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2020 A level Economics H2 Paper 2 (Answers)

Government expenditure on large-scale infrastructure projects such as airports and mass rapid transit (MRT) can contribute significantly to a country’s economic growth.

(a) Explain how government expenditure on large-scale infrastructure can contribute to a country’s economic growth. [10]

Introduction Government expenditure on large-scale infrastructure such as airports and mass rapid transit (MRT) can generate actual and potential economic growth for a county. Actual growth is defined as the increase in an economy’s level of output or real GDP while potential growth is the increase in the productive capacity of the economy.

Referring to Figure 1, the economy is initially in equilibrium at Y1 below full-employment level, Yf1. An increase in government expenditure on large scale infrastructure of $10m will cause the G component to increase and cause an initial shift of AD (=C+I+G+X-M) rightwards from AD1 to AD2. This increase in autonomous expenditure of $10m will generate revenue of S10m for firms in such sectors (e.g. construction), which will then be used as factor payments to the resources that produce the capital goods. This $10m of factor payments becomes income of the household sector who are concurrently the resource owners. Households will then divide this increase in $10m of income between consumption on domestic goods ($6m) and withdrawals in terms of savings, taxes and imports ($4m) based on MPCd=0.6 and MPW=0.4. The induced consumption of $6m on consumer goods will further create income for individuals employed in the consumer goods industry, who will further spend their additional income on consumption. This cycle of spending and re-spending on consumption will continue until the increase in income becomes negligible. The cumulative increase in induced consumption can be illustrated by a further shift of AD rightward from AD2 to ADn by another $15m (assume MPCd of 0.6; k = 2.5). ADn is where the multiplier process has come to a halt when the addition to withdrawals equal to the initial change in injection. Thus, the $10m increase in government expenditure has created a $25m rise in real GDP. Diagrammatically, the economy's output increases to a new equilibrium level at Yn, signifying actual economic growth.

In the long run, government expenditure on large-scale infrastructure can also improve the productive capacity of the economy, for example, a more efficient transport networks can facilitate a more productive workforce by reducing the time wasted from commuting and unproductive hours spent in traffic congestion. Hence, productivity in the economy rises. These will result in potential growth, reflected by the shift of the LRAS1 to LRAS2 to the right (Figure 1), hence increasing the productive capacity of the economy from Yf1 to Yf2.

Conclusion In conclusion, government expenditure on large-scale infrastructure can promote both actual and potential growth, giving rise to non-inflationary economic growth in the long run.


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