with the prudent attitude, results in Singapore being one of the countries with the highest saving rates in the world. This in turn implies that Singapore has one of the smallest value of multiplier in the world.
The MPS also depends on the level of interest rate in the economy. If the interest rate in the country is high, the households would be induced to save more out of an additional dollar of income. If interest rates were low, however, the households may not save as much out of their increase in income. This is true especially in times of high inflation, where real interest rates may be negative. This would then negatively affect the value of the multiplier.
The marginal propensity to tax (MPT) depends largely on the tax system in the county. A steeply progressive taxation system implies that as income rises much more tax will have to be paid out of the additional income earned. For example, a person earning $1000 per month may pay a marginal tax rate of 2%, whereas a person earning $10,000 per month may pay a progressively higher rate of say 20%. Thus, the more progressive the tax system, the higher the MPT and the smaller the value of the multiplier.
The MPT also depends on the extent of government benefits for the people. A welfare state, e.g. the UK, usually have a higher level of MPT as a large amount of tax revenue has to be collected to finance. the welfare benefits. Given the higher leakages through taxation, the value of k will be smaller.
The marginal propensity to import (MPM) depends on the country’s attitude towards foreign imports. This attitude depends on factors such as the price competitiveness and availability of imports relative to domestically produced substitutes. If imports are relatively cheaper than domestically produced substitutes, the MPM tends to be higher as people would rather buy imports than domestically produced products when income increase. This would then reduce the value of the multiplier as the increase in income is leaked out through imports.
The openness of the economy also directly affects the value of MPM. A country like Singapore has a high MPM value as we lack of natural resources for production and consumption. This means that with additional income received, bulk of it will be spent on buying imports. This lowers the value of the multiplier in Singapore.
(The estimated value of the value of the SG multiplier is 1.6)
From the above explanation, we see that the multiplier process increases the initial injection by one sector of the economy into a more than proportionate increase in national income. The value of the multiplier is inversely affected by the marginal propensity to save, tax and import.
JC Economics – Marginal Propensity to Save & Singapore Economic Crisis
Introduction: define marginal propensity to save or MPS
Higher MPS, means less Consumption levels. So lower AD, withdrawal or leakage. Fall of national income by a multiple fold. So recovery from crisis even harder.
Small K value, so impact of withdrawal is slight. Moreover, it is a global crisis, so impact on X is more significant than on C and I. require global economy before SG can recover.
Evaluation: More in our Econs intensive revision lessons
Conclusion: impact is overall negative, although it near negligible.
Econs Tuition teacher’s Remarks: Most students did not get 20 or more marks out of 25m, cos they didn’t highlight impact of weaker S$ on our imports. More on this key point in our Econs revision lessons.)