2023 JC2 H2 Price Stability Tutorial Package - Final 3

2023 H2 Price Stability - Suggested Answers to Practice Questions
10. Practice Questions
Structured Question
1 Draw and explain the economic model that can be used to illustrate the following:
I. Demand-pull inflation
II. Cost-push inflation
Figure 1: Demand-pull inflation

General Price Level
AS
P3
P2 AD3
P1 AD2
AD1
0 Y1 Y f Real GDP
• Demand-pull inflation refers to rising prices caused by rising AD near or at the full
employment level of national output. This can be due to strong economic sentiments,
where there is positive consumer and business outlook. With consumers being
optimistic about their future income, they will increase their consumption
expenditure (C), while firms’ optimism about their expected profits would cause
them to increase investment expenditure (I). As both C & I are components of AD,
AD increases.
• As seen in Figure 1, the economy is initially in equilibrium at Y1 level of real output
where the economy is near full employment level of output, Yf. The increase in AD
from AD1 to AD2 creates shortages in the economy and raises the general price level
steeply from P1 to P2 and real output level increases to Yf where there is no more
spare resources and real output cannot rise any further.
• At full employment output of Yf, there is no more spare resources and real output
cannot rise any further. If AD rises from AD2 rises to AD3, this simply causes firms
to bid up factor prices as they compete for resources with one another. As there is
no overall increase in utilisation of resources, but merely a transfer of resources from
one firm to another, total output remains unchanged.
• Firms then pass on the higher cost of production to households in the form of higher
prices of goods and services, resulting in the general price level rising to P3. This is
a case of demand-pull inflation.
Learning point:
• It is important to note that AD has to be rising near or at the full employment output
level Yf, in order for there to be demand-pull inflation.
Figure 2: Cost-push inflation

General Price Level
P2 AS2
P1
AS1
AD1
0 Y2 Y1Yf Real GDP

• Cost-push inflation refers to rising prices caused by persistent increases in costs of
production, for reasons not associated with an increase in AD.
• In Figure 2 above, at the initial equilibrium where AD1 intersects with AS1, the initial
general price level is P1 and the corresponding real output is Y1.
• When there is an increase in the costs of production at all levels of output, e.g. due
to increase in prices of factors of production,
OR
• with Singapore‘s high dependence on imports both for production and
consumption, a weakening S$ raises cost of imported goods and services and also
the price of imported factor inputs, raising the costs of production.
• The short-run aggregate supply decreases and the AS curve shifts upwards from AS1
to AS2.
• Therefore, the general price level rises from P1 to P2 while real output falls from Y1
to Y2.
• When the costs of production rise persistently, it leads to cost-push inflation.
Learning point:
• It is important to note that the increase in cost of production must not be due to an initial
increase in AD.
Case Study Questions
Question 1: Oil prices and deflationary impacts on various countries
Figure 1: Crude oil prices and UK inflation, 2007–2015

120 5
Percentage change in Coonsumer Price Index

4.5
100
4
US dollars per barrel of oil
3.5
80
3
60 2.5
2
40
1.5
1
20
0.5
0 0
2007 2008 2009 2010 2011 2012 2013 2014 2015
Year
Crude oil prices UK inflation rate
Source: OPEC, Office for National Statistics
Extract 1: UK slips into deflation
The UK has officially slipped into deflation for the first time in more than half a century, but
economists and policy makers are not concerned, saying that a brief period of gently falling
prices is more likely to help growth than harm it.
Prices, as measured by the consumer prices index (CPI), fell by 0.1% because of the slide in
global oil prices, which has reduced the cost of imports. It is not just the price of oil that is
falling; so are the prices of most commodities. Now that prices of consumer essentials like
food and energy are stagnant or falling, many households are finally getting a boost in living
standards as purchasing power of incomes rise. Many, including pensioners, should benefit.
Moreover, deflation will help the country to fully restore export competitiveness. Bank of
England Governor Mark Carney has consistently said that any period of negative inflation is
likely to be temporary, and will not morph into the pernicious deflation seen in countries such
as Japan.
However, while the data should not be mistaken for “damaging deflation”, Chancellor George
Osborne cautioned, “We have to remain vigilant to deflationary risks even when our system
is well equipped to deal with them should they arise.” Deflationary expectations create a
vicious cycle of falling prices and wages which shrinks an economy as households put off
consumption in anticipation of lower prices. This leads to bankruptcies, firms selling off
unprofitable branches, higher unemployment and output decline. Meanwhile, the Trades
Union Congress general secretary, Frances O’Grady, commented, “The first period of
negative inflation in over half a century could signal that there’s something very wrong with
the recovery.” David Kern, Chief Economist at the British Chambers of Commerce, said: “(The)
recent trade and manufacturing figures have been disappointing, and ongoing global
uncertainties, especially in the emerging markets, reinforce our view that the recovery is
fragile, and no risks should be taken.”
Source: Various, 2015
Questions
(a) State the relationship between crude oil prices and the UK inflation rate in [1]
Figure 1.
(b) Explain why pensioners benefit from a period of deflation. [2]
(c) Explain why deflation may be undesirable. [3]
(a) State the relationship between crude oil prices and the UK inflation rate in [1]
Figure 1.
• Crude oil prices and the UK inflation rate has a direct/positive relationship. [1]
Note: No marks given if student states that a rise in crude oil prices will lead to a rise in the UK
inflation rate. The word ‘direct/positive’ relationship needs to be present.
(b) Explain why pensioners benefit from a period of deflation. [2]

• Deflation refers to a sustained decrease in the general price level of goods and services
in the economy.
• When the general price level of goods and services falls, the pensioners who receive a
fixed amount of income periodically (typically monthly), would have a higher
purchasing power [1] and are able to purchase more goods and services, thus improving
their material standard of living. [1]
(c) Explain why deflation may be undesirable. [3]

When there is deflation, households delay their purchase of goods and services as they
expect prices to be lower in future, causing consumption expenditure to decrease.
Producers anticipate lower profits and will be less willing to invest, leading to a fall in
investment expenditure. [1]
• Deflation leads to a fall in consumption and investment expenditure, causing AD and
real output to fall. [1] With lower demand for goods and services, the derived demand
for factors of production, including labour, falls, and hence demand-deficient
unemployment rises. [1]
• This is why according to Extract 1, deflation could lead to “bankruptcies, firms selling
off unprofitable branches, higher unemployment and output decline”. [1]
Question 2: Stagflation Concerns
Extract 1: Singapore not facing stagflation, but inflation will remain high
The Singapore economy is not facing stagflation, according to the Senior Minister of State for
Trade and Industry, S Iswaran. Prices have been rising in Singapore - with inflation hitting a
26-year high of 7.5 per cent in April and May.
And according to Mr Iswaran, prices will continue to go up, with inflation remaining at a rate
that Singaporeans have not experienced until recently. Mr Iswaran said, "Singapore is not
facing stagflation. Singapore's economy grew by 4.3 per cent in the first half of this year. Our
job market remained healthy in the first quarter of the year. More than 73,000 jobs were created,
and unemployment remains low."
Worldwide growth is expected to remain soft in the second half of this year, following months
of cooling due to high oil prices and weakening consumer confidence. And this slowing
growth is compounded by steps to contain accelerating inflation - a situation not unique to
Singapore. However, the Singapore government remains upbeat.
Mr Iswaran said, "In Singapore, the strong pipeline of foreign investments and tourism
projects that we have secured will also provide a certain level of support to the economy for
the rest of the year and beyond. These projects will give rise to new activities and help to
create jobs."
He said that we also have to take care that wage growth does not exceed growth in
productivity so as not to set off a domestic wage-price inflation spiral. During this period of
economic volatility, it is important that companies continue to upgrade business capabilities
and enhance competitive edge.
Source: adapted from Channel NewsAsia, 21 July 2008
Extract 2: The Specter of Stagflation Looms over U.S. economy
Lately, many people are hearing an echo - faintly perhaps but distinctly audible - of the
stagflation of the 1970s. Even as economic growth sags, oil and gasoline prices are surging to
new heights. Gold prices are on the rise, along with the prices of basic commodities like wheat
and steel. And there are signs that overall inflation, after years of only modest increases, may
be breaking out of its box.
For central bankers, especially the Federal Reserve chairman, Ben Bernanke, all this could not
come at a worse time. With the credit markets in disarray from the collapse of the housing
bubble, Bernanke is cutting rates in a headlong rush to blunt the risks of recession.
Analysts say that by tolerating such price rises, and maybe even allowing them to escalate,
the Federal Reserve is risking its hard-won credibility as an inflation fighter, which will
ultimately require it to push interest rates higher than they would have had to in order to
contain the damage.
On one hand, officials are cutting interest rates to keep the economy growing. On the other
hand, the fear of rising inflation makes it more difficult for the Fed to jolt the U.S. economy
with another wave of cheap money.
Like the Fed, economists generally remain more concerned about the immediate threat of
recession than the more distant fear of higher inflation. The consensus view of economists is
that the expected slowdown is likely to create enough spare capacity to suck inflationary
pressures out of the economy. Once the interest rate cuts have nursed the economy through
the next few difficult quarters, they say, the Fed can easily raise rates again to respond to any
pickup in inflation. "They are going to fix the wound now," said David Durst, chief investment
strategist of the Global Wealth Management Group of Morgan Stanley. "They are going to
take care of the growth situation and then fight inflation when the economy gets stronger."
Source: adapted from The New York Times, 1 December 2008
Extract 3: Spectre of the double-dip1 haunts uneasy US

A crippled housing market. Stubbornly high levels of unemployment. Falling consumer
confidence. Slower growth in industrial production. No wonder Ben Bernanke, the world's
most powerful central banker, appeared a worried man in his testimony to Congress about
the state of the US economy last week.
Cheap money, tax breaks, higher public spending and bank bailouts acted like a massive shot
of adrenaline and appeared to do the trick. The US economy has traditionally had good self-
healing properties, and after plunging into recession in late 2008 and early 2009 it returned to
growth in the middle of last year. In the final quarter of 2009, it grew by 1.4%. But growth
since the start of 2010 has dropped back, and leading indicators point to even weaker activity
in the second half of the year. Stubbornly high unemployment and the bombed-out state of
the housing market help to explain why consumer confidence has nose-dived recently. Those
who fear a double dip warn that companies, even if awash with cash, are not going to invest
unless they can expect strong demand for their products.
Americans can expect the Fed to leave interest rates at current emergency levels for some time
to come. But Stephen Lewis at Monument Securities says cheap money alone is unlikely to
turn the economy around soon. "On the balance of probabilities it seems that, in at least one
quarter in the next three, US GDP will record a quarter-on-quarter decline. Such a
development would excite talk of a 'double-dip' recession. But it should, more accurately, be
interpreted as evidence of an economy in depression."
Source: adapted from The Guardian, 25 July 2010
1
A double-dip recession refers to a recession followed by a short-lived recovery, followed by another recession. Gross domestic
product (GDP) growth slides back to negative after a quarter or two of positive growth.
Figure 1: Singapore’s GDP Growth (%)
Source: MAS Survey of Professional Forecasters: March 2010
Figure 2: US unemployment rate (%) Figure 3: US Consumer Price Index
Source: Bureau of Labour Statistics
Questions
(a) Explain what is meant by GDP at constant prices? [2]
(b) With the aid of a diagram, explain why the Minister of State remains [4]
upbeat about the future economic situation in Singapore.
(c) Explain how a wage-price inflation spiral could occur if wage growth [4]
exceeds growth in productivity.
(d) (i) Explain how the data suggest that the US is heading towards stagflation. [3]
(ii) “… Economists generally remain more concerned about the immediate [4]
threat of recession than the more distant fear of higher inflation.” Explain
the above view.
(e) Assess the success of the policies used by US to help its economy. [10]
a) Explain what is meant by GDP at constant prices? [2]
• [Explain GDP] Gross Domestic Product (GDP) refers to the value of all final output
produced by factors of production located within the geographical boundary of the
country, over a given time period. [1]
• [Explain the concept of ‘at constant prices’] GDP at constant prices refer to the value of
GDP that has been computed with the use of base year prices (instead of current year
prices) i.e. real GDP so that inflation is taken into account and changes in the value will
reflect changes in the real output only. [1]
Note:
Answers which use the terms, ‘real’, ‘non-inflationary’, base year etc, without explaining these terms
will be awarded a max of 1m.
b) With the aid of a diagram, explain why the Minister of State remains [4]
upbeat about the future economic situation in Singapore.
Note: The word ‘future’ in the question hints at the need to include an explanation about
productive capacity and the vertical range of the AS curve.
• According to Extract 1, Singapore can expect to have a “strong pipeline of foreign

investments and tourism projects”.
• This means there will be more foreign direct investment inflow into Singapore, resulting
in investment expenditure (I) increasing. More tourism projects will help attract more
tourists to visit Singapore, increasing the exports of goods and services (X). [1]
Figure 1: The Singapore Economy

General Price Level
AS1 AS2
P2
P1
AD2
AD1
0 Y2 Real GDP
Y1
• As seen in Figure 1, the increase in investment and export revenue, coupled with the
multiplied increases in income-induced consumption given that there is spare capacity,
leads to a larger increase in AD and this is represented by a rightward shift of the AD
curve from AD1 to AD2. [1]
• The increase in real output also means that firms’ derived demand for labour increases,
leading to lower demand-deficient unemployment. This is supported by Extract 1 where
there will be ‘new projects [which] help to create jobs’. [1]
• Moreover, the increase in FDI leads to an increase in capital accumulation and hence
productive capacity of the economy, increasing AS in the long run from AS1 to AS2.
• With the increase in AD and AS, the general price level remains at P1 while real GDP
increases from Y1 to Y2, resulting in sustained growth, which is non-inflationary
economic growth. Hence, the Minister of State remains upbeat about the future
economic situation in Singapore. [1m for link to sustained growth and/or lower
unemployment with accurate and well-labelled diagram.]
Note: Answers that only analyse change in AD will be capped at 3m.
c) Explain how a wage-price inflation spiral could occur if wage growth [4]
exceeds growth in productivity.
[For Tutors]
• When there is wage growth, there would be an increase in cost of production, causing short-run
AS to fall and shift upwards, leading to cost-push inflation.
• When there is productivity growth, there would be a fall in unit cost of production and an increase
in productive capacity of the economy, causing long-run AS to increase, shifting the AS curve
downwards and rightwards. Note that we have included a fall in unit COP for this point.
Figure 2: Wage-price inflation spiral

General Price Level
AS3
P3
AS2
P2
P1 AS1
AD
1 Real GDP
0 Y3 Y2 Y1
• When wage growth exceeds productivity growth, the net effect is that there will be an
increase in unit cost of production and productive capacity. [1]
• AS therefore shifts upwards and rightwards from AS1 to AS2 as shown in Figure 2
above. Assuming that there is spare capacity in the economy, the general price level
increases from P1 to P2 and the real GDP falls from Y1 to Y2. [1]
• With the increase in general price levels, workers are likely to demand for higher wages
in order to maintain their real incomes. This again increases production costs for firms,
causing the short-run AS to fall, as depicted by an upward shift of the AS curve from
AS2 to AS3. As a result, the general price level rises further to P3, while real output falls
to Y3. [1]
• The inflationary expectations result in a vicious cycle of wages and prices chasing each
other upwards, which is the situation of a wage-price spiral. [1]
d) (i) Explain how the data suggest that the US is heading towards stagflation. [3]
• Stagflation refers to the situation of high inflation, rising unemployment and low or
negative economic growth. [1]
• Figure 2 shows that unemployment in US is rising steadily. This shows rising
unemployment and likely decreasing output and hence negative growth as well. Extract
2 also shows that there is an “immediate threat of recession”, indicating weak economic
growth. [1m for evidence of rising unemployment and weak/negative economic growth]
• Moreover, according to Extract 2, “oil and gasoline prices are surging to new heights”
together with the “prices of basic commodities”. These suggest that prices of raw
materials are rising, leading to cost-push inflation and this is supported by Figure 3
which shows the rising general price levels in US. [1m for evidence of high inflation]
• Hence, the weak economic growth, rising unemployment and cost-push inflation
suggest that the US economy is heading towards stagflation.
(ii) “… Economists generally remain more concerned about the immediate [4]
threat of recession than the more distant fear of higher inflation.” Explain
the above view.
Explain why economists are more concerned about the immediate threat of recession [2]
• The US economy has been battered by the collapse of the housing bubble (Extract 2)
which has dampened business and consumer confidence in the economy, leading to falls
in investment and consumption, and hence AD decreases. [1]
• Without government intervention, the fall in AD, coupled with the reverse multiplier
effect, is likely to lead to a fall in real GDP, and there is a possibility of the US slipping
into recession, resulting in even higher unemployment. Economists are therefore
concerned about the immediate threat of recession. [1]
Explain why economists are less concerned about the distant fear of high inflation [2]
• Economists are less worried about inflation as it is not likely to be sustained in the short
run, as mentioned in Extract 2 where the “expected slowdown is likely to create enough
spare capacity to suck inflationary pressures out of the economy”.
• This means that there is likely to be negative growth caused by a fall in AD, which can
create spare capacity in the economy so that resources can be utilised without bidding
up factor prices when increasing production, reducing concerns about demand-pull

inflation. [1]
• Moreover, the Fed can use contractionary monetary policy to curb inflation in the future
as Extract 2 mentions that “Fed can easily raise rates again to respond to any pickup in
inflation”. [1]
e) Assess the success of the policies used by US to help its economy. [10]
Question Interpretation
Command Assess To present a balanced analysis of the

word/phrase effectiveness of the policies, considering
how they may work and their limitations,
before giving a judgement on whether the
policies adopted by US is successful.
Content Policies used by Expansionary interest rate monetary policy
US… → decrease interest rates
Expansionary fiscal policy → increase G,
decrease direct taxes
to help its economy Aim is to achieve actual growth

Context US economy Large US economy with rising
unemployment and poor consumer and
business confidence as mentioned in case
extracts
A relevant response requires an explanation of how expansionary monetary and fiscal policy can be
used by US to address recession and help its economy achieve actual growth. This needs to be followed
by an analysis of the limitations associated with each policy. Finally, the evaluation requires making
a well-substantiated judgement on the relative effectiveness of the policies in helping the US economy
recover from recession and achieve actual growth.
Suggested Answer
Introduction
• [Set the context] According to Extract 2 and Figure 2, the US economy is facing the risk
of stagflation, where there is weak economic growth, rising unemployment and cost-
push inflation.
• [Define key terms + outline approach] A recession is defined as two consecutive
quarters of negative economic growth. As explained in (d)(ii), a recession is a more
immediate threat, and the US government has adopted expansionary monetary and
fiscal policy to stimulate actual growth in the economy.
Body 1: Explain what expansionary monetary policy is and how it can help the US economy achieve
actual growth
• Expansionary interest rates monetary policy through reducing interest rates was used
by the US government to achieve actual growth for the US economy.
• This would lower the cost of borrowing for households and firms, which is mentioned
in Extract 2 as “cheap money”. This incentivises consumers to borrow to purchase big-
ticket items, causing consumption expenditure (C) to increase. Lower interest rates also
raises firms’ expected profitability, thus incentivising them to borrow more to finance
investments, causing investment expenditure (I) to increase.
Figure 3: Expansionary monetary policy to achieve actual growth
• As seen in Figure 3 above, the increase in C and I will first increase AD from AD1 to AD2.
If there is spare capacity in the economy, the multiplier effect will be triggered, and
successive rounds of increases in income-induced consumption would occur to lead to
a larger increase in the aggregate demand (AD) from AD2 to AD3. This leads to an
increase in the general price level from P1 to P3 and a multiplied increase in real GDP
from Y1 to Y3.
• The increase in real GDP means that real output in the economy has increased, achieving
actual growth and addressing the situation of recession in the US. Firms also increase
their derived demand for labour, thus reducing demand-deficient unemployment from
(Yf – Y1) to (Yf – Y3).
Body 2: Explain the limitations of expansionary interest rates monetary policy and why it may not
help the US economy to achieve actual growth (1 thorough explanation from the set below would
suffice for a 10m CSQ qn)
• As mentioned in Extract 3, “consumer confidence has nose-dived” and “companies are
not going to invest unless they expect strong demand”. This indicates poor consumer
and business confidence in the US economy, which would result in interest
insensitivity.
o As such, consumers and firms, worried about future incomes and profit levels, may
not be incentivised to borrow to increase their consumption and investment
respectively despite lower interest rates. Hence, this limits the increase in AD and
hence real GDP resulting from the reduction in interest rates.
• Moreover, Extract 3 states that interest rates are at emergency levels, implying that they
are low and near the zero lower bound. The US economy could thus be facing liquidity
trap where the central bank fails to lower interest rates further, rendering the policy
ineffective.
Body 3: Explain what expansionary fiscal policy is and how it could help the US economy achieve
actual growth
• Expansionary fiscal policy is another policy to help the US economy recover from the
recession and achieve actual growth.
o It can be implemented through an increase in government expenditure (G) or
decrease in direct taxes (T). This is mentioned in Extract 3, where the US
government used “tax breaks” and “higher public spending” to stimulate actual
growth in the economy.
o An increase in government expenditure, a component of AD, would directly cause
an increase in AD.
• When personal income taxes are reduced, households’ disposable incomes and
purchasing power increases, incentivizing higher consumption expenditure (C).hen
government reduces personal income taxes, it raises consumers’ disposable income,
leading to an increase in purchasing power which stimulates consumption expenditure
(C).
• When government reduces corporate taxes, it raises firms’ post-tax profits which
stimulate investments, thus increasing investment expenditure (I).
o As explained earlier, if there is spare capacity in an economy, the increase in G, C
and I, coupled with the multiplier effect, would lead to a larger increase in AD. This
would result in a multiplied increase in real GDP from Y1 to Y3, enabling the
economy to achieve actual growth.
Body 4: Explain the limitations of expansionary fiscal policy and why it may not help the US economy
to achieve actual growth (1 thorough limitation from the set below would suffice for a 10m CSQ qn)
• Given the weak business and consumer confidence in the economy, there is likely to
be tax insensitivity, as firms and consumers remain pessimistic about future profits and
income. A fall in direct taxes may not be able to stimulate consumption and investment,
thus limiting the effectiveness of expansionary fiscal policy in stimulating actual growth.
• The US also has debt burden amounting to trillions of dollars. Borrowing by the
government to finance a budget deficit when pursuing expansionary fiscal policy could
lead to higher interest rates, raising the cost of borrowing and crowding out private
sector investments. The expected increase in AD from an increase in G or decrease in T
is thus likely to be negated by the fall in I, thus reducing the effectiveness of the policy
in raising AD and hence real GDP.
Evaluative Conclusion: (Stand + 1 well-substantiated ATMS evaluative angle will suffice)

• [Stand]: Overall the data suggests that the policies adopted by the US government had
limited success in helping the US economy achieve actual growth.
• [Situation]: This is evident in Extract 3 which mentioned that “cheap money alone is
unlikely to turn the economy around soon”. This is likely due to the very poor business
and consumer confidence which makes it difficult for the fall in interest rate to stimulate
consumption and investment expenditure. This is likely to also result in tax insensitivity,
hence severely limiting the effectiveness of a reduction in direct taxes in stimulating
actual growth. Moreover, Figure 2 showed that US experienced high unemployment
levels of 8-10% in 2009, which would have likely contributed to the continuous
pessimistic business outlook and worsened the recession.
• [Alternative]: While the policies adopted could have helped US achieve some actual
growth initially, the positive impact of the policies seem to have worn off around 2010
as mentioned in Extract 3. The US government could consider enhancing the
effectiveness of the policies by implementing supply-side policies to reduce economy-
wide cost of production. This would not only increase short-run AS and hence real
output, but could also help to mitigate cost-push inflation as well, thus effectively
mitigating the risk of stagflation.
Mark Scheme
Level Descriptors Marks
L2 For a well-developed answer that has: 4-7
• Good scope – explains how the policies used by the US
government, ie, expansionary fiscal and monetary policies,
work to stimulate actual growth in the US economy, with
limitations that are well supported with relevant case
evidence.
• Good rigour – develops explanation according to context in
case material where possible. Policies assessed must be the
ones mentioned in the extracts.
L1 For a well-developed answer that: 1-3
• Lacks scope – explains only monetary or fiscal policy with
rigour or both policies without limitations.
• Lacks rigour – descriptive answer without application to
case material.
E For an answer that uses economic analysis to support an 1-3
evaluative judgement on the overall success of the policies
adopted by the US government.
Essay Questions
Essay Question 1 (N2013 H2)
On 1 September 2011, the Monetary Authority of Singapore (MAS) reported that

inflationary pressures remained strong because of the tight domestic labour market, high
consumer spending and rising global commodity prices.
Source: http://www.mas.gov.sg/resource/econ_research/eco_dev_ana/
Recent_Economic_Development.pdf, accessed 1 September 2011
(a) Explain how the factors mentioned above will lead to inflationary pressures remaining
strong in Singapore.
[10]
Part (a) Question Interpretation
Command Explain how To give a thorough explanation of the relevant

word/phrase cause and effect relationships i.e how the
different factors (causes) mentioned in the
preamble lead to inflation in Singapore (effect)
Content Inflationary pressures Demand-pull and cost-push inflation
Context Singapore Explain how Singapore back in 2011 can be
affected by tight domestic labour market, high
consumer spending and rising global
commodity prices.
A relevant response requires an explanation of how the different factors mentioned in the preamble lead
to high inflation in Singapore in 2011. Both demand-pull and cost-push inflation should be explained
with relevant diagrams.
Suggested Answer
Introduction:
• Inflation can be defined as a sustained increase in the general price level of goods and
services in the economy. Inflation becomes a problem when the rise in general price level
is sustained and excessive.
• There can be demand-pull inflation due to an increase in the aggregate demand (AD) or
cost-push inflation due to a decrease in the aggregate supply (AS)
Body 1: Explain how high consumer spending and tight domestic labour market leads demand-pull
inflation in Singapore
• High consumer spending could contribute to demand-pull inflation in Singapore.
Demand-pull inflation refers to rising prices caused by rising AD near or at the full
employment level of national output.
• A tight labour market could mean that the Singapore economy is operating very near the
full employment level of output Yf. This is shown in Figure 1, where the economy is
initially in equilibrium at Y1 output level at the rising portion of the AS curve.
• As consumption expenditure is a component of AD, high consumer spending, probably
due to strong consumer confidence, would directly increase AD from AD1 to AD2.
Coupled with the multiplier effect where there are multiple rounds of increases in income-
induced consumption when income increases, there will be a larger increase in AD to AD3,
and a multiplied increase in real national income from Y1 to Y3.
• As AD rises from AD1 to AD2 due to the increase in C, the general price level (GPL)
increases from P1 to P2 and real output level increases to Yf. At full employment output
level Yf, there is no more spare resources and real output cannot rise any further. When
AD continues to rise from AD2 to AD3 because of the multiplier effect, industries which
are already at full employment would have to compete for resources and this will cause
the bidding up of the prices of the factors of production. The higher unit cost of production
incurred by firms are then passed on to households in the form of higher prices of goods
and services, resulting in the GPL escalating from P1 to P3. This is a case of demand-pull
inflation in Singapore.
Figure 1: Demand-pull inflation
General Price Level

AS
P3
P2
AD3
P1 AD2
AD1
Real GDP
0 Y1 Yf
Body 2: Explain how tight domestic labour market and rising commodity prices lead to cost-push
inflation in Singapore
• A tight domestic labour market could also mean that there is a shortage of labour in the
market. This could be due to restrictions on the use of foreign labour in Singapore, which
result in a fall in labour supply or a smaller extent of rise in labour supply as compared to
the rise in labour demand. The labour shortage causes wages to rise and increases the cost
of production for firms.
• Moreover, the rising commodity prices would mean that prices of raw materials are
increasing. As Singapore has no natural resources and imports a lot of raw materials, the
rising commodity prices would result in increased cost of production arising from
imported inflation.
• Therefore a tight domestic labour market and rising commodity prices would increase cost
of production in the economy, leading to a fall in short-run AS, and the AS curve shifts
upwards from AS1 to AS2 as shown in figure 2 below.
• As a result, there is a further increase in the general price level from P1 to P2, leading to
cost-push inflation. At the same time, the real GDP falls from Y2 to Y1.
Figure 2: Cost-push inflation
General Price Level
P2 AS2
P1
AS1
AD1
0 Y2 Y1 Yf Real GDP
Summative Conclusion:
• Therefore, high consumer spending contributed to demand-pull inflation when the
Singapore economy is operating at very near the full employment level of output. At the
same time, the rising global commodity prices with the tight domestic labour market
contributed to cost-push inflation in Singapore.
Mark scheme
Level Knowledge, Comprehension, Analysis and Application Marks
L3 For a well-developed answer that has: 8 – 10

• Good scope – explains all the three different causes of inflation
mentioned in the preamble, covering both demand-pull and cost-push
inflation.
• Good rigour – uses AD/AS analysis and shows good understanding of
how each factor in the preamble leads to inflation, with well-explained
and accurate diagram(s).
L2 For an underdeveloped answer that: 5–7

• Lacks scope – explains fewer than 3 causes of inflation or fails to link
to either demand-pull or cost-push inflation.
• Lacks rigour – generic textbook approach without focus on the causes
of inflation given in the preamble.
L1 For an answer that shows some knowledge of inflation but with weak 1–4
analysis and application to context.
(b) Discuss alternative economic policies that the Singapore government might consider
adopting to alleviate these inflationary pressures. [15]
Part (b) Question Interpretation

Command Discuss To examine and present a balanced analysis of
word/phrase policies, considering how policies work and
their limitations/unintended consequences,
before giving a judgement on the
appropriateness and/or effectiveness of the
policies that the Singapore government could
adopt
Content Economic policies Contractionary demand-management policies
(appreciation of exchange rate or fiscal policy),
and supply-side policies
Alleviate these To reduce demand-pull and cost-push inflation

inflationary pressures
Context Singapore Justify the use of suitable economic policies in
Singapore, applying the characteristics of the
Singapore economy and to the causes
mentioned in preamble.
A relevant response requires an explanation of how different economic policies could be adopted by the
Singapore government to alleviate demand-pull and cost-push inflation, caused by the factors explained
in (a). The policies should include contractionary monetary policy through currency appreciation or
contractionary fiscal policy and supply-side policies. Students should also explain the limitations and/or
unintended consequences associated with each policy. The evaluation then requires a judgement and
sound justification on which is/are the most appropriate policies that the Singapore government should
adopt to alleviate inflationary pressures.
Suggested Answer
Introduction:
• There are various economic policies that the Singapore government can consider adopting
to alleviate the inflationary pressures. These include contractionary exchange rate
monetary policy, contractionary fiscal policy and supply-side policies.
Scope: Students are to explain the O-W-L of one demand management policy (either expansionary
exchange rate policy or expansionary fiscal policy) and one-supply side policy.
Thesis 1: Explain how exchange rate monetary policy works to alleviate the inflationary pressures in
Singapore
• Firstly, contractionary monetary policy through currency appreciation could be used to

alleviate cost-push inflation due to the rising commodity prices and demand-pull
inflation in Singapore.
• The Singapore central bank, the Monetary Authority of Singapore (MAS) could intervene
in the foreign exchange market to cause an appreciation of the Singapore dollar by buying
the Singapore dollars.
o As MAS buy the Singapore dollars, the demand for Singapore dollars increases and
cause the Singapore dollars to appreciate.
o As the Singapore dollar appreciates, the exports becomes relatively more expensive in
terms of foreign currency and this decreases the quantity demanded for exports. On
the other hand, the import becomes relatively cheaper in terms of domestic currency
and this increases the quantity demanded for imports.
o Assuming that the absolute sum of the price elasticities of demand for imports and
exports is greater than one, i.e. the Marshall-Lerner Condition holds, the appreciation
of the Singapore dollar would lead to a fall net export revenue and hence a fall in AD.
Figure 2: Contractionary Monetary Policy to reduce inflation

General Price Level
P2 AS2
P1 AS1
AD2
AD1
0 Real GDP
Y1 Y2
• With reference to figure 2 above, initially, the economy is experiencing both demand-pull
and cost-push inflation, where the AD increased from AD1 to AD2 while AS decreased
from AS1 to AS2.
• The implementation of contractionary monetary policy through currency appreciation
results in the fall in AD as shown by a leftwards shift from AD2 to AD1.
• Moreover, as mentioned in the preamble, Singapore is also facing rising commodity prices.
An appreciation of the exchange rate helps lower the prices of imported inputs in terms
of the local currency, thus reducing cost of production, and increasing short-run AS. This
is shown by the downward shift of AS curve from AS2 to AS1, managing cost-push
inflation due to high import prices.
o As a result, the general price level falls from P2 to P1, reducing inflation.
• The impact on real GDP would depend on the extent of shifts of AD and AS. In figure 2,
the extent of fall in AD is the same as the fall in AS, hence real GDP remains unchanged
at Y2.
Anti-thesis 1: Explain the limitation OR unintended consequence of contractionary exchange rate

monetary policy and why it may not be the best way to alleviate the inflationary pressures in Singapore
(1 well-explained point will suffice)
• However, the effectiveness of contractionary exchange rate monetary policy through

appreciating the Singdollar to mitigate inflation could be constrained/limited by the
amount of foreign reserves that the government has.
• If the MAS has insufficient foreign reserves, this would prevent it from buying enough of
its own currency to sufficiently appreciating the SGD to lower the price of improted raw
materials to reduce the rate of inflation.
o Moreover, if there is a global economic boom, an appreciation of the Singdollar may
not dampen external demand sufficiently to reduce (X-M) to decrease AD to mitigate
inflation as well.
OR
• Another limitation is that there are time lags associated with the implementation of
contractionary monetary policy as it takes time to recognise the problem of high inflation
(recognition lag), for the Singapore government to intervene and adjust the policy band
accordingly to achieve the desired exchange rate (implementation lag) and for consumers
to take time to respond and change their consumption patterns (impact lag).
o Hence, by the time the policy takes effect, the economy could have already recovered
from high inflation and the policy might only result in an increase in unemployment.
• [Situation]: Nonetheless, the time lags is a less significant issue in Singapore, as the MAS
formulates and conducts the exchange rate policy in a forward-looking manner, such that
the impact of the policy is evaluated over the medium term based on reasonable
assumptions of economic outlook and possible negative shocks.
• An unintended consequence could be that the reduction of inflation through reducing AD and
increasing AS may result in conflict with the other macroeconomic goals of the Singapore
government, which is to achieve economic growth and full employment.
o When the AD falls by a larger extent than the increase in AS, the real GDP falls, and there
would be negative growth in the economy.
o Moreover, with the fall in AD for goods and services, there may be increase in demand-deficient
unemployment as fewer factors of production are employed to produce the lower level of output.
Alternative Thesis 1: Explain how contractionary fiscal policy works to alleviate the inflationary
pressures in Singapore
• Contractionary fiscal policy is another policy that can be used to alleviate the
inflationary pressures in Singapore due to the strong consumer confidence.
• This involves either reduction in government expenditure (G) or increase in direct taxes
(T) to reduce the AD.
o When there is reduction in government expenditure, it directly decreases AD since
government expenditure is a component of AD.
o The Singapore government could also increase personal income tax, which would
lower the households’ disposable income, purchasing power and hence reducing
consumption expenditure. This would directly address the high consumer spending
mentioned in the preamble. Alternatively, the government could increase corporate
income tax, which would reduce firms’ post-tax profits and hence discourage
investments and reducing investment expenditure.
Figure 3: Contractionary fiscal policy to manage demand-pull inflation
General Price Level

AS
P2
P3 AD2
P1 AD3
AD1
0 Y1 Yf Real GDP
• Output economy is experiencing
With reference to figure 3 above, initially, the Singapore
demand-pull inflation where there is increase in AD from AD1 to AD2, thus causing
general price level to rise from P1 to P2.
o With contractionary fiscal policy leading to a fall in government, consumption and
investment expenditure, there is a fall in AD, and AD shifts leftwards from AD2 to
AD3, and the general price level falls from P2 to P3, reducing demand-pull inflation.
• Therefore, contractionary fiscal policy may be used to dampen the high consumer
spending mentioned in the preamble.
Alternative to Anti-thesis 1: Explain the limitation OR unintended consequence of contractionary fiscal

policy and why it may not be the best way to alleviate the inflationary pressures in Singapore (1 well-
explained point will suffice)
• However, contractionary fiscal policy may also not be effective in alleviating the
inflationary pressures in Singapore due the unintended consequences and limitations
associated.
• An unintended consequence is that contractionary fiscal policy brings about adverse
long-run supply side effects when the government cuts its developmental expenditure in
the building of healthcare and educational infrastructure. This would restrict potential
growth in the long run.
• Moreover, raising personal income tax and corporate income tax create disincentive to
work and invest which also restricts potential growth in the long run.
• [Magnitude]: Given that the strong consumer spending is the key issue in the preamble,
of the different types of contractionary fiscal policy, the increase in personal income tax
may be the most effective as it deals with the root cause of the inflationary pressure.
Thesis 2: Explain how supply-side policies work to alleviate the inflationary pressures in Singapore
• Supply-side policies can be used to fight demand-pull and cost-push inflation in

Singapore as well, in particular, to tackle the issue of the tight labour market.
• Singapore government could provide greater subsidies to encourage labour to improve
their skills and productivity. Alternatively, more foreign labour could be allowed into
Singapore.
o These actions would increase the quality and quantity of labour respectively in the
Singapore economy, increasing the productive capacity and long-run AS, thus causing
a rightward shift of the AS curve.
o In addition, as more labour enters the economy, and the supply of labour increases,
wages could be pushed down, causing a fall in the cost of production and a downward
shift of the short-run AS curve.
Figure 4: Supply-side policies to reduce inflation

General Price Level
AS1 AS2
P3
P2
P1
AD2
AD1
Real GDP
0
Yf1 Yf2
o Hence, supply-side policies may cause AS to increase in both the short and long run.
This is represented by the AS curve shifting downwards and to the right from AS1 to
AS2, as shown in figure 4.
• Assuming the Singapore economy is operating at the full employment level of output,
initially there is a rise in AD from AD1 to AD2 due to demand-pull inflation, causing
general price level to increase from P1 to P3. With the increase in AS due to supply-side
policies, there would be a fall in general price level from P3 to P2, thus curbing inflation.
Anti-thesis 2: Explain the limitation OR unintended consequence of supply-side policies and why they
may not be the best way to alleviate the inflationary pressures in Singapore (1 well-explained point
will suffice)
• However, supply-side policies alone may also not be effective in alleviating the
inflationary pressures as it involves long time lags and the outcomes are uncertain.
• A clear limitation of labour upskilling projects is that they take long time to bear fruit and
there are risks involved as labour may not successfully attain the required skills.
• A possible limitation and unintended consequence would also be the large amounts of spending by
the government and the possibility of the Singapore government faced with budget constraint.
Besides, large amount spent on upskilling labour would mean that there is lesser amount available
to develop other essential areas such as healthcare.
• A large influx of foreign labour may cause unhappiness among the local populace and could result
in political and social instability, which could adversely affect consumer and investor confidence
(and hence C and I expenditure) in the long run.
• Therefore, supply-side policies alone may not be the best policy to alleviate the
inflationary pressures in Singapore.
Evaluative conclusion: ([Stand] + TWO well-substantiated ATMS angles. Note that there are some
opportunities to score evaluation marks within the body para itself! If you did those, then a stand + 1
more ATMS evaluation angle here would work )
• [Stand]: To alleviate the inflationary pressures, the Singapore government could adopt a
combination of contractionary monetary policy through currency appreciation (depends on
choice of demand side policy earlier analysed in your body) and supply-side policies.
• [Situation]: Currency appreciation (depends on choice of demand side policy) is an essential
policy due to Singapore’s heavy reliance on imports which makes it highly susceptible to
imported cost-push inflation. With an appreciation of the Singapore currency, the
Singapore government can have better control over the rising global commodity prices.
Although a currency appreciation would make Singapore’s exports more expensive in
terms of foreign currency, as the exports have high import content, the lower cost of
imports could help to lower the cost of producing exports, cushioning the negative impact
of higher export prices arising from an appreciation of the exchange rate.
o [Alternative]: However, reducing AD alone might not be appropriate in alleviating
inflationary pressures over a sustained period of time, as it could lead to a fall in real
GDP eventually. As such, supply-side policies should be used in tandem with
monetary policy to ensure that the productive capacity of the Singapore economy
continues to increase so the general price level may fall while allowing for real output
to increase.
• [Situation]: Contractionary fiscal policy (depends on choice of demand side policy), on the
other hand, may not be that suitable as developmental expenditure is necessary for the
Singapore economy to achieve potential growth in the long run. Moreover, with the
Singapore economy highly dependent on foreign talent and foreign investment, raising
direct taxes is in conflict with Singapore’s growth strategy and would only further restrict
economic growth and lead to higher unemployment. Further, the Singapore government
might not want to dampen the consumption spending by increasing the personal income
tax as that could lower the material standard of living of its citizens.
• Therefore, to be effective in alleviating the inflationary pressures in Singapore, the
government could consider to use a combination of currency appreciation (depends on
choice of demand side policy) and supply-side policies to focus on alleviating the inflationary
pressures resulting from rising commodity prices and the tight labour market.
Mark scheme
For a well-developed answer that has:

L3 • Good scope – exhibits clear analytic understanding of demand-side 8 – 10
and supply-side policies and how they could be used to address the
different causes of inflation and alleviate inflationary pressures,
together with limitations/unintended consequences.
• Good balance – explains the usefulness and limitations of the above-
mentioned policies
• Good rigour – utilises appropriate AD/AS analysis, together with real-
world examples applied to the different causes of inflation in Singapore,
with well-explained and accurate diagram.
For an underdeveloped answer that:

L2 • Lacks scope – limited explanation of how demand-side and supply- 5–7
side policies could be effective in alleviating inflationary pressures,
with either demand or supply-side policies missing from analysis or
fails to address both types of inflation.
• Lacks balance – only has either workings OR limitations of the policies
analysed
• Lacks rigour – gives a descriptive explanation of the usefulness and
limitations of the policies to alleviate inflationary pressures or has
limited application to Singapore context.
For an answer that shows some knowledge of how macroeconomic

L1 policies work to alleviate inflationary pressures. Answer may contain 1–4
multiple conceptual errors.
Level Evaluation, Synthesis Marks
For a well substantiated evaluation of the effectiveness of various

E3 policies to alleviate inflationary pressures that is contextualised and 5
well supported with economic analysis.
For an answer that makes some attempt at evaluating the effectiveness

E2 of alternative policies to alleviate inflationary pressures. 3–4
For an unsubstantiated answer that addresses the question.

E1 1–2
Essay Question 2
(b) Discuss whether managing the exchange rate is always the best way to fight inflation
in Singapore. [15]
Question interpretation
Command Discuss whether To examine and present a balanced analysis of the
word/phrase policy by explaining how it works and its
always the best way unintended consequences/limitations. This is
followed by challenging absolute terms present
(“always”, “best”) and analysing the effectiveness of
1 other policy, before providing a well-reasoned
evaluative judgement on whether managing
exchange rate is the best way to fight inflation.
Content Managing the Contractionary exchange rate monetary policy
exchange rate, through currency appreciation → reduces (X-M) and
fight inflation AD → reduces GPL
Context Singapore Justify the use of exchange rate monetary policy in
Singapore (trade dependent country)
A relevant response requires an explanation of how exchange rate monetary policy works to fight
inflation in Singapore and how one other policy could also be used to fight inflation in Singapore.
Students should also explain the unintended consequences/limitations associated with each policy. The
evaluation then requires a judgement on whether contractionary exchange rate monetary policy is the
best way to fight inflation in Singapore and a sound justification of the stand made.
Suggested Answer
Introduction:
• Contractionary exchange rates monetary policy through a currency appreciation may be
used to reduce both demand-pull and cost-push inflation in Singapore.
Thesis 1: Explain how contractionary exchange rate monetary policy works to fight inflation in
Singapore
• To mitigate inflation, the Singapore central bank, the Monetary Authority of Singapore
(MAS) could intervene in the foreign exchange market to cause an appreciation of the
Singapore dollar, by shifting the managed float band upwards to allow the exchange rate
to float at a higher value.
o By buying more Singapore dollars with foreign reserves, the MAS causes the demand
for Singapore dollars to increase and the Singapore dollar to appreciate.
o As the Singapore dollar appreciates, exports become relatively more expensive in
foreign currency terms and this decreases the quantity demanded for exports. On the
other hand, imports become relatively cheaper in domestic currency terms and this
increases the quantity demanded for imports.
o Assuming that the absolute sum of the price elasticities of demand for imports and
exports is greater than one, i.e the Marshall-Lerner condition holds, the appreciation
of the Singapore dollar would lead to a fall in net export revenue (X-M) and hence a
fall in AD.
Figure 1: Contractionary Exchange Rates Monetary Policy to reduce inflation

General Price Level
P2 AS2
P1 AS1 AD2
AD1
0 Real GDP
Y1 Y2
• With reference to Figure 1 above, assume that initially, the economy is experiencing both
demand-pull and cost-push inflation and AD increases from AD1 to AD2 while short-run
AS decreases from AS1 to AS2. As a result there is inflation in the economy, represented
by the increase in general price level from P1 to P2.
o The implementation of contractionary monetary policy through currency appreciation
results in the fall in AD as shown by a leftwards shift from AD2 to AD1.
o Moreover, as Singapore has no natural resources, it is heavily dependent on imported
inputs. Currency appreciation could therefore help Singapore to reduce price of
imported inputs in terms of Singapore dollar and thus the cost of production,
increasing short-run AS. This is shown by the downward shift of AS curve from AS2
to AS1, managing cost-push inflation.
o As a result of the fall in AD and rise in AS, the general price level falls from P2 to P1,
reducing inflation.
• The impact on real GDP would depend on the extent of shifts of AD and AS. In Figure 1,
the extent of fall in AD is the same as the fall in AS, hence real GDP remains unchanged
at Y1.
Anti-thesis 1: Explain the limitation OR unintended consequence of contractionary exchange rate

monetary policy and why it may not be the best way to fight inflation in Singapore (1 well-explained
limitation/unintended consequence will suffice.)
• However, contractionary monetary policy through currency appreciation may not be the
best way to fight inflation in Singapore as there are unintended consequences and
limitations to it.
• A limitation is that there are time lags associated with the implementation of
contractionary monetary policy as it takes time to recognise the problem of high inflation
(recognition lag), for the Singapore government to intervene and adjust the policy band
accordingly to achieve the desired exchange rate (implementation lag) and for consumers
to take time to respond and change their consumption patterns (impact lag).
o Hence, by the time the policy takes effect, the economy could have already recovered
from high inflation and the policy might only result in an increase in unemployment.
• [Situation]: Nonetheless, time lags is a less significant issue in Singapore, as the MAS
formulates and conducts the exchange rate policy in a forward-looking manner, such that
the impact of the policy is evaluated over the medium term based on reasonable
assumptions of economic outlook and possible negative shocks.
• An unintended consequence could be that the reduction of inflation through reducing AD and
increasing AS may result in conflict with the other macroeconomic goals of the Singapore
government, which is to achieve economic growth and full employment.
o When the AD falls by a larger extent than the increase in AS, the real GDP falls, and there
would be negative growth in the economy.
o Moreover, with the fall in AD for goods and services, there may be increase in demand-deficient
unemployment as fewer factors of production are employed to produce the lower level of output.
Thesis 2: Explain how supply-side policies work to fight inflation in Singapore

• Supply-side policies can be used to fight demand-pull and cost-push inflation in
Singapore as well. Singapore government could provide greater subsidies to encourage
research and development projects which could increase the quality of resources and
hence increase the productive capacity of the economy as well as lowering the unit cost of
production in the economy.
• This would cause the AS to shift downwards and rightwards from AS1 to AS2 in
Figure 3.
Figure 3: Engagement in R&D to reduce inflation

General Price Level
AS1 AS2
P2
P3
P1
AD2
AD1
Real GDP
0
Yf1 Yf2
o Assuming the Singapore economy is operating at the full employment level of output,
initially there is a rise in AD from AD1 to AD2 due to demand-pull inflation.
• With the increase in AS due to supply-side policies, there would be a fall in general price
level from P2 to P3, curbing demand-pull inflation.
Anti-thesis 2: Explain the limitation OR unintended consequence of supply-side policies and why they
may not be the best way to fight inflation in Singapore (1 well-explained limitation/unintended
consequence will suffice.)
• However, supply-side policies alone may also not be the best way to fight inflation as it
involves long time lags and the outcomes are uncertain.
• Research and development projects take long time to bear fruit and there are risks
involved as the projects may fail.
• Moreover, the subsidies and grants required would involve large amount of financial resources by
the government and the Singapore government is faced with budget constraint. Besides, large
amount spent on encouraging R&D would mean that there is lesser amount available to develop
other essential areas such as healthcare, giving rise to significant opportunity costs.
• Therefore, supply-side policies alone may not be the best way to fight inflation.
(Optional) Thesis: Explain how contractionary fiscal policy works to fight inflation in Singapore
• Contractionary fiscal policy is another policy that can be used to fight inflation in
Singapore.
• This involves either reduction in government expenditure or increase in direct taxes to
reduce the AD.
o When there is reduction in government expenditure, it directly decreases AD since
government expenditure is a component of AD.
o The Singapore government could also increase personal income tax, which lowers
households’ disposable income, purchasing power and hence consumption
expenditure. Or they could increase corporate tax, which would decrease firms’ post-
tax profits and hence discourage investments and reduce investment expenditure.
Figure 2: Contractionary fiscal policy to manage demand-pull inflation
General Price Level

AS
P2
P3 AD2
P1 AD3
AD1
0 Y1 Yf Real GDP
o With reference to Figure 2 above, initially, the Singapore Output
economy is experiencing
demand-pull inflation where there is increase in AD from AD1 to AD2, thus general
price level increases from P1 to P2.
• With contractionary fiscal policy leading to a fall in government, consumption and
investment expenditure, there is a fall in AD, and AD shifts leftwards from AD2 to AD3,
and the general price level falls from P2 to P3, reducing demand-pull inflation.
(Optional) Anti-thesis: Explain the limitation OR unintended consequence of contractionary fiscal

policy and why it may not be the best way to fight inflation in Singapore (1 well-explained
limitation/unintended consequence will suffice.)
• However, contractionary fiscal policy may also not be the best way to fight inflation in
Singapore due the unintended consequences and limitations associated with it.
• A possible unintended consequence of contractionary fiscal policy is the adverse long-
run supply side effects when the government cuts its developmental expenditure in the
building of healthcare and educational infrastructure. This would reduce the extent of
increase in AS in the long run, thus restricting potential growth.
• Moreover, raising personal income tax and corporate income tax create disincentive to
work and invest which also restricts potential growth in the long run.
• The effectiveness of contractionary fiscal policy may be limited due to strong business confidence
that led to the demand-pull inflation in the first place. The strong business confidence could result
in the tax cuts being ineffective as consumers and firms may experience tax insensitivity and would
likely continue to spend on consuming goods and services and investments respectively.
Evaluative conclusion: [Stand] + TWO well-substantiated ATMS angles.

• [Stand]: The best way to fight inflation in Singapore would be through a combination of
currency appreciation and supply-side policies.
• [Magnitude]: Managing the exchange rate may not always be the best way to fight
inflation in Singapore as it could result in negative growth for the economy should the AD
fall by a larger extent than the increase in AS.
o [Alternative]: Hence, it is imperative that the Singapore government adopts a
combination of contractionary monetary policy through currency appreciation and
supply-side policies to reduce inflation.
• [Situation]: Currency appreciation is an essential policy due to Singapore’s heavy reliance
on imports which makes it therefore highly susceptible to cost-push inflation. With an
appreciation of the Singapore currency, the Singapore government can have better control
over the rising commodity prices. Although a currency appreciation would make
Singapore’s exports more expensive in terms of foreign currency, as the exports have high
import content, the lower cost of imports could help to lower the cost of producing exports,
thus cushioning the negative impact on the more expensive exports.
o [Alternative]: However, the fall in AD alone might be insufficient in alleviating
inflationary pressures, especially if a significant extent of the inflationary pressure is
due to increases in costs of production. Supply-side polices that helps to lower cost of
production and help keep exports competitive in the long run should also be
introduced. In addition, supply-side policies should be used in tandem with
monetary policy to ensure that the productive capacity of the Singapore economy
continues to increase so the general price level may fall further even as real output
increases.
• [Situation]: Contractionary fiscal policy (if student has chosen to explain fiscal policy), on the
other hand, may not be that useful as developmental expenditure is necessary for the
Singapore economy to achieve potential growth in the long run. Moreover, with the
Singapore economy highly dependent on foreign talent and foreign investment, raising
direct taxes is in conflict with Singapore’s growth strategy and would only further restrict
economic growth and lead to higher unemployment.
Note: The answers for EQ1(b) and EQ2(b) may share similarities. However, the key difference is that a
preamble with specific causes of inflation is provided for EQ1. Therefore, for EQ1(b), the choice of
policies used for explanation should be targeted at the given causes (i.e. tight domestic labour market,
high consumer spending and rising global commodity prices). The evaluation should then consider the
suitability of the policies based on the causes of inflation that the Singapore government could effectively
tackle, without causing too much side effects.
Mark scheme
L3 For a well-developed answer that has: 8 – 10

• Good scope – exhibits clear analytic understanding of how contractionary
exchange rate monetary policy and 1 other policy work to fight inflation,
together with limitations/unintended consequences.
• Good balance – explains the usefulness and limitations/unintended
consequences of the above-mentioned policies
• Good rigour – utilises appropriate AD/AS analysis, together with real-world
examples applied to the different causes of inflation in Singapore, with well-
explained and accurate diagrams.

• Lacks scope – limited explanation of how exchange rate monetary policy and
1 other policy work to fight inflation, with either demand or supply-side
policies missing from analysis.
• Lacks balance – only has either workings OR limitations/unintended
consequences of the policies analysed
• Lacks rigour – gives a descriptive explanation of the usefulness and
limitations of the policies to alleviate inflationary pressures or has limited
application to Singapore context.
L1 For an answer that shows some knowledge of how macroeconomic policies 1 – 4

work to fight inflation. Answer may contain multiple conceptual errors.
Level Evaluation, Synthesis Marks
E3 For a well substantiated evaluation of whether managing exchange rates is the 5

best way to fight inflation in Singapore, substantiated with real word
knowledge, economic theory or with considered weighing of the various
arguments presented in the essay.
E2 For an answer that makes some attempt at evaluating whether managing 3 – 4

exchange rates is the best way to fight inflation in Singapore.
E1 For an unsubstantiated answer that addresses the question. 1–2

Essay Question 3 (Adapted from N2009 H1)
Many economists argue that achieving a low and stable rate of inflation is the single most
important macro-economic objective for governments.
(b) Discuss the view that a government’s fiscal and monetary policies should be focused
primarily on achieving a low and stable rate of inflation. [15]
Question Interpretation
Command Discuss the view, To examine whether the main focus of fiscal and
word/phrase focused primarily monetary policies should be to achieve low and
stable inflation, as opposed to other macro-
economic goals
Content Fiscal and monetary Contractionary and expansionary fiscal and
policies, low and stable monetary policies. Desirable effects of achieving
rate of inflation macroeconomic objectives.
Context No specific context Students are free to bring in examples from
different countries.
The focus of this question is about which macroeconomic objective is most important when it comes to
enacting demand-management policies. A relevant response requires an explanation of the benefits of a
low and stable inflation rate, as well as benefits of achieving other macro-economic goals such as
economic growth and full employment. The evaluation then requires a judgment on whether fiscal and
monetary policies should focus primarily on achieving a low and stable inflation rate and provide a
sound justification of the stand made.
Suggested Answer
Introduction:
• Every government has four macroeconomic objectives that it seeks to achieve, i.e. strong
economic growth, full employment, price stability and a healthy balance of trade.
• Low and stable rate of inflation is one which ranges between 2% and 3% for most countries,
and is also known as price stability.
• This essay aims to discuss whether price stability should be the primary focus of fiscal and
monetary policies, as opposed to the other macroeconomic objectives.
Briefly explain how contractionary fiscal and monetary policies could be used to achieve low and stable
inflation
• Fiscal and monetary policies are both demand-management policies and to lower inflation,
will be contractionary in nature. Contractionary fiscal policy entails either decreasing
government expenditure G or increasing direct taxes T, which lowers C (due to lower
disposable income) and I (due to lower post-tax profitability). Contractionary monetary
policy entails decreasing money supply to increase interest rates, resulting in higher cost
of borrowing, which lowers C, by disincentivising borrowing for big-ticket items, and I,
by decreasing expected profitability.
• With a fall in G, C and I, there is a fall in AD causing a fall in the general price level, thus
reducing demand-pull inflation, and helping the economy to achieve low and stable
inflation.
Thesis 1: Demand-management policies should focus on low and stable inflation due to benefits to
economic agents
• A government’s fiscal and monetary policies should focus on achieving a low and stable
rate of inflation due to the benefits it brings to economic agents (households and firms).
• Low and stable inflation rate protects the real income of the majority in the country.
Consumers’ purchasing power and hence material standard of living (SOL) are thus
maintained. Moreover, low inflation encourages savings as consumers do not need to
worry that the real value of their savings would be eroded by high inflation rates, which
improves households’ future material SOL.
• For firms, low and stable rate of inflation allows them to better predict their cost of
production and expected revenue, and hence their profits. As firms are able to project their
expected return with greater certainty, firms could have greater confidence in planning
for and undertaking long-term investments, thus improving their long-term viability.
Thesis 2: Demand-management policies should focus on low and stable inflation as it forms the
foundation upon which other macroeconomic objectives can be achieved
• Low and stable inflation can also lead to the achievement of other macroeconomic
objectives.
• As low inflation encourages savings, supply of loanable funds increases, lowering interest
rates. This reduces the cost of borrowing, which further incentivises consumption C and
investment I, and hence AD. Due to the multiplier effect where there are multiple rounds
of increase in induced-consumption, real GDP increases by a multiplied amount of the
initial increase in C and I, thus achieving actual growth.
• With actual growth, derived demand for labour increases as firms step up production to
meet increased demand for goods and services, thus reducing demand-deficient
unemployment in the economy.
• In addition, higher investment increases capital stock accumulation, leading to an increase
in productive capacity, hence contributing to potential growth of the economy. With an
increase in both actual and potential growth, low inflation thus facilitates the achievement
of sustained growth.
Anti-thesis 1: Demand-management policies should focus on other macroeconomic objectives as doing

so will bring about benefits to economic agents
• A government’s fiscal and monetary policies should also focus on achieving economic
growth and reducing unemployment as doing so brings about benefits to economic
agents.
• The government could adopt expansionary fiscal and monetary policies to achieve
economic growth and reduce demand-deficient unemployment.
• For instance, governments may increase government expenditure (G) to increase AD,
and/or lower direct taxes (T) to increase C, I, and therefore AD. This leads to subsequent
increases in induced-consumption, causing real GDP to increase by a multiplied amount
of the initial increase in AD, thus achieving actual growth and reducing demand-deficient
unemployment.
• Firstly, achieving economic growth and reducing unemployment in an economy would

allow the citizens of a country to enjoy higher material standard of living. With higher
output levels and lower unemployment, households would have higher income and
higher purchasing power to consume more and better quality goods and services. With
higher incomes, C will increase. An increase in the domestic income level would also mean
a greater ability to import and hence, import expenditure (M), will increase. Consumers
benefit as they are able to enjoy a greater quantity, wider variety and higher quality of
goods and services.
• As incomes increase with actual growth, households also experience higher savings which
would allow consumers to maintain their consumption levels and material living
standards in future.
• Secondly, with a higher national income from actual economic growth and a larger tax
base due to low unemployment, the government is able to collect more tax revenue and
has a higher budget to spend more on programmes for low-income households. Thus,
income redistribution policies could be implemented to reduce income inequality and
hence inequity in the economy.
[Note that if a student argues that FP and MP should not focus on achieving a low and stable rate of
inflation as there are some limitations and unintended consequences of the policies, this could work too,
but it would offer less scope than the anti-thesis presented above, as other macroeconomic goals are not
considered.]
Evaluative Conclusion: (any 2 ATMS evaluative angles below would suffice)

• [Stand + Situation]: All in all, whether fiscal and monetary policies should focus primarily
on achieving a low and stable rate of inflation depends on the state of the economy, in
particular, the stage of development of the economy and the economic problems faced.
• [Situation]: For developing economies which are more likely to have a greater spare
capacity, fiscal and monetary policies should focus on achieving economic growth instead,
which can help it to reduce unemployment as well. On the other hand, for developed
countries which are more likely to operate near or at the full employment level of output,
they are susceptible to demand-pull inflation should AD increase further. For such
economies, the fiscal and monetary policies should focus primarily on achieving low and
stable inflation instead.
• [Situation]: However, even for developed economies, when the economy is experiencing
a period of recession caused by a lack of demand, the government should focus on
expansionary fiscal and monetary policies to achieve economic growth and reduce
demand-deficient unemployment. The increase in income levels helps mitigate the fall in
material standard of living caused by the recession. There is less need to focus on a low
and stable rate of inflation as there is sufficient spare capacity during a recession, such that
demand-pull inflation is less of an issue.
• [Magnitude]: Instead of focusing primarily on achieving a low and stable rate of inflation,
the government’s fiscal and monetary policies should focus on achieving sustained
growth instead, as by definition, this would mean that price stability is also achieved. This
could in turn lead to stronger business and consumer confidence in the economy,
encouraging consumption, investment and increasing output, thus lowering the
unemployment level.
o Hence, overall, the government’s fiscal and monetary policies should focus
primarily on achieving sustained growth instead.
Mark scheme

L3 For a well-developed answer that has: 8 - 10
• Good scope – exhibits clear analytic understanding of the benefits
of achieving a low and stable rate of inflation as well as other
macroeconomic objectives and how fiscal and monetary policies can
help with these objectives.
• Good balance – explains benefits of price stability as well as other
macroeconomic objectives.
• Good rigour – utilises appropriate AD/AS analysis, together with
real-world examples applied to the benefits of achieving different
macroeconomic objectives.
• Lacks scope – limited explanation of how fiscal and monetary
policies work to achieve price stability and other macroeconomic
objectives, with some macroeconomic goals missing from analysis.
• Lacks balance – only has benefits of price stability and lacking
benefits of other macroeconomic objectives.
• Lacks rigour – gives a descriptive explanation of benefits of
achieving different macroeconomic objectives.
L1 For an answer that shows some knowledge of why governments 1–4
would want to focus on achieving low and stable inflation rates.
Answer may contain multiple conceptual errors.
Level Evaluation Marks
E3 For an answer that uses economic analysis to support an evaluative 5
judgement on whether government should focus primarily on
achieving low and stable inflation rate
E2 For an answer that makes some attempt at a judgement on whether 3 – 4
government should focus primarily on achieving low and stable
inflation rate. However, there are some logical flaws in the judgement
and/or inaccuracies in the synthesising process.
E1 For an unsupported evaluative answer on whether government 1 – 2
should focus primarily on achieving low and stable inflation rate
Essay Question 4
b) Evaluate whether the most effective use of supply-side policies is the management of
unemployment. [15]
Question interpretation
Command Evaluate whether, To examine how supply-side policies could be used
word/phrase Most effective use to manage unemployment and give a judgement on
whether its most effective use is to reduce
unemployment, by comparing it with the other
macro-economic issues (inflation/deflation and
negative/weak economic growth) that can also be
managed by supply-side policies
Content Supply-side policies, To explain how supply-side policies can be used to
management of reduce unemployment.
unemployment
Context No specific context Bring in examples from different countries.
A relevant response requires an explanation of how supply-side policies could be used to reduce
unemployment and the limitations. The essay should then explain how supply-side policies could also
be used to manage other macro-economic issues such as inflation/deflation and negative/weak economic
growth and the relevant limitations. The evaluation then requires a judgement on whether supply-side
policies are the most effective in reducing unemployment and provide a sound justification of the stand
made.
Note: Students only need to explain for the case of inflation or deflation and the case of either negative
or weak economic growth.
Part (b) Suggested Answer
Introduction:
• Supply-side policies to reduce unemployment refer to policies that control the aggregate
supply (AS) by changing the costs of production or productive capacity of an economy.
• There are different types of unemployment, including structural unemployment, frictional
unemployment and demand-deficient unemployment
• Other than unemployment, supply-side policies could also be used to manage inflation as
well as negative economic growth.
Body 1: Explain how supply-side policies work to manage different types of unemployment
• Supply-side policies could be effective in reducing structural unemployment.
• To reduce structural unemployment, the government could implement policies to
encourage workers to upgrade themselves and to acquire new skills that are relevant for
an expanding (sunrise) industry.
o Such policies could be implemented by providing government subsidies and grants to
lower the cost of training and encourage workers to take on those trainings.
Government could also implement direct provision of training for workers to learn
new skills. For example, in Singapore, the Skills Future Credit scheme was introduced
to encourage all Singaporeans to enrol in courses to upgrade themselves or learn new

skills so that they can stay relevant and meet the evolving needs of the economy.
Under this scheme, all Singaporeans aged 25 and above will receive $500 per year to
pay for work-related courses.
o This encourages Singaporeans to equip themselves with the relevant skill-sets so that
they are able to transit into new jobs in rising industries and reducing structural
unemployment.
• Supply-side policies could be effective in reducing demand-deficient unemployment
which arises from increased cost of production.
o Supply-side policies through privatisation or deregulation could lead to lower cost of
production and a rise in quality of resources in the economy as the private sector is
more incentivised to innovate. This increases the AS and cause it to shift downwards
and rightwards. This could lead to an increase in real output, and firms to demand for
more factors of production, thus reducing demand-deficient unemployment.(or use
transfer payments).
Body 2: Explain the limitation associated with using supply-side policies to reduce structural
unemployment (1 point below would suffice)
• However, supply-sides policies may not be the most effective in reducing structural
unemployment as skills upgrading and training programs involve significant time lags as
it takes time to set up training institution and facilities, as well as matching workers with
suitable and relevant courses. Workers may also be reluctant to attend training if they
underestimate benefits to themselves due to imperfect information.
• Moreover, it is administratively difficult to ensure that all workers take the initiative to enrol in
courses to upgrade themselves. There could also be high administrative cost due to the need to verify
all the claims being filed.
• However, supply-side policies could be less effective in reducing demand-deficient
unemployment due to a fall in AD. As demand-deficient unemployment is mainly due to
the lack of AD and hence lower demand for factors of production, supply-side policies
may not be able to effectively target the root causes of demand-deficient unemployment
• This is especially the case when the economy is having a lot of spare capacity and if the
supply-side policies continues to increase the productive capacity of the economy, which
would then worsen demand-deficient unemployment instead
Body 3: Explain how supply-side policies could be effective in reducing inflation and achieving economic
growth
• Supply-side policies could be effective in reducing inflation and achieving economic
growth as well. When there is demand-pull inflation in the economy, supply-side policies
that increases the productive capacity of the economy could help to increase the AS and
curb the increase in general price level.
• When there is cost-push inflation, supply-side policies that reduces the cost of production
and help to increase the AS and curb the increase in prices as well. Therefore, supply-side
policies to encourage research and development could help to curb both demand-pull and
cost-push inflation
• As seen in figure 2, assuming that the economy is experiencing a high level prices, as
represented by the intersection of AS1 and AD1 where the GPL is at P1.
• R&D projects could increase the quality of resources and hence increase the productive
capacity of the economy as well as lowering the unit cost of production in the
economy.
• This would cause the AS to shift downwards and rightwards from AS1 to AS2, thus
reducing inflation by reducing general price level from P1 to P2.
• Moreover, the increase in output from Y1 to Y2 mean that there is actual growth in the
economy. The increase in full employment output from Yf1 to Yf2 also indicates that
there is potential growth in the economy.
• Therefore, supply-side policies could be effective in reducing inflation and achieving
sustained economic growth for a country.
Figure 2: Engagement in R&D to reduce inflation
Body 4: Explain the limitation associated with using supply-side policies to reduce inflation and achieve
economic growth
• However, supply-side policies may not be the most effective in reducing inflation and
achieving economic growth due to the long time-lags involved as well, especially in the
case of research and development projects where there is a high degree of uncertainty in
outcomes.
• They might also not tackle the root cause of the inflation or if negative growth were caused
by AD factors such as poor export or consumer demand.
Evaluative Conclusion:
• [Stand + Magnitude]: The most effective use of supply-side policies is in managing
unemployment, as unlike demand-management policies which can only deal with
demand-deficient unemployment, supply-side policies are able to deal with a range of
different types of unemployment (e.g. demand-deficient, structural, frictional).
o [Magnitude]: However, it should be noted that there are some goals that no other
policies can achieve except for supply-side policies (e.g. fighting cost-push inflation and
aiming for potential growth) – therefore, the most effective use of supply-side policies
could be in targeting a mix of goals that no other policy can manage effectively, namely
structural unemployment, cost-push inflation and the achievement of potential growth
in the long run.
• [Situation]: However, it should be noted that the most effective use of supply-side policies
can depend on the situation of the economy as well. When there is significant worry about
structural change in the economy (e.g. in the current era of rapid digitalisation) but less
worry about cost pressure (e.g. relatively low current oil prices), the most effective use of
supply-side policy could be structural unemployment.
Mark Scheme
Level Knowledge, Application/Understanding and Analysis Marks

L3 For a well-developed answer that has: 8 - 10
• Good scope – exhibits clear analytic understanding of how supply-side
policies can be used to manage different types of unemployment, as well
as other macroeconomic aims, together with limitations/unintended
consequences.
• Good balance – explains the usefulness and limitations of the above-
mentioned policies
• Good rigour – utilises appropriate AD/AS analysis, together with real-
world examples applied to the different causes of unemployment as well
as other macroeconomic objectives in Singapore, with well-explained and
accurate diagram.
• Lacks scope – limited explanation of how supply-side policies work to
achieve low unemployment and other macroeconomic objectives, with
some macroeconomic goals missing from analysis.
• Lacks balance – only has benefits of low unemployment and lacking
benefits of other macroeconomic objectives or lacks limitations of supply-
side policies.
• Lacks rigour – gives a descriptive explanation of benefits of achieving
different macroeconomic objectives.
L1 For an answer that shows some knowledge of how supply-side policies 1–4
work to achieve low unemployment. Answer may contain multiple
conceptual errors.
Evaluation
E3 For an answer that uses economic analysis to support an evaluative 5
judgement of whether the most effective use of supply-side policies is in
the management of unemployment, through a reasoned comparison with
other aims.
E2 For an answer that makes some attempt at a judgement on whether the 3–4
most effective use of supply-side policies is in the management of
unemployment. However, there are some logical flaws in the judgement
and/or inaccuracies in the synthesising process.
E1 For an unsupported evaluative answer on the effectiveness of supply-side 1-2
policies is in the management of unemployment, with some allusion to
other aims.

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2023 H2 Price Stability - Suggested Answers to Practice Questions

10. Practice Questions

Figure 1: Demand-pull inflation

Figure 2: Cost-push inflation

0 Y2 Y1Yf Real GDP

Case Study Questions

Question 1: Oil prices and deflationary impacts on various countries

Figure 1: Crude oil prices and UK inflation, 2007–2015

Percentage change in Coonsumer Price Index

Crude oil prices UK inflation rate

Source: OPEC, Office for National Statistics

Extract 1: UK slips into deflation

(b) Explain why pensioners benefit from a period of deflation. [2]

(c) Explain why deflation may be undesirable. [3]

(b) Explain why pensioners benefit from a period of deflation. [2]

(c) Explain why deflation may be undesirable. [3]

Question 2: Stagflation Concerns

Extract 2: The Specter of Stagflation Looms over U.S. economy

Source: adapted from The New York Times, 1 December 2008

Extract 3: Spectre of the double-dip1 haunts uneasy US

Source: adapted from The Guardian, 25 July 2010

Figure 1: Singapore’s GDP Growth (%)

Source: MAS Survey of Professional Forecasters: March 2010

Figure 2: US unemployment rate (%) Figure 3: US Consumer Price Index

Source: Bureau of Labour Statistics

(a) Explain what is meant by GDP at constant prices? [2]

a) Explain what is meant by GDP at constant prices? [2]

• According to Extract 1, Singapore can expect to have a “strong pipeline of foreign

Figure 1: The Singapore Economy

Note: Answers that only analyse change in AD will be capped at 3m.

Figure 2: Wage-price inflation spiral

up factor prices when increasing production, reducing concerns about demand-pull

Command Assess To present a balanced analysis of the

to help its economy Aim is to achieve actual growth

Figure 3: Expansionary monetary policy to achieve actual growth

Evaluative Conclusion: (Stand + 1 well-substantiated ATMS evaluative angle will suffice)

Essay Question 1 (N2013 H2)

On 1 September 2011, the Monetary Authority of Singapore (MAS) reported that

Part (a) Question Interpretation

Command Explain how To give a thorough explanation of the relevant

Figure 1: Demand-pull inflation

General Price Level

Level Knowledge, Comprehension, Analysis and Application Marks

L3 For a well-developed answer that has: 8 – 10

L2 For an underdeveloped answer that: 5–7

Part (b) Question Interpretation

Alleviate these To reduce demand-pull and cost-push inflation

• Firstly, contractionary monetary policy through currency appreciation could be used to

Figure 2: Contractionary Monetary Policy to reduce inflation

Anti-thesis 1: Explain the limitation OR unintended consequence of contractionary exchange rate

• However, the effectiveness of contractionary exchange rate monetary policy through

Figure 3: Contractionary fiscal policy to manage demand-pull inflation

General Price Level

Alternative to Anti-thesis 1: Explain the limitation OR unintended consequence of contractionary fiscal

• Supply-side policies can be used to fight demand-pull and cost-push inflation in

Figure 4: Supply-side policies to reduce inflation

Level Knowledge, Comprehension, Analysis and Application Marks

For a well-developed answer that has:

For an underdeveloped answer that: