7.
1 Government macro policy – Essay
Frequently asked topics
Explain instruments of different type of policies (monetary, fiscal and supply-side)
Explain expenditure-dampening policy and expenditure-switching policy
Essay lists
17S2 Explain the difference between fiscal policy and monetary policy. Show how
each can be used to increase aggregate demand. [8]
16S2 Using examples, explain the instruments of monetary policy and supply-side
policy. [8]
07S Explain the difference between expenditure-switching and expenditure -
dampening policies as a means of correcting a balance of payments disequilibrium.
[8]
17S2 Explain the difference between fiscal policy and monetary policy. Show how
each can be used to increase aggregate demand. [8]
Plan
P1 Define AD
P2 Explain fiscal policy and how fiscal policy could increase AD
P3 Explain monetary policy and how monetary policy could increase AD
Sample
Aggregate demand is the total spending on an economy’s goods
and services at a given price level in a given time period. It has 4
components: consumption, investment, government spending and
net export. AD=C+I+G+(X-M).
Fiscal policy refers to the use of revenue and expenditure decisions
by a government to influence economic activity in a country. The
main instruments of fiscal policy include government spending on
areas such as education, health, defence, social services,
government borrowing to cover the gap between revenue and
expenditure and the use of taxation to change the amount of money
in circulation. To increase AD, government could use expansionary
fiscal policy. For instance, government could reduce income tax or
VAT so that consumers have more disposable income to consume.
Government could also reduce the level of corporation tax so that
business has more retained profits to invest. Finally, government
could increase spending on infrastructure, education, healthcare
etc. As C, I and G are core components of AD, these will significantly
increase AD.
Monetary policy refers to any policy measures or instruments to
influence the price or quantity of money. The three instruments of
monetary policy are the interest rate, the money supply and the
exchange rate. To increase AD, government could also use
expansionary monetary policy is intended to increase aggregate
demand. If interest rate decreases, the return of saving money
decreases, consumer may not save money in the bank and increase
consumption. Meanwhile, it is cheaper to borrow money from the
bank; consumer may purchase cars or houses as the cost of loans
decreases. Similarly, business will increase the investment as cost
of loans decreases. In this case, both consumption and investment
will increase, AD will increase.
(282 words)
16S2 Using examples, explain the instruments of monetary policy and supply-side
policy. [8]
Plan
P1 Define monetary policy
P2 Explain its instruments
P3 Explain supply-side policy
P4 Explain its instruments
Sample
Monetary policy refers to any policy measures or instruments to influence the price
or quantity of money. The three instruments of monetary policy are the interest
rate, the money supply and the exchange rate.
If an economy is facing a relatively high rate of unemployment and a relatively low
rate of economic growth, a government may decide to stimulate the economy by
reducing the interest rate or increasing the money supply. If interest rate decreases,
the return of saving money decreases, consumer may not save money in the bank
and increase consumption. Meanwhile, it is cheaper to borrow money from the
bank; consumer may purchase cars or houses as the cost of loans decreases.
Similarly, business will increase the investment as cost of loans decreases. In this
case, both consumption and investment will increase, AD will increase. On the other
hand, if an economy is facing a relatively high rate of inflation, a government may
decide to deflate the economy by increasing the rate of interest and decreasing the
money supply.
Supply side policy measures are designed to increase aggregate supply by improving
the workings of product and factor market. Such policies are often taken in an
attempt to improve the efficiency of markets.
For factor market measures, cutting corporation tax may encourage investment, as
firms will have more funds to invest and they will know that they will be able to keep
more of any profit earned. Cutting income tax may increase incentives to work,
people are more willing to seek employment, rather than receive unemployment
benefits. Increasing spending on education and training may raise the quality of
labour force, which will improve the productivity and flexibility of the labour force.
For product market, encouraging privatisation will increase the size of private sector
and decrease the size of public sector. Firms in private sector are likely to be more
efficient than those in the public sector, especially when there is an intense
competition in an industry. Encouraging deregulation will allow greater competition,
because a reduction into an industry will enable more firms to enter.
(345 words)
07S Explain the difference between expenditure-switching and expenditure -
dampening policies as a means of correcting a balance of payments disequilibrium.
[8]
Plan
P1 Explain expenditure - dampening policy
P2 Explain expenditure - switching policy
Sample
Expenditure-reducing policy involves reducing the level of total
spending so reducing imports and forcing domestic producers to
export. Examples of expenditure reducing policies
include contractionary fiscal policies. For instance, government
could increase income tax or VAT so that consumers have less
disposable income to consume. Government could also increase the
level of corporation tax so that business has less retained profits to
invest. Finally, government could reduce spending on infrastructure,
education, healthcare etc. As C, I and G are core components of AD,
these will significantly decrease AD. Contractionary monetary
policies such as a rise in interest rates or a decrease in the money
supply are other examples of expenditure-dampening policy. If
interest rate increases, the return of saving money increases,
consumer may save money in the bank and decrease consumption.
Meanwhile, it is more expensive to borrow money from the bank;
consumer may delay the purchase cars or houses as the cost of
loans increases. Similarly, business will decrease the investment as
cost of loans increases. These policies would reduce the level of AD
in the economy and thus reduce incomes throughout the economy.
This reduces the demand for imports and thus the expenditure on
them which will, ceteris paribus, improve the trade balance in the
current account thus rectifying a current account deficit.
Expenditure-switching policy intends to move domestic and foreign
expenditure more towards domestic production. This could be done
by protectionism, such as imposing or increasing tariffs, quotas,
embargoes, domestic subsidies and non-tariff barriers like red tape
and standards. These policies will either increase the price of
imported goods or simply block imports from entering the country
thus reducing the expenditure on imports which will, ceteris paribus,
improve the trade balance in the current account and thus rectify a
current account deficit. A weaken exchange rate could also be
considered as expenditure-switching policy. A weak exchange rate
makes export cheaper and imports dearer. This will lead to an
improvement in the trade balance of the current account and
reduce a current account deficit.
(336 words)
