ACJC Macro Policies Suggested Essay Answers

1 © ACJC/Econs Department/2024 H2 Macro Policies Suggested Answers Macroeconomic Policies Tutorial Suggested Answers for SECTION A: ESSAY QUESTIONS Question 1 The recent worldwide recession caused many governments to re- assess their use of fiscal policy in order to stimulate their stagnating economies. (a) Explain the possible demand-side and supply-side reasons for a recession in an economy. [10] (b) Assess the relative importance of fiscal policy and exchange rate policy to manage Singapore economy when faced with a worldwide recession. [15] (a) Explain the possible demand -side and supply- side reasons for a recession in an economy. [10] Question analysis Concepts Cause: • Demand factor - AD • Supply factor - AS Effect: • “Recession” – fall in RNO Context • General Command Word Explain: Use economic analysis to explain cause and effect No evaluation or balance in positions needed. Introduction A technical recession is defined as two consecutive quarters of negative actual economic growth, measured by a negative real GDP growth rate. This implies a fall in RNO. Requirement 1: Demand reasons A recession experienced by major trading partners is one possible demand-side reason for a recession in an economy. A recession in the economies of the major trading partners implies a fall in household incomes for trading partners. Assuming the exports of the economy are normal goods (YED > 0), there will be a fall in the demand for the economy’s exports. This causes the

2 © ACJC/Econs Department/2024 H2 Macro Policies Suggested Answers price and quantity of exports to fall, resulting in a fall in export revenue (X). Hence, there will be a fall in AD (AD0 to AD1), ceteris paribus. At the same time, weak confidence on the future economic outlook could prompt consumers to save more, rather than consume, leading to a fall in consumption expenditure (C). Firms may also expect a fall in profitability on investments in the future, hence less willing and able to invest, fall in investment expenditure (I). (Reverse multiplier process) The fall in X, C and I will likely lead to a fall in AD. Assuming the economy is currently NOT at full employment, the fall in AD causes an unplanned rise in inventories stocks, signaling firms to decrease output, this results in a fall in RNO (Y0 to Y1). The fall in RNO implies a fall in economic activity, reducing the derived demand for factors of production, causing prices of factor of productions to be bid downwards. This means household incomes fall, inducing a fall in consumption expenditure by the amount equal to the marginal propensity to consume (MPC). This causes AD to fall again (AD1 to AD2), resulting in another fall in RNO (Y1 to Y2). This process repeated until RNO falls by a multiplied extent equal to the original fall in (C, I and X) x 1/(1-MPC). The fall in RNO implies negative economic growth. If this is sustained for two or more qu