International Trade Lecture PDF

Official (Open) International Trade Lecture 12 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Explain the benefits of international trade using the concept of...

Official (Open) International Trade Lecture 12 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Explain the benefits of international trade using the concept of comparative advantage. b) Analyse the impact of trade protectionism on businesses in an economy with reference to the types of trade barrier set up by an economy's trading partners. c) Evaluate the impact to businesses from free trade agreement with reference to the associated benefits and costs. 2 Official (Open) International Trade It refers to buying & selling activities across national boundaries It takes place when countries exchange goods & services they specialise in For example: Thailand - Rice Germany- Machineries Australia- Minerals 3 Official (Open) Comparative Advantage & Specialisation Good A Comparative Advantage – The ability of a country to produce a good at a lower opportunity cost than another country Z (possible Specialisation – Countries produce with trade) goods that they have a comparative X advantage Trade allows countries to consume PPF goods and services exceeding their production possibilities frontier Example: Instead of producing at point Y Good B X, Country can specialize production at point Y, trade with other countries and consume at point Z instead 4 Official (Open) Trade between Singapore and Malaysia Malaysia Output Singapore Output A B C X Y Z (units per year) (units per year) Pharmaceuticals 50 25 0 Pharmaceuticals 100 50 0 Food 0 50 100 Food 0 10 20 Without trade: Malaysia – Produce at Point B Singapore – Produce at Point Y Opportunity Cost of producing 1 unit of food: Malaysia – 0.5 units of pharmaceuticals -> lower cost, comparative advantage in food Singapore – 5 units of pharmaceuticals -> higher cost, comparative advantage in pharmaceuticals With trade: Malaysia – Produce only food at Point C, trade food for pharmaceuticals Singapore – Produce only pharmaceuticals at Point X, trade pharmaceuticals for food 5 Official (Open) Trade between Singapore and Malaysia Malaysia PPF Singapore PPF Pharmaceuticals Pharmaceuticals Malaysia: Singapore: Produce at C 100 X Produce at X Consume at Q Consume at R R (possible with trade) A Y 50 50 Q (possible B with trade) PPC PPC C Y Z Food Food 50 100 10 20 Official (Open) Gains from Trade Create more choices of goods & services Alleviate Domestic Shortages – Supplement domestic supply through import Lower Unit Cost – With more goods produced for the world, there is Economies of Scale Increase Competition and Prevent Monopolies World Peace and Prosperity – Trade promotes social, cultural & political understanding and cooperation Economic Development – encourages domestic companies to be more competitive, hence productive. Technology will be transferred from developed to developing countries. 7 Official (Open) Why we import P (Pw < Pd) S Suppose domestic market price is at Pd and world price is at Pw Pw < Pd , imports are cheaper than producing domestically Without trade: Pd & Qd Pd Ed Ew Pw With trade: Pw & Qw Domestic Quantity Supplied: Qds D Import Quantity: (Qw – Qds) Import Consumers benefit Q Businesses lose out Qds Qd Qw 8 Official (Open) Why we export P (Pw > Pd) S Export Suppose domestic market price is at Pd and world price is at Pw Pw > Pd , exports are cheaper than Pw foreign competitors Ew Without trade: Pd & Qd Pd Ed With trade: Pw & Qw Domestic Quantity Supplied: Qds D Export Quantity: (Qw – Qds) Consumers lose out Q Businesses benefit Qds Qd Qw 9 Official (Open) Protectionism – Barriers to Trade Protectionism is a policy of sheltering the domestic industries from foreign competition through the imposition of trade barriers on foreign goods and services. The government’s use of trade barriers – (i) embargoes, (ii) tariffs, (iii) quotas, and (iv) other restrictions, to protect domestic producers from foreign competition 10 Official (Open) Trade Embargo Law that bars trade with another country Example – UN sanctions on North Korea due to its nuclear weapons programme 11 Official (Open) P Trade Tariffs S Trade tariffs are tax on import, with the intended effect of raising the price of the imported good. Tariff Suppose world price is at Pw revenue Ewt Without trade tariffs: Pw & Qw Pwt Ew Tariffs With trade tariffs: Pwt & Qwt Pw Domestic Quantity Supplied: Qdst Import with tariffs D Import Quantity: (Qwt – Qdst) Import without tariffs Consumers lose out Q Businesses benefit Qds Qdst Qwt Qw 12 Official (Open) P Import Quotas Sd Sdq Import Quotas are a limit on the quantity of a good that may be imported in a given time period Importer Suppose world price is at Pw profit Ewq Without import quota: Pw & Qw Pwq Ew With import quota: Pwq & Qwq Pw Domestic Quantity Supplied: Qdsq Import with quota D Import Quantity: (Qwq – Qdsq) Import without quota Consumers lose out Q Businesses benefit Qds Qdsq Qwq Qw 13 Official (Open) Other restrictions Trade restrictions imposed due to health, safety and other regulatory controls Example: EU ban on genetically modified food, China import restrictions on Australia food products 14 Official (Open) Arguments for Protectionism Infant Industry: New industries need protection before they are developed and become efficient enough to compete in the world market Dumping: Foreign firm selling its exports at a lower price than its cost of production National Security: Cannot be dependent on foreign imports especially for goods that are essential to national survival e.g. steel, food, water Employment: Domestic industries help create jobs for people in the country Cheap Foreign Labour: Cheap foreign goods undercuts prices of domestic goods and depress local wages 15 Official (Open) Arguments for Protectionism 16 Official (Open) Arguments against Protectionism Adverse Repercussion on World Trade: Trade barrier retaliation from trading countries, misallocation of resources and production Market Inefficiency: Lack of competition brings about inefficiency, higher costs of production and prices domestically Loss of Consumer Welfare: Higher prices of imports, less choices available 17 Official (Open) Arguments against Protectionism 18 Official (Open) Free Trade Agreement Free Trade Agreements are agreements between two countries or two groups of countries to remove barriers to trade between participating countries That means removing or in most cases, minimizing all quotas, tariff restrictions, restrictions to foreign investments, and other impediments to mobility of goods FTAs aim to increase two-way trade, thereby increasing economic progress and prosperity 19 Official (Open) Free Trade Agreement 20 https://www.mti.gov.sg/Trade/Free-Trade-Agreements Official (Open) Exchange Rate Exchange rate is the price at which one currency changes for another currency in the foreign exchange market, e.g. 150 Japanese Yen per US dollar Exchange rate is driven by demand and supply of the currency-pair in the foreign exchange market To import goods, countries need to pay for the imports using the exporting country’s currency 21 Official (Open) Exchange Rate: USD Market Supply & Demand Exchange Rate (Yen per USD) Yen per USD S Demand and Supply for USD is driven by: World demand for U.S. exports U.S. import demand E1 Interest rate in U.S. and other country Expected future exchange rate D Q Q1 22 Official (Open) World Demand for USD Market Supply & Demand Exchange Rate (Yen per USD) U.S. Exports S Suppose World demand for U.S. exports ↑ E2 Demand for USD ↑ E1 D2 Exchange rate (Yen per USD) ↑ D1 Q Q1 Q2 23 Official (Open) U.S. Import USD Market Supply & Demand Exchange Rate (Yen per USD) Demand S1 S2 Suppose U.S. import demand ↑ Supply for USD ↑ E1 Exchange rate (Yen per USD) ↓ E2 D1 Q Q1 Q2 24 Official (Open) USD Market Supply & Demand Exchange Rate (Yen per USD) U.S. Interest Rate S2 S1 Suppose U.S. interest rate ↑ E2 Demand for USD ↑ Supply for USD ↓ E1 D2 Exchange rate (Yen per USD) ↑ D1 Q Q1 Q2 25 Official (Open) USD Market Supply & Demand U.S. Expected Future Exchange Rate (Yen per USD) Exchange Rate S2 S1 Suppose U.S. expected future E2 exchange rate ↑ Demand for USD ↑ E1 Supply for USD ↓ D2 Exchange rate (Yen per USD) ↑ D1 Q Q1 Q2 26 Official (Open) The End 27 Official (Open) Money & Monetary Policy Lecture 11 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Analyse the impact on the growth of business sales and profits with reference to the types of monetary policy adopted by a central bank in an economy. 2 Official (Open) Money Money is any commodity or token that is generally acceptable as a means of payment Money must be large enough to meet ordinary transaction needs but not be so plentiful that it becomes worthless Fiat Money - Money accepted by law. Not back by any commodity e.g. gold or silver. 3 Official (Open) Functions of Money Medium of Exchange: Widely accepted in exchange for goods & services Unit of Account: Provide a common measurement of relative value of goods & services Store of Value: Ability to retain value over time 4 Official (Open) Opportunity Cost of Money Money itself does not yield any return People & businesses can convert these money into deposits, bonds, real estate to grow. As such, people & businesses incur opportunity cost for holding money (e.g. forgone interest, forgone profits) Given the opportunity cost, why do people & businesses still hold onto money? 5 Official (Open) Demand for Money Transactionary Demand for Money: To pay everyday predictable expenses, e.g. bills, food, mortgage payments Precautionary Demand for Money: To pay unpredictable expenses, e.g. emergency medical treatments, retrenchment Speculative Demand for Money: To take advantage of expected future changes in price of assets. Depends on interest rate (opportunity cost) and market conditions 6 Official (Open) Central Bank All countries have their central bank, which conducts the monetary policy. Its role is to manage the currency, money supply, interest rates and oversees the commercial banking system. 7 Official (Open) Role of Central Bank Conducts Monetary Policy Controls the money supply Issuance of currency Oversight of payment systems Supervises and regulates financial institutions Serving as banker to and financial agent of the Government Manage foreign reserves Lender of last resort 8 Official (Open) Money Creation through Fractional Reserve Banking System Fractional Reserve Banking System: Banks are only required to retain a portion of the deposits as reserves (e.g. 10%) Remainder can be loaned out (e.g. 90%), which creates more deposits and loans in subsequent rounds Central Bank can control total money supply through adjusting Required Reserve Ratio and monetary base New deposits New deposits ↑ loans by Bank B received by Bank C New deposits ↑ loans by Bank A $81,000 received by Bank B $81,000 received by Bank A $90,000 $90,000 Reserves held by $100,000 Bank B ($9,000) Reserves held by Bank A ($10,000) 9 Official (Open) Money Multiplier An increase in monetary base by Central Bank will lead to an initial increase in excess reserves held by banks. This will lead to a multiple increase in money supply, due to the fractional banking system 𝟏𝟏 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 = 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 (𝑹𝑹𝑹𝑹𝑹𝑹) 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 𝒊𝒊𝒊𝒊 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺 = ∆ 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑿𝑿 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 10 Official (Open) Money Multiplier Suppose Central bank increases monetary base by $500 million, required reserve ratio is 0.1 𝟏𝟏 𝟏𝟏 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 = = = 𝟏𝟏𝟏𝟏 𝑹𝑹𝑹𝑹𝑹𝑹 𝟎𝟎.𝟏𝟏 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 𝒊𝒊𝒊𝒊 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺 = ∆ 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹𝑹 𝑿𝑿 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 = $𝟓𝟓𝟓𝟓𝟓𝟓 𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎 𝑿𝑿 𝟏𝟏𝟏𝟏 = $𝟓𝟓 𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃 11 Official (Open) Monetary Policy Monetary policy changes money supply which affects interest rates, and interest rates affect Consumption (C) and Investment (I) AE = C + I + G + (X – M) Think of interest rate as price of money: When money supply increase, interest rates fall When money supply falls, interest rates increase 12 Official (Open) Monetary Policy Tools Open Market Operations: The buying and selling of government securities by the central bank in the banking system. The operations affect money supply and interest rate. Discount Rate: The interest rate that the central bank charges on loans to banks Required Reserve Ratio (RRR): The reserve requirement is a bank regulation that sets the minimum reserves each bank must hold to customer deposits. 13 Official (Open) Monetary Policy Tools: Open Market Operations Recessionary Gap Inflationary Gap Expansionary Monetary Policy Contractionary Monetary Policy Central Bank buys government security from the banks Central Bank sells government security to the banks Banks will have more excess reserves and will loan out with lower interest Banks will have less excess reserves and will loan out with higher interest rates rates Consumers borrow more for Consumption, Consumers borrow less for Consumption, Businesses borrow more for Investment Businesses borrow less for Investment ↑ AE, ↑ GDP ↓ AE, ↓ GDP 14 Official (Open) Monetary Policy Tools: Discount Rate Recessionary Gap Inflationary Gap Expansionary Monetary Policy Contractionary Monetary Policy Central Bank lowers Discount Rate Central Bank raises Discount Rate Banks encouraged to borrow more from Central Bank and charge clients Banks discouraged to borrow from Central Bank and charge clients higher lower interest rates interest rates Consumers borrow more for Consumption, Consumers borrow less for Consumption, Businesses borrow more for Investment Businesses borrow less for Investment ↑ AE, ↑ GDP ↓ AE, ↓ GDP 15 Official (Open) Monetary Policy Tools: Required Reserve Ratio Recessionary Gap Inflationary Gap Expansionary Monetary Policy Contractionary Monetary Policy Central Bank lowers minimum Required Reserve Ratio Central Bank raises minimum Required Reserve Ratio Banks create more loans and deposits, money supply increases and interest Banks create less loans and deposits, money supply decreases and interest rates falls rates rises Consumers borrow more for Consumption, Consumers borrow less for Consumption, Businesses borrow more for Investment Businesses borrow less for Investment ↑ AE, ↑ GDP ↓ AE, ↓ GDP 16 Official (Open) AE Graph Real Aggregate Expenditure ($ per year) Recessionary Gap AE=Y AEFE AEFE AE1 Suppose there is a recessionary gap AE1 Central Bank undertake Open Market Operations and buys government security Money Supply ↑, Interest Rate ↓ Consumption ↑, Investment ↑ Recessionary Gap 45o AE ↑, GDP ↑ Y1 YFE Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) Inflationary Gap AE2 AE=Y AE2 AEFE AEFE Suppose there is an inflationary gap Central Bank undertake Open Market Operations and sells government security Money Supply ↓, Interest Rate ↑ Consumption ↓, Investment ↓ Inflationary Gap 45o AE ↓, GDP ↓ YFE Y2 Real GDP ($ per year) Official (Open) 1979 Volcker Shock 19 Official (Open) 2008 Financial Crisis 20 Official (Open) 2008 Financial Crisis 21 Official (Open) The End 22 Official (Open) Fiscal Policy Lecture 10 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Analyse the impact on the growth of business sales and profits with reference to the recessionary and inflationary gap in an economy. b) Analyse the impact on the growth of business sales and profits with reference to the types of fiscal policy adopted by a government in an economy and spending/tax multiplier 2 Official (Open) Keynesian Economics The Aggregate Expenditure (AE) approach can be used to explain what causes the National Income (GDP) to change GDP = C + I + G + (X – M) Driven by Income: Autonomous (Not driven by Income): Consumption spending by Investment spending by businesses (I) households (C) Government spending (G) Exports & Imports (X-M) 3 Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function AE refers to total spending in an economy at different levels of real GDP AE (C) Starting with AE = C Upward sloping: MPC Income/Output (GDP) ↑, Consumption (C) ↑ Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function AE refers to total spending in an AE (C+I) economy at different levels of real GDP AE (C) Next, AE = C + I Upward sloping: MPC Investment spending is autonomous Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function AE (C+I+G) AE refers to total spending in an AE (C+I) economy at different levels of real GDP Then, AE = C + I + G Upward sloping: MPC Government spending is autonomous Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function AE (C+I+G+X-M) AE (C+I+G) AE refers to total spending in an economy at different levels of real GDP Lastly, AE = C + I + G + X - M Upward sloping: MPC Export and Imports are autonomous Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function: AE=Y Equilibrium Income AE AE* Equilibrium Income level happens where total value of goods & services produced (Y) is equal to total spending for these goods & services (AE). Y = AE 45o Y* Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) AE Function: AE=Y Equilibrium Income Inventory accumulation AE AE* If Y>AE, this means production is higher than expenditure, and hence inventory accumulation Businesses cut back on production, Y falls until Y=AE Inventory If Y Full Employment GDP Creates inflationary pressure on wage and price Inflationary Positive output gap: Inflationary Gap Gap 45o YFE Y1 Real GDP ($ per year) Official (Open) AE Graph Real Aggregate Expenditure ($ per year) Inflationary Gap AE1 AE=Y AE1 AEFE AEFE Suppose MPC is 0.5 and output gap is +$1 billion Spending Multiplier = 1/(1-0.5) = 2 ∆𝑮𝑮𝑮𝑮𝑮𝑮 Change in AE required = 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 to reach YFE −$𝟏𝟏 𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃𝒃 = 𝟐𝟐 Inflationary = -$500 mil Gap Government can decrease 45o expenditure by $500mil YFE Y1 Real GDP ($ per year) Official (Open) Fiscal Policy Fiscal Policy is the use of government expenditure, taxation, and transfer payments to influence the economy, employment and price level Government Expenditure^: Roads, railway lines, seaports, airports, schools, healthcare facilities Taxation: Personal Income Tax, Corporate Tax, GST Transfer Payments: GST vouchers, CDC vouchers, tuition grant, healthcare subsidies ^Directly accounted for under GDP expenditure approach 19 Official (Open) Fiscal Policy https://www.mof.gov.sg/docs/librariesprovider3/budget2024/download/pdf/fy2024_building_a_resilient_future_english.pdf https://www.mof.gov.sg/docs/librariesprovider3/budget2024/download/pdf/fy2024_supporting_businesses_and_driving_growth_english.pdf 20 https://www.mof.gov.sg/docs/librariesprovider3/budget2024/download/pdf/fy2024_investing_in_our_people_english.pdf Official (Open) Taxation Progressive Tax: Taxes income at an average rate that increases as income increases, e.g. Personal Income Tax with different tax brackets Proportional Tax: Taxes income at a constant average rate regardless of the level of income, e.g. Personal Income Tax with a single rate Regressive Tax: Taxes income at an average rate that decreases as income increases, e.g. GST 21 Official (Open) Expansionary & Contractionary Fiscal Policy Recessionary Gap Inflationary Gap Expansionary Fiscal Policy Contractionary Fiscal Policy ↑ Government Expenditure, Transfer Payments ↓ Government Expenditure, Transfer Payments ↓ Taxes ↑ Taxes ↑ AE, ↑ GDP ↓ AE, ↓ GDP 22 Official (Open) Covid-19: GDP & Unemployment https://www.mof.gov.sg/docs/default-source/default-document-library/news-and-publications/featured-reports/17- 23 feb-2022-6-30pm-assessment-of-the-impact-of-key-covid-19-budget-measures.pdf Official (Open) Covid-19: Singapore’s Fiscal Policy https://www.mof.gov.sg/docs/default-source/default-document-library/news-and-publications/featured-reports/17- 24 feb-2022-6-30pm-assessment-of-the-impact-of-key-covid-19-budget-measures.pdf Official (Open) Covid-19: Policy Impact https://www.mof.gov.sg/docs/default-source/default-document-library/news-and-publications/featured-reports/17- 25 feb-2022-6-30pm-assessment-of-the-impact-of-key-covid-19-budget-measures.pdf Official (Open) The End 26 Official (Open) Determination of National Income Lecture 9 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Determine the change to equilibrium national income of an economy from change in consumption and investment with reference to the Keynesian Model 2 Official (Open) Classical Economics Business cycles are natural, and unemployment is the result of a short-lived adjustment in which wages and prices decline or people voluntarily choose not to work. Thus, there is a natural tendency for the economy to restore full employment over time. Continuing depression is impossible because markets eliminate persistent shortages Assumed that the economy will automatically adjust itself through price and wage changes, i.e. flexible prices and wages 3 Official (Open) Great Depression Great Depression of 1929-1939 – prolonged recession resulting in widespread poverty Wall Street Crash of 1929 Bank Run of 1930 Smoot-Hawley Tariff Act of 1930 Gold Standard US GDP fell by estimated 29% between 1929-1933 4 Official (Open) Keynesian Economics “The General Theory of Employment, Interest and Money” by John Maynard Keynes in 1936 Demand↑ Assumed sticky prices in short run and aggregate demand drives output in the economy Income↑ Output↑ Demand creates its own supply: The more people spend, the more production will be carried out in the economy, therefore more jobs are created 5 Official (Open) Keynesian Economics Level of national income can be regulated or adjusted through stimulating demands in the economy, which will lead to increase spending. The aggregate expenditure approach can be used to explain what causes the National Income (GDP) to change GDP = C + I + G + (X – M) Consumption spending Investment spending by households (C) by businesses (I) 6 Official (Open) Consumption GDP = C + I + G + (X – M) Consumption spending by households Consumption is driven by disposable income (income after paying for taxes) The higher the disposable income, the higher the consumption 7 Official (Open) Consumption Graph Consumption Consumption ($ per year) Function C Consumption function shows the amount households spend for goods and services at different C2 levels of disposable income C1 Disposable Income (Yd) ↑, Consumption (C) ↑ Y1 Y2 Disposable Income ($ per year) Official (Open) Consumption Graph Savings & Consumption ($ per year) Dissavings C=Yd Breakeven C Savings: The amount households do not spend on goods and Income services C Savings = Disposable Income (Yd) – Consumption (C) When Yd > C, S>0. Saving occurs 45o When Yd < C, S50% monthly Due to excessive growth of money supply in the economy Hoarding occurs, money loses its function and economy falls apart 30 Official (Open) The End 31 Official (Open) Circular Flow and National Income Lecture 7 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Analyse the flow of income and expenditure using 4-sector circular flow model b) Determine the national income of an economy with reference to the expenditure approach. 2 Official (Open) Four Macroeconomic Goals There are four basic macroeconomic goals which affect the economic welfare of a country’s citizens: a) A steady growth of the national output b) A high level of employment c) A stable price level d) A satisfactory balance-of-payments 3 Official (Open) Sustainable Growth in National Output Sustainable economic growth implies higher sales and revenue to businesses. In the circular flow model (where output eventually is equal to income), higher sales and revenue will translate to higher output and jobs for households. Households will therefore benefit from a better living standard with the wages. 4 Official (Open) US GDP per capita 5 Official (Open) Low Unemployment rate High employment means jobs are created in a country and more people are employed. These people benefit from receiving income from jobs as compared to if they are unemployed and have no income. 6 Official (Open) US Unemployment Rate 7 Official (Open) Stable Prices A stable price level is desirable because it helps maintain the purchasing power of the peoples’ income. It is also good for businesses because it helps remove uncertainties. 8 Official (Open) US CPI 9 Official (Open) Satisfactory Balance of Payments The balance of payments refers to a country’s transactions with other countries. The balance of payments classifies these transactions in mainly two accounts Current account: transactions in goods, services, investment income and current transfers Capital account: transactions in financial instruments A satisfactory balance of payments usually implies that a country is in good financial condition. 10 Official (Open) US Balance of Payments 11 Official (Open) Circular Flow Model The circular flow of income refers to the flow of goods and services (including financial assets and factor services) and payments in the economy. 12 Official (Open) 2-Sector Circular Flow Model 2 Sectors: Households & Firms Households demand various goods and services, which are supplied by firms. In order to produce the goods and services demanded by households, firms have to hire services supplied by households. Assumptions: 1. Households spend all their earnings 2. Firms produce only consumption goods Two markets: Product market, Factor market 13 Official (Open) 2-Sector Circular Flow Model Product Market Households Expenditure Supply of Goods and Firms Services by Firms Households Firms Factor Payments Supply of Factors of Production Factor Market by Households 14 Official (Open) 2-Sector Circular Flow Model: With Saving and Investment 2 Sectors: Households & Firms Households demand various goods and services, which are supplied by firms. In order to produce the goods and services demanded by households, firms have to hire services supplied by households. In addition, households save and firms invest in capital goods. Assumptions: 1. Households spend a portion of their earnings and save the remainder 2. Firms produce only consumption goods and borrow to invest in production Three markets: Product market, Factor market, Financial market 15 Official (Open) 2-Sector Circular Flow Model: With Saving and Investment Product Market Firms Households Loans Savings Financial Market Factor Market 16 Official (Open) 3-Sector Circular Flow Model 3 Sectors: Households & Firms & Government Households demand various goods and services, which are supplied by firms. In order to produce the goods and services demanded by households, firms have to hire services supplied by households. In addition, households save and firms invest in capital goods. Government collects tax revenue, provide subsidies to households and firms, spends on goods and services Assumptions: 1. Households spend a portion of their earnings and save the remainder 2. Firms produce only consumption goods and borrow to invest in production Three markets: Product market, Factor market, Financial market 17 Official (Open) 3-Sector Circular Flow Model Product Market Goods and Government Services Expenditure Taxes Taxes Firms Government Households Subsidies Subsidies Financial Market Factor Market 18 Official (Open) 4-Sector Circular Flow Model 4 Sectors: Households & Firms & Government & Foreign Households demand various goods and services, which are supplied by firms. In order to produce the goods and services demanded by households, firms have to hire services supplied by households. In addition, households save and firms invest in capital goods. Government collects tax revenue, provide subsidies to households and firms, spends on goods and services Firms export goods and services to foreign sector, while household sector import from foreign sector Assumptions: 1. Households spend a portion of their earnings and save the remainder 2. Firms produce only consumption goods and borrow to invest in production Three markets: Product market, Factor market, Financial market 19 Official (Open) 4-Sector Circular Flow Model Foreign Exported Goods Imported Goods Export Income Import Payment Product Market Firms Government Households Financial Market Factor Market 20 Official (Open) Gross Domestic Product (GDP) It is the market value of all final goods and services produced in a nation during a period of time usually one year 21 Official (Open) Gross National Product (GNP) GNP is the money value of final goods & services produced by factors that belong to the country whether the factors are physically located in the country or in a foreign country. 22 Official (Open) Gross Domestic Product (GDP) vs Gross National Product (GNP) Owned by factors belonging to Singapore Owned by factors belonging to foreign Produced in Singapore Produced in foreign 23  Not included in GDP: Official (Open) Non-productive financial transactions No real goods and services produced Example: Transfer payments, tax, subsidies, grants, donations, second-hand transactions 24 Official (Open) Not included in GDP: Intermediate Goods Adding both value of final product and intermediate product creates double counting. Final product value already includes intermediate components Example: Individual car parts 25 Official (Open) GDP: Expenditure Approach GDP = C + I + G + (X – M) Consumption spending by households (C) Investment spending by businesses (I) Government expenditure on goods and services (G) Net exports of goods and services (X- M) Note: There are three methods of calculating GDP – Output, Income and Expenditure 26 Official (Open) Nominal vs Real GDP Nominal values are exposed to price distortions while real values have been adjusted to remove these distortions. Because we usually use GDP to measure the health of an economy, we need to remove price distortions so that we can then distinguish if there are true improvements in national income. 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 = 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝐺𝐺𝐺𝐺𝐺𝐺 𝑋𝑋 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 Price index is a measurement of price level. It shows the average cost of a basket of goods/ services consumed by households in a given year compared with another reference year. 27 Official (Open) US Nominal and Real GDP 28 Official (Open) Real GDP: Standard of Living GDP measures the Reflects the country’s Directly affects the economic improvement in well-being of people performance of a standard of living over in the country country time 29 Official (Open) Problem 1: Non-market transaction GDP only includes market transactions. When there is no buying and selling involved, such transactions are excluded Example: Homemaker’s work, bartering of goods and services, volunteer/unpaid services 30 Official (Open) Problem 2: Underground Economy Illegal/informal activities produce goods and services regardless of whether these goods and services are permitted by the law. These are not captured in GDP Example: Gambling, prostitution, loan- sharking, tuition, babysitting 31 Official (Open) Problem 3: Type of Products It does not take into consideration the kind of goods being produced. For example, the GDP could be high, but a big proportion is spent on military goods or exploitation of natural resources, standard of living does not improve. 32 Official (Open) Problem 4: Quality of Products GDP only includes market transactions. It does not consider the quality of the product, i.e., how it has improved over time Example: Smartphones, Laptops 33 Official (Open) Problem 5: Neglect of Leisure Time When the people work longer, the GDP will be larger. However, the longer they work, the less time they have for rest and leisure, standard of living is reduced. This is not reflected in GDP. A higher GDP number doesn’t necessarily mean the people are better off. 34 Official (Open) Problem 6: Economic Bads More production creates more goods and services and these are included in GDP. However, if production creates pollution, the amount of pollution is not deducted from GDP. Example: Carbon emissions, water pollution 35 Official (Open) Real GDP per Capita Countries with large population will tend to have higher real GDP than smaller countries. Real GDP per capita will give a better comparison for average income of a person in a country. 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 𝑝𝑝𝑝𝑝𝑝𝑝 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 = 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 To make comparison easier among countries, this figure is usually converted to a common currency e.g. in US Dollar. 36 Official (Open) US Real GDP and Real GDP per capita 37 Official (Open) GDP per Capita – Singapore 38 Official (Open) Problem 1: Distribution GDP per capita ignores the distribution of income within the population of the country. The income and wealth could be in the hand of a few rich individuals or families Example: Gini Coefficient Reference – https://worldpopulationreview.com/country- rankings/wealth-inequality-by-country 39 Official (Open) Problem 2: Measurement Errors GDP is calculated by each country’s own government. Developed countries have better technology and more sophisticated methods to gather and collect data. Less-developed countries may not have such advanced methods. Less-developed countries may suffer from measurement errors in calculation of GDP. The comparison of GDP per capita may be flawed. 40 Official (Open) Problem 3: Exchange Rate fluctuations When we compare GDP per capita, we have to convert the GDP per capita of different countries into a common currency. For example, it is meaningless to compare the GDP per capita of Singapore in Singapore dollars with GDP per capita of Malaysia in Malaysian ringgits. To compare a dollar to a ringgit, we convert them into a common currency. But exchange rates change all the time, this could cause GDP per capita to change too. 41 Official (Open) Problem 4: Purchasing Power Purchasing power refers to how much money can buy. If prices of goods and services in a country are very expensive, it would imply that purchasing power is weak. When we compare GDP per capita of two countries, the country with higher GDP per capita may actually have a weak purchasing power. So this is not accounted for in the GDP per capita number. Example: Norway vs Singapore 42 Official (Open) Standard of Living: Alternative Measures Due to the limitations of GDP and GDP per capita, GDP may not be a suitable yardstick to measure economic welfare. Some common alternative measures of economic welfare, in addition to GDP, include the following measures: a) Literacy rate – measures the proportion of the population that is able to read and write. b) Life expectancy rate – measures the average life span of an adult. c) Infant mortality rate – measures the number of babies that die before the age of one. 43 Official (Open) Standard of Living: Alternative Measures d) Number of doctors/dentists per 1000/10000 people e) Number of hospital beds per 1000/10000 people f) Number of televisions per 1000/10000 people g) Number of telephones per 1000/10000 people h) Number of cars per 1000/10000 people i) Number of trees per capita j) Percentage of people with internet connections k) Crime rate 44 Official (Open) The End 45 Official (Open) Market Structures Lecture 6 Official (Open) Learning Objective By the end of this lecture, you should be able to: a) Analyse the market structure that a business operates and its business competition strategy with reference to the associated market characteristics. 2 Official (Open) Market Structure Market structure refers to the characteristics that affect the behaviour of the firms in a market. 4 main types: a) Perfect Competition b) Monopoly c) Monopolistic Competition d) Oligopoly 3 Official (Open) Comparison of Market Structures Perfect Monopolistic Oligopoly Monopoly Competition Competition Number of Sellers Large Many Few One Homogenous or Type of Product Homogeneous Differentiated Unique Differentiated Entry Condition Very Easy Easy Difficult Impossible 4 Official (Open) Perfect Competition a) Large number of small firms – No single firm can influence the price b) Homogeneous product – Goods cannot be distinguished from one another c) Price taker – Firms have no control over the price of their product d) Free entry and exit of firms – No restrictions on entry and exit from the market e) Perfect Knowledge – Firms and consumers have complete knowledge on products and prices to make decisions 5 Official (Open) Perfect Competition Examples: Farming Fishing Wood pulping and paper milling Plumbing Dry cleaning and laundry services 6 Official (Open) Perfect Competition: Short Run and Long Run Equilibrium In the Short Run: a) Supernormal Profit b) Normal Profit c) Subnormal Profit In the Long Run: Normal Profit 7 Official (Open) Perfect Competition: Short Run Equilibrium (P>ATC) (P=ATC) (PATC P* Profit ATC Supernormal Profit Demand MR Q Q* 14 Official (Open) Monopoly: Comparison to Perfect Competition Comparing to Perfect Competition: Monopoly Demand & Revenue Q*< QPC P* > PPC P MC Less efficient outcome under monopoly structure P* New firms cannot enter market to Profit ATC compete and lower prices Ppc Demand MR Q Q* Qpc 15 Official (Open) Monopoly: Short Run and Long Run Equilibrium In the Short Run: a) Supernormal Profit b) Normal Profit c) Subnormal Profit In the Long Run: Normal Profit Supernormal Profit 16 Official (Open) Monopolistic Competition a) Many sellers b) Differentiated product – Real or apparent differences between goods and services across firms, e.g. through advertising, packaging, product quality, design, better services c) Price maker – Firms has some control over its own price due to product differentiation. Non-price competition d) Free entry and exit of firms – No restrictions on entry and exit from the market e) Imperfect Knowledge – Firms and consumers have some knowledge on products and prices to make decisions 17 Official (Open) Monopolistic Competition Examples: Computers Frozen Food Clothing Hair Saloons Restaurants Hotels 18 Official (Open) Monopolistic Competition: Demand and Revenue Curve Demand curve of the monopolist Monopolistic Competition competitive firm is downward- Demand & Revenue sloping and is more elastic (flatter) than a monopoly due to P competition A monopolistic competitive firm can either set the price or the amount produced, but it cannot do Demand both. The higher the price it charges, the less will be the quantity sold. MR Q 19 Official (Open) Monopolistic Competition: Short Run and Long Run Equilibrium In the Short Run: a) Supernormal Profit b) Normal Profit c) Subnormal Profit In the Long Run: Normal Profit 20 Official (Open) Monopolistic Competition: Short Run Equilibrium (P>ATC) (P=ATC) (P