(2017) A Level H2 Econs Essay Q2 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)
(2017) A Level H2 Econs Paper 2 Essay Q2
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2. Falling interest rates, continued income growth and other factors contributed to a period of rapid residential property price inflation in Singapore from the middle of 2009. However, the government has successfully pursued policies to restrict this rise to the extent that residential property prices actually fell in 2014 and 2015.
(a) Use supply and demand analysis to explain why falling interest rates and continued income growth may have led to a rapid rise in residential property prices. [10]
Impact of falling interest rates
A fall in interest rates will make mortgage loans more affordable (fall in price of mortgages) → home loans are complement goods for residential property → fall in price of home loans will result in an increase in demand for residential property from DD0 to DD1
This shifts demand for residential property to the right which increases price from P0 to P1
Impact of continued income growth
Continued income growth → rise in disposable incomes of individuals in Singapore → increased purchasing power → increase in demand for housing
This further shift demand for residential property from DD1 to DD2 such that the cumulative impact of a fall in interest rates & continued income growth leads to price to increase to P2
Supply of housing is price inelastic
There are various reasons leading to supply in Singapore being relatively price inelastic.
Singapore has a small land area of 710km2 and thus there is limited land space available. Most land made available for sale are either by Government Land Sales (which are controlled by the government) & by en-bloc sales (usually involves bidding by interested developers)
Residential property also takes on average, 3-5 years to construct, such that supply of residential property does not quickly respond to price changes.
As reflected in Figure 1 below, a cumulative shift of demand from DD0 to DD2 will lead to a sharp increase in price from P0 to P2, because of supply (SSi) being relatively price inelastic. This is in comparison with if supply is price elastic (SSe) - the price increase will only be from P0 to Pref
Conclusion
The sharp increase in residential property prices were due to multiple non-price factors of demand causing an increase in demand - but also because supply is price inelastic, resulting in any changes in demand to result in sharp changes in prices.
(b) Discuss the policies that might be used by the Singapore government to reduce residential property price inflation. [15]
Cooling measures
The government has implemented multiple rounds of cooling measures in the last decade whenever it assesses the need to keep residential property prices in check.
Making loans more difficult to obtain
One key cooling measure is implementing legislation to decrease the “Loan-to-value” ratio. The “Loan-to-value” ratio is the maximum permissible loan quantum that an individual is allowed to take up expressed as a percentage of property price. This was set at 80% and recently reduced to 75%.
Another similar measure is to implement a framework known as the “Total Debt Servicing Ratio (TDSR)”. With the “TDSR” - individuals are only allowed to borrow up to a certain amount as a percentage of income where monthly installments after including all other personal liabilities that an individual has (e.g. credit cards, car loans)
The current TDSR is 55% of a person’s income (this is reduced from 60% previously in the latest round of cooling measures implemented by the government in late 2021)
These measures make it more difficult for individuals to take up loans to finance their homes → reducing the size of the market available (as less people are eligible to take up loans to buy homes) → fall in demand for residential property → leftward shift in demand from DD0 to DD1 → fall in price from P0 to P1
Ev: While the measure may reduce demand for housing, it may make it more difficult for genuine first time buyers to purchase a home (unintended consequences → potentially affecting birth rates as individuals may delay decisions such as marriage and childbirth)
Increase government land sales
The government holds on to land parcels which they release for sale at periodic times
During periods where residential property prices are rising caused by an increase in demand, the government can choose to release more land parcels for sale to increase supply of land → reducing prices of land
As land is an important factor input in the production of housing → a fall in price of land → increase supply for residential property from SS0 to SS1 → fall in price from P0 to P1
Ev: Limited land parcels available, also - residential construction will still take years to complete, it may not alleviate those who have an immediate need for housing. Prices for resale homes may still go up in the interim period.
Implementing stamp duties on developers
The government can / has implemented an Additional Buyers’ Stamp Duty on developers where developers have to pay 30% on the land price as a tax
If they complete and sell all units within 5 years, they get a 25% remission of the tax
This gives the producers an incentive to release all units available for sale instead of holding on to units (this may potentially yield them a better price in the future but keeps the stock of housing available reduced) → increase supply for residential property from SS0 to SS1 → fall in price from P0 to P1
Ev: This puts pressure on the developers, again there is an unintended consequence - during the COVID-19 pandemic, in a bid to ‘complete’ projects in time, developers may inevitably vie for the limited resources and end up causing an increase in construction costs → shifting SRAS to the left → causing cost push inflation
Conclusion
The solutions that the Singapore government might use to resolve residential property inflation (as it has from time to time) may cause various unintended consequences - even though past attempts for such measures have indeed tamed residential property price inflation.
This may however just create pent-up demand for properties which may cause property prices to rise sharply potentially in the future.
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