Zenith Education Studio
A Level Economics: Macroeconomic Aims and Policies (Theme 3.2) (Part 2)
In a previous article, Zenith covered parts 3.2.1 and 3.2.2 from Theme 3: Macroeconomics of the A Level Economics syllabus (applicable to both H1 and H2 students). Do check out the previous article before reading this one, as it outlines the key definitions and concepts of Standard of Living, Economic Growth, Price Stability, and Employment, which are necessary for understanding this article, which seeks to elaborate on the Macroeconomic policies for building a sustainable economy. In this article, Zenith will be aiming to comprehensively cover Theme 3.2.3 as shown in Figs. 1 and 2. Throughout this article, Zenith has indicated where particular concepts are only applicable to H2 students. Concepts boxed in red in Fig 1 are only applicable to H2 students.
Fig 1. A Level H2 Economics Syllabus for Theme 3.2
Fig 2. A Level H1 Economics Syllabus for Theme 3.2
Macroeconomic policies are strategies implemented by the government of a particular country to influence how its economy functions, such that Macroeconomic goals can be met. To recap, the four Macroeconomic goals (applicable to H2 students only) are:
Balance of Payments (BOP)
These Macroeconomic policies can influence either the Aggregate Demand (AD) or the Aggregate Supply (AS). Fiscal policies and monetary policies fall under demand-side policies, while all remaining policies are supply-side policies. For the A Level Economics examinations, students are required to know only specific supply-side policies, which Zenith will cover in this article, for the following purposes:
Policies for improving the quantity, quality, and mobility of FOPs (both H1 and H2)
Policies for improving efficiency and overcoming barriers to trade (H2 only)
Policies incentivising enterprise (H2 only)
Demand-side policy: Fiscal Policies
There are two main types of fiscal policies. Fiscal policies affect the Aggregate Demand (AD) of an economy through injections and withdrawals made by the government. The first type of fiscal policy refers to government spending policies, where the government, through making purchases from producers, injects cash flow into the economy. This contributes to the expansion of the circular flow of income. The second type of fiscal policy refers to tax policies, where the government collects money from producers, households, and foreign importers. This contributes to a contraction of the circular flow of income.
1. Government Spending
Governments inject money into the economy as they spend on infrastructure and other national interests. For example, public goods such as national defense and street lights. They also accumulate money when the economy is going through an upturn such that when it goes through a downturn, such as during the Covid-19 pandemic, the government is still able to provide their residents with sustained welfare and subsidies. It is important to remember that the government normally acts in the interest of the nation. It is not driven by a profit motive as producers are, nor are they driven by the satisfaction derived from consumption as consumers are.
On a day-to-day basis, government spending on infrastructures such as parks, libraries, and community centers also helps to improve the overall Standard of Living (SOL) of the people. These locations provide employment opportunities for its people, as a library requires librarians, community centers require receptionists and parks require maintenance officers. They also improve the non-material SOL of the people as these spaces encourage rest and recreation, which are beneficial to the psychological wellbeing of a population.
Furthermore, government spending also influences how resources within an economy are allocated. It is not uncommon that governments to provide subsidies to local businesses. However, which businesses and what aspects of them the government decides to provide subsidies to will affect the future development of the economy. For instance, in Singapore, the government agency Enterprise Singapore runs the Productivity Solutions Grant (PSG), which provides subsidies to companies who are looking to go digital. This subsidy thus encourages more producers who are in search of subsidies to adopt and utilise technology in their operations. Such a scheme shapes the economy such that more resources are dedicated to the tech industry and businesses that readily adopt digital solutions in their daily operations. In the long run, if companies sustain what they kickstart using the provided subsidies for technological advancements, the economy might also become increasingly tech-based. You can find out more about the PSG here. Do note that Zenith is in no way affiliated with the grant or Enterprise Singapore, however, this initiative can be a useful example to cite in your A Level Economics essays. Learn more about how to approach the A Level Economics essay here.
2. Tax Policies
Tax policies, as its name suggests, are systems of taxation implemented by the government to collect revenue from its residents. This acts as a form of withdrawal from the circular flow of income, which causes a contraction in the economy. There are two main reasons why the government might decide that it is suitable to implement tax policies.
One of the key reasons why a government might choose to tax certain goods is because these goods are deemed as demerit goods which cause a negative impact on society if consumed in large quantities. Such goods include cigarettes and alcohol, which are detrimental to an individual’s health. Find out how taxation on such goods works in this article. The other main reason why governments tax the people is that they can redistribute the wealth accumulated by individuals from high-income brackets. Progressive taxes typically serve this purpose. In Singapore, the income tax system is progressive, which means that the higher a person’s income is, the higher the amount of tax they have to pay. An individual who earns $120,000 SGD annually has to pay a total of $7950 SGD in taxes, as compared to an individual who earns $80,000 a year, who has to pay $3350 SGD in taxes. Find out more about how the income brackets are divided, and the specificities of Singapore’s progressive income tax system here, at this webpage by the Inland Revenue Authority of Singapore (IRAS).
Demand-side policy: Monetary Policies
Monetary policies are instruments adopted by a nation’s central bank in order to manage the economy’s overall money supply. Similar to how fiscal policies work, monetary policies can either cause the AD to shrink or expand. There are two main types of monetary policies. Interest rate monetary policies control whether and how much banks are able to lend money, and also set the official rate at which money can be lent to borrowers. Exchange rate policies manage the local currency’s value in the foreign exchange (forex) market. In simple terms, the policy essentially decides how “expensive” the local currency is in terms of foreign currencies. For example, as of 22 November, £1 (one English pound) can buy $1.83 in SGD, which means that the pound is “stronger” and more “expensive” than the Singapore dollar, as 1 unit of it can buy 1.83 units of SGD.
1. Interest Rate Monetary Policies
Interest rate policies function to encourage or discourage spending within the economy. When the interest rate is high, it means that the cost of borrowing from the bank increases. For instance, an interest rate of 30% per annum means that if I borrow $100 from the bank in 2021, I will have to return a total of $130 in 2022. While $30 might not seem significant, people typically borrow from banks for big-ticket purchases such as housing or cars. If an individual borrows $100 000 from the bank for the purchase of a car, they will have to return $130 000 to the bank, which is a whopping $30 000 more than they borrowed initially. The high-interest rate thus discourages spending, which has a cooling down effect on the economy, which results in the GPL falling.
In contrast, when the interest rate is 2% per annum, it means that if I borrow $100 000 from the bank for the purchase of a car, I will only have to return the bank $102 000, as the interest is only $2000. This is a big difference from when the interest rate is 30% of what I borrow. As such, when the government is seeking to encourage expenditure such that an expansion of the economy occurs, lowering the interest rate promotes borrowing, which encourages people to make big-ticket purchases.
2. Exchange Rate Monetary Policies
Exchange rate monetary policies can cause the appreciation or depreciation of a currency and affects the money supply in an economy. Money supply is defined as the total amount of money circulating in an economy at any given point in time. Money supply is managed by the government of a country when it buys and sells the particular currency in the forex market. It induces a weakening (depreciation) of its own currency by selling it in the forex market, which results in an increase in the money supply of the particular currency. This reduces the purchasing power of its people, and causes a contraction in the circular flow of income, as consumers are less willing and able to consume. Contrastingly, buying a country’s own currency in the forex market results in a strengthening (appreciation) of it. Money supply is reduced as the currency that is purchased is kept in the government’s own reserves and is excluded from the circular flow of income. The purchasing power of the people increases as the value of the currency increases, and an expansion in the circular flow occurs as people are more willing and able to consume.
Singapore, due to its small and open economy, adopts the exchange rate monetary policy. The Monetary Authority of Singapore (MAS) even has a PDF resource on its website, which can be accessed here, that delineates how the exchange rate monetary policy benefits the Singapore economy. In sum, the exchange rate policy is suitable for Singapore because it ensures price stability and promotes sustained economic growth. It is more suitable than the interest rate policy as the interest rate is hard to control in Singapore’s open economic environment. Furthermore, volatile prices caused by managing interest rates can make Singapore less attractive to foreign investors and exporters, which Singapore is highly dependent on.
Supply-side policies influence the Aggregate Supply (AS) of a particular economy and has a direct impact on its Real National Income (RNI).
1. Policies for improving the quantity, quality, and mobility of FOPs
Policies that encourage skills retraining and/or upskilling, such as the SkillsFuture Scheme in Singapore, improve the quantity, quality, and mobility of human labour, which is a key aspect of production. As more employees are equipped with the skills required for a particular industry, the quantity of labour increases. The quality of labour increases as these employees continually upskill themselves and stay updated on developments in their particular industry. They also become mobile FOPs when they have skills required for multiple industries. For example, an individual might have both hairdressing and baking skills, which allows them to work in either of the industries. When one industry is doing worse off than the other, they have the option of making a career switch instead of remaining unemployed.
2. Policies for improving efficiency and overcoming barriers to trade (H2 only)
Policies such as the removal of welfare benefits (e.g. removing subsidies) might encourage employees and businesses to become more diligent. Individuals who are not working and living off state support might also be forced to find jobs if their benefits are removed. This is because they cannot rely on the government to support them if they are no longer able to sustain themselves. Such a measure, however, has to be carried out in moderation as the removal of welfare benefits can have harsh impacts on the less privileged in society who are unable to sustain themselves for other reasons which are not related to being inefficient.
The removal of bureaucratic red tape, such as lengthy and expensive application processes for registering a business, will also increase the efficiency of an economy. Both time and money are saved and can be invested in other aspects of the business, such as marketing or research and development (R&D), which may bring about more productive material gains that contribute directly to economic expansion.
3. Policies incentivising enterprise (H2 only)
Policies such as demonopolising specific industries and lowering barriers to entry can increase the competitiveness of a particular industry. Increased competitiveness is desirable in situations where it incentivises research and development (R&D), such that companies are able to distinguish themselves as superior over their competitors. Such developments benefit the whole economy at large as it leads to an improvement in the quality of the goods or services being provided. It might also result in lower prices for consumers as businesses might choose to provide their goods and services at a lower price to out-compete their competitors. This is an effective method according to the law of demand which states that quantity demanded increases as the price level falls.
With that, we have come to the end of Theme 3.2 of the A Level Economics syllabus for both H1 and H2 students. Zenith, as Singapore’s top Economics tuition center, has covered the following concepts in this article:
Interest Rate Monetary Policy
Exchange Rate Monetary Policy
Case Study: Singapore
Policies for improving quantity, quality and mobility of FOPs
Policies for improving efficiency and overcoming barriers to trade (H2 only)
Policies incentivising enterprise (H2 only)
As Theme 3.2.3 has shown, A Level Economics can be very much relevant to your daily life! In fact, most of the examples you are expected to know are heavily related to Singapore, as one of the syllabus’ aims is for candidates to develop an awareness about the economy within their own society. Zenith can’t promise that preparing for the A Level Economics examinations will always be a breeze, but we can tell you that it will definitely be a worthwhile journey! Find out more about our meticulously curated A Level Economics tuition programme here, and sign up for a free trial lesson today. Don’t be a stranger, and bring a friend or two if you’d like too––we’d love to see you in class!