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National income is the total income earned by the nation over a period of time
Point: A fall in housing prices in the US → Fall in the consumption expenditure and investment expenditure
- Banks in the US have great exposure in the subprime mortgage market
- If housing prices in the US fall → Borrowers in the market may default on their loans → Banks may make huge losses → Close down
- Furthermore, due to interbank debt, the closure of some banks in the US will lead to closure of more banks → Domino effect → Collapse of banking system → Some households in the US will not be able to borrow for consumption + Some firms will not be able to borrow for investment → Fall in consumption expenditure and investment expenditure
- Fall in value of houses → Discretionary spending → Rise in marginal propensity to save + Fall in marginal propensity to consume → Fall in consumption expenditure
Point: A fall in consumption expenditure and investment expenditure in the US → Fall in the aggregate demand → Fall in the national income of Singapore
- Aggregate demand is the total demand for the goods and services produced in the economy over a period of time
- Comprised of consumption expenditure, investment expenditure, government expenditure on goods and services + net exports
- Households in US decrease consumption expenditure → Purchase both less domestic and imported goods → Purchase less goods and services from Singapore → Fall in exports in Singapore
- Firms in US decrease investment expenditure → Invest both less in US and other economies such as Singapore → Fall in foreign direct investments in Singapore
- Fall in foreign direct investments + Fall in exports in Singapore → Fall in aggregate demand → Fall in national income
In the above diagram, a fall in aggregate demand (AD) from AD0 to AD1 leads to a fall in national income (Y) from Y0 to Y1
- Aggregate demand falls → Unplanned rise in inventories → Firms cut down on output → Employ less factor inputs → Pay less factor income to households → Household income falls → Consumption expenditure falls
- Consumption expenditure falls → Firms produce even less output → Employ less factor inputs → Pay even less factor income to households → Further fall in household income → Further fall in consumption expenditure
- Fall in aggregate demand in Singapore → Larger fall in national income
- Known as reverse multiplier effect
- Fall in housing prices in US → Fall in national income in Singapore exacerbated by reverse multiplier effect → Fall in standard of living, ceteris paribus
- Therefore, the government needs to enact policies to cushion the effect of a decline in housing prices in the US on the Singapore economy
- Closeness of economy (Dependency) -> Large fall in X
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