Essay, Macro: Circular flow of income in Singapore and the US

a. Explain the difference in the relative importance of the components of the circular flow of income for a small and open economy such as Singapore versus a large and less open economy like the USA. (10)

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a. The circular flow of income in a four sector economy comprises of households, firms, the government, and external trade, and illustrates the flow of goods, services and their payments in the economy. This is shown in the diagram below:

def When households and firms save part of their incomes it constitutes a withdrawal. They may be in form of tax payments and imports also. Withdrawals reduce the flow of income.

def On the other hand, injections increase the flow of income. Injections can take the forms of investment,government spending and exports.

The equilbrium national income is attained when withdrawals equal injections. Otherwise, when injections are higher than withdrawals, national income will increase until the level of withdrawals increase to match injections, and vice versa.

The Singaporean economy can be characterised as small and open, while the US economy is large (about sixty times larger by GDP) and relatively less open to trade.

Domestic consumption in the USA is relatively more important in the circular flow than in Singapore. In Singapore, due to a higher savings rate because of compulsory savings via the CPF and Asian conservatism, and due to a higher marginal propensity to import because of Singapore's limited domestic market and high openness to trade, the marginal propensity to withdraw is much higher in Singapore than in the US.

The US also has a more domestic demand driven economy, as domestic consumption, investment and government expenditure is a big component of GDP. Singapore on the other hand is more trade reliant, and external demand forms a great part of national income in Singapore.

The marginal propensity to tax is higher in the US, as they operate many welfare oriented policies, while in Singapore, low tax rates are in place both for corporations and individuals so as to attract talent and companies to base their operations in Singapore. This means that withdrawals via taxes are more important for the US, while in Singapore savings and imports are more important as withdrawals.

conclusion The marginal propensity to withdraw in Singapore is rather low, as there is a high leakage via imports and savings. This leads to a low multiplier in Singapore. On the other hand, the US has a large domestic market, its lower leakages via savings and imports is likely to lead to a higher multiplier, implying more scope for the government to conduct fiscal policy.

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