Model essay (a): why Singapore's multiplier is small

What this lesson teaches

• I can use AD and AS to find the equilibrium national output and general price level.

  Syllabus 9570, 3.1.2(d). Aggregate Demand and Aggregate Supply: How interaction of AD and AS determines equilibrium level of national output and general price level

• I can explain how a change in AD has a multiplied effect on national income.

  Syllabus 9570, 3.1.2(e). Aggregate Demand and Aggregate Supply: How changes in the components of AD can have a multiplied effect on national income

Make a guess

Why does $1 billion of new government spending raise income by less in Singapore than in a large economy like the US?

1. More of each extra dollar is spent on imports.
2. Singapore's government spends less money overall each year.
3. Singapore's workers earn lower wages.

The answer to part (a)

Introduction

When the government raises spending, national income rises by more than the first increase. This is the multiplier effect. The size of the multiplier (k) equals 1 divided by the marginal propensity to withdraw (MPW). The MPW is the share of each extra dollar of income that leaks out of the circular flow through savings (MPS), taxes (MPT) and imports (MPM). Singapore's multiplier is smaller than that of a large, less open economy because its leakages, especially into imports, are much larger.

Paragraph 2: the multiplier process

Suppose the government spends $1 billion more on building hospitals. Government spending (G) is an injection, so AD shifts right from AD0 to AD1 in Figure 1. The construction firms and their workers earn $1 billion more income. They spend part of it on food, transport and other goods, which becomes income for other firms and workers. They in turn spend part of their extra income, and so on. Each round of induced consumption raises AD further, to AD2. With spare capacity, real output rises from Y0 to Y2, by more than the first $1 billion.

Paragraph 3: Singapore leaks into imports

The process is smaller in Singapore because so much of each extra dollar is spent on imports. Singapore produces almost none of its own food, energy or cars, and few of the electronics its people buy. So when households and firms spend their extra income, a large share goes to foreign producers. That spending becomes income in other countries, not in Singapore, so it does not start another round of spending here. Singapore's MPM is very high, so each round of spending shrinks quickly.

Paragraph 4: Singapore leaks into savings

Saving is also high. Workers in Singapore must put part of their wages into their Central Provident Fund (CPF) accounts. Households also save a large share of their income by choice. Money saved is not spent on goods and services, so the MPS is high. Together with taxes, the high MPM and MPS give Singapore a high MPW. For example, if MPW is 0.8, k is only 1 / 0.8 = 1.25. Then $1 billion of extra spending raises national income by only about $1.25 billion.

Paragraph 5: the large, less open economy

A large economy with low trade, such as one where imports are a fifth of what households buy, keeps most of its spending at home. Its producers make most of the goods its people buy, so each round of income is largely spent on domestic output. Its MPM, and therefore its MPW, are lower, so its multiplier is larger. If its MPW is 0.4, k is 2.5: the same $1 billion raises national income by $2.5 billion.

Conclusion

The same rise in government spending raises national income by less in Singapore. More of each extra dollar leaks out of the circular flow, mainly into imports and also into savings. Its high MPW gives a small multiplier, while a large, less open economy keeps more spending at home and has a larger multiplier.

Margin notes: how each paragraph scores

Introduction

Defines the multiplier and the MPW with all three leakages, and states the comparison the answer will prove.

Paragraph 2

The process explained round by round, with Figure 1 showing the first injection (AD1) and the final effect (AD2). Showing both shifts is the rigour L3 needs.

Paragraph 3

The main reason, imports, explained with Singapore's features and why import spending ends the chain here.

Paragraph 4

A second leakage (CPF and savings) and a short calculation that makes the size concrete.

Paragraph 5

Completes the comparison with a matching calculation, so the two economies are contrasted directly.

Conclusion

A direct answer in two sentences. No evaluation marks are available for a 10-mark part.

Overall: L3, 9 or 10 marks

The process and both reasons explained, with a diagram and a clear comparison. Explaining only the multiplier process, with no comparison, would cap the answer at L2.

Worked example: A 3-minute plan

Explain the process, then compare the leakages.

1. Intro: multiplier; k = 1 / MPW; MPW = MPS + MPT + MPM.
2. Process: G up, incomes up, induced consumption, more rounds (Figure 1).
3. Imports: Singapore imports most of what it consumes, high MPM, spending leaks abroad.
4. Savings: CPF and high saving, high MPS.
5. Compare: large, less open economy keeps more spending at home, bigger k.

Watch out for this

Singapore's multiplier is small because its government spends less than large economies.

The size of the multiplier does not depend on how much is spent. It depends on how much of each extra dollar of income leaks out of the circular flow, through imports, savings and taxes.

Check your understanding

If MPS = 0.3, MPT = 0.1 and MPM = 0.4, what is the multiplier?

1. 2.5, because 1 / 0.4 uses only the propensity to import.
2. 1.25, because 1 / (0.3 + 0.1 + 0.4) = 1 / 0.8.
3. 5, because the multiplier is 1 divided by the 0.2 that is spent.