GCE A'Level CSQ 2022 Question 2- Suggested Answers
(a) Distinguish between a rise in total output and a rise in productivity. [2]
A rise in total output is an increase in the quantity or volume of goods and services produced either by firms or the economy. However, a rise in productivity describes that the rate at which output is being produced has increased given the same amount of unit input (e.g. same manpower hours)
(b) Explain one reason why a firm with significant market power and the long-run excess process might choose to spend large sums on research and development (R&D). [2]
A firm’s traditional goal is to profit maximize.
The firm might choose to devote large sums on R&D towards “product innovation” to provide higher quality goods and services to the marketplace in order to strengthen its brand loyalty or raise its demand for its goods and services. This would allow the firm’s demand curve to shift rightwards and become more price inelastic (due to a lack of close available substitutes in the market). This allows them to further strengthen their price-setting ability, charge higher prices while restricting output and thus increase their future supernormal profits.
(c) Explain, with reference to Extract 8, what might be the opportunity cost of the S$19 billion invested by the Singapore government to build the country into a global R&D hub. [2]
Opportunity cost is the net value of the next best alternative forgone when the government decides to increase spending to build the country into a global R&D hub. With a finite amount of government budget, the S$19 billion that was used could have been channeled into increased spending on the healthcare sector in Singapore. The increase in social welfare and equity in the healthcare market is now being forgone.
(d) Explain how the creation of an innovation culture in Singapore is likely to have benefited the Singapore economy. [6]
An innovation culture is one that provides “enabling conditions” for innovation to take place. This will enhance dynamic efficiency in firms and have beneficial effects on Singapore’s macroeconomic goals.
An increase in investments in innovation would enhance the productivity of firms which reduces the unit cost of production and boost profitability, thus resulting in Singapore being “a magnet for foreign technology firms”. Investment expenditure increases. To support the innovation culture, the government has also poured in S$19 billion to build the country into a global R&D hub. Government expenditure also rises and overall AD would increase. With a shift in the AD curve rightwards from AD0 to AD1, there would be an unplanned fall in inventories which would cause producers to ramp up production in the production cycle. This would cause real national output to rise and thus real national income to increase from Y0 to Y1, via the multiplier effect. Actual growth is achieved. Furthermore, accompanying an increase in output would be an increase in derived demand for more labor, thus reducing demand-deficient unemployment in Singapore.
​
Innovation culture would also raise the quantity and quality of capital accumulation and the level of technology in the country. Furthermore, it provides and draws “globally-mobile entrepreneurs and top-grade talent” which enhances the quantity and quality of labor. This will cause the productive capacity of the Singapore economy to rise. In the long run, the LRAS curve will shift rightwards from LRAS0 to LRAS1, causing the full employment level to rise from Yf0 to Yf1. Potential growth is achieved. With greater spare capacity, there will be an abundance of under-utilized resources that would exert downward pressures on the cost of production and hence the price of goods and services produced in the economy, thus achieving price stability and sustained economic growth.
Given that the innovation culture has helped achieve many of Singapore’s macroeconomic goals, it is likely to benefit from it.
(e) Discuss whether subsidizing the purchase of electric cars would improve the efficiency of resource allocation in the market for transport in Singapore. [8]
The market for transport in Singapore results in market failure due to the emission of nitrogen oxides from diesel and petrol fuel cars similar to those in the UK. Negative externalities in the consumption of ICE (internal combustion cars) give rise to “heart and lung diseases” which incur medical costs on third parties that are not compensated for; resulting in marginal external costs.
When left to the free market, consumers of ICE would only consider their marginal private benefits and costs and choose to consume cars at MPB = MPC at Qp. However, since there is an existence of MEC (MEC > 0), there would be a divergence between MSC and MPC (since MPC + MEC = MSC). Assuming no positive externalities in car consumption, MPB = MSB. The socially optimal output level Qs is determined by MSC = MSB, where additional social costs and benefits are considered in allocating resources to car consumption. Since Qp > Qs, from the societal’s view, there is an overconsumption of private cars, resulting in MSC > MSB at Qp. Additional costs to additional consumption of cars is greater than the additional benefits associated with it. Social welfare is not maximized due to the existence of deadweight loss area ABC and thus the private car market in Singapore would fail.
Subsidizing the purchase of electric cars to consumers would increase the willingness and ability for consumers to afford cars in Singapore. This would cause the demand for electric cars to increase. Since electric cars and petrol cars are substitutes, there would be a fall in demand for the latter, which would cause the MPB of petrol cars to fall from MPB to MPB'. The fall in the MPB may cause the market to consume cars at Qs, which would eliminate the deadweight loss associated with the negative externalities in consumption, correcting market failure.
However, there might be limited effectiveness in this policy. Firstly, electric cars require massive infrastructure development of charging points in Singapore. Currently, the provision of charging points is still inadequate which may pose an inconvenience to consumers, preventing them to make the switch. Furthermore, the unit cost of producing electric cars is higher since “battery technology” are not advanced enough to bring it down to be priced competitively, thus electric car prices are deemed as “still too high”. Thus, electric cars and petrol cars are weak substitutes, which reduces the extent of fall in the MPB of petrol cars in favor of electric cars, resulting in a deadweight loss to still persist in the traditional car market.
In conclusion, subsidizing electric cars may not provide enough financial incentives for consumers to make the switch and reduce petrol car consumption in Singapore. Singapore has limited land space and controlling the car population is an important objective. Singapore is known for its high car prices globally because there are other policies that go into the final price of the car. This includes the need to purchase a COE (certificate of entitlement), road taxes, and the ARF (additional registration fee). Given huge sunk costs, consumers may be unwilling to switch to electric cars and choose to use their petrol cars until the COE expires. Hence, a reduction in sales taxes and mandatory consumption of hybrid cars in Singapore by 2040, together with greater investment in charging stations would be ideal to result in that switch and solve the market failure in the traditional car market.
(f) Discuss the extent to which government policy can influence a country’s comparative advantage in a good or service. [10]
The theory of comparative advantage states that it is mutually beneficial for two countries to trade with one another when each country specializes in the production of a good or service that it has a comparative advantage in. Having comparative advantage means having a lower opportunity cost incurred to a production of a good relative to another country. This results in lower unit cost of production. Comparative advantage can originate naturally - having factors of production or resources endowed to a country (e.g. Saudi Arabia having an enormous volume of natural gas and crude oil deposits found naturally). Alternatively, comparative advantage can be developed over time, through improvements in factors of production through R&D, improvement in technology and enhancement of labor.
Thesis: Appropriate and effective government policy implementation can positively affect a country's comparative advantage.
With reference to Extract 7, Germany has replaced South Korea as the most innovative nation according to the Bloomberg Innovation Index. Germany may have gained a comparative advantage in the manufacturing sector due to government intervention. Through massive R&D funding from the government to come up with advanced technological methods to produce goods and services, the productivity of Germany surpassed South Korea. Germany has gained comparative advantage as there is a lower opportunity cost incurred when producing goods and services in Germany compared to South Korea.
Anti-Thesis: The government would have limited effect in influencing a country’s comparative advantage.
Governments across the world have finite resources. implementation of policies to support innovation and producing a more productive labor force draws upon scarce financial resources that would incur opportunity costs in other microeconomic or macroeconomic aims. Governments may be reluctant to devote too much financial resources in R&D spending due to high risks and uncertainty involved in R&D projects. The government, to a large extent cannot allow a country to gain comparative advantage owing to factor endowments. Given Singapore is naturally a small and resource poor nation, government policies will not allow Singapore to gain comparative advantage in extracting and exporting crude oil over Saudi Arabia. Land resources are unfortunately perfectly immobile.
In conclusion, in the sphere of dynamic comparative advantage, government policies do have plenty of room to influence a country’s comparative advantage. Take for example, through successful education, innovation and other supply-side policies, Singapore was able to transform itself from a backward nation to an advanced economy that has gained comparative advantage in oil refining, semiconductors and financial services. This feat is achieved through a combination of identifying the appropriate niche industries suitable for our factor endowments, effective governance to encourage enterprise and innovation as well as a strong government budget surplus. However, if we consider natural factor endowments as a source of comparative advantage, government policies would have little ability to influence that.