ACJC_H2_ECONS_P2_essay_Q5_(size_policy_choice)

1 Suggested Answers for 2018 Econs H2 Prelims Paper 2 Essay Question 5: Discuss the extent to which the size of the economy affects a government’s choice of macroeconomic policy tools. Question Requirement: • Explain what it means by “size of the ec onomy” and how it affects a government’ choice of macroeconomic policy tools (interest rate, exchange rate, fiscal) • Discussing the extent requires students to co nsider other variables that the government takes into account while making decisions on the choice of macroeconomic policy tools used. • An overall judgment on the extent to which the size of the economy affects the choice of macroeconomic policy tools, by taking into account all possible variables on balance and certain economic conditions the country may be in. Introduction: A government has several macroeconomic policy tools such as interest rate, government spending, tax rates and exchange rates, which it can make use of, to achieve the various macro objectives. How the government decides to use what policy tools takes into account several variables, such as the size of the economy, openness of the economy as well as the current economic condition the country is in. To what extent the size of the economy determines the government’s choice of macro policy tools depends on the type of country as well as the current economic condition the country is in. Point 1: Size of the economy determines the choice of macroeconomic policy tools the government uses Size of the economy usually refers to the value of Gross Domestic Product (GDP) of the country. This value of GDP is affected by the population size and hence, the overall size of the domestic market. Larger economies such as China and United States of America (USA) tend to have a larger population size and hence, domestic markets, compared to smaller economies such as Singapore. The larger domestic market means that domestic consumption expenditure (C) as a proportion of the country’s overall Gross Domestic Product (GDP) is relatively higher than those of the smaller economies. Therefore, to achieve the macroeconomic objectives such as healthy economic growth, the governments of the larger economies tend to rely more on manipulating demand-management policy tools such as interest rates and tax rates to affect consumption spending. For example, the USA uses the interest rates to achieve economic growth. In times of slower economic growth, the USA may reduce the interest rates so as to reduce the cost of borrowing, hence spurring domestic consumption. It may also reduce the income tax rates, to increase the disposable income and hence, increase C. Since C takes up a large proportion of the USA’s aggregate demand, it is effective in helping the government to achieve the macro objectives. These larger economies also are able to adopt protectionism tools to p