Edexcel A Level Economics A:复习笔记2.6.4 Conflicts & Trade-offs Between Objectives & Policies

Trade-offs Between Macroeconomic Objectives

  • Policy decisions by governments often create a trade-off in the macroeconomic objectives
  • Achieving one objective may come at the cost of worsening progress in another objective

An Explanation of the Common Trade-offs That Exist Between the Macroeconomic Objectives

Trade-off Explanation
Economic Growth & Inflation Increasing economic growth causes the economy to move closer to full employment. Prices for remaining resources are bid up leading to inflation which may outpace the target inflation rate of 2%
Economic Growth & Environmental Sustainability Economic growth often increases pollution, negative externalities and the depletion of non-renewable resources. The higher the growth, the faster the depletion
Economic Growth & Inequality During periods of high economic growth, the profits the owners of the factors of production receive are disproportionate to any increase in workers' wages leading to greater inequality
Economic Growth & Balanced Budget Economic growth driven by expansionary fiscal policy often requires a budget deficit
Economic Growth & Balancing the Current Account Economic growth usually leads to higher incomes which leads to an increase in imports by households thereby worsening the current account balance
Low Unemployment & Low Inflation The closer an economy moves to full employment the less workers will be available for hire and wage inflation will help increase overall inflation

 

Exam Tip

You are usually examined on trade-offs and conflicts in longer essay questions. In your responses, be more precise than general. For example do not speak about contractionary monetary policy, but focus on a specific contractionary monetary policy tool (e.g. increasing interest rates) - and then logically explain the conflicts or trade-offs that will develop.

Short-run Phillips Curve

  • The Short-run Phillips Curve (SRPC) observes that there may be a trade-off between unemployment and inflation
    • Rising inflation is accompanied by falling unemployment
    • Rising unemployment is accompanied by falling inflation
    • This trade-off makes it difficult for the government to achieve both low unemployment and low inflation

2-6-4-short-run-phillips-curve-_edexcel-al-economics

The Short-run Phillips Curve illustrates the relationship between changes to aggregate demand (AD), inflation & unemployment

Diagram Analysis

  • The economy is initially in equilibrium at AP1YFE
  • At this point, unemployment is at 4% and inflation is at 3% and this is considered to be full employment (YFE)
    • There is always some unemployment due to the frictional and structural unemployment that exists
  • An increase in AD from AD1→AD2 causes a positive output gap (YFE-Y2)
    • With an increase in output the demand for labour rises & unemployment falls from 4%→3%
    • The remaining labour in the market is scarcer & workers are able to negotiate higher wages
      • This causes wage inflation in the economy
    • Wage inflation leads to an increase in inflation from 3%→4%
  • A decrease in AD from AD1→AD3 causes a negative output gap (YFE-Y3)
    • With a decrease in output the demand for labour falls & unemployment rises from 4%→5%
    • Labour is more abundant & to get hired workers have to accept lower wages
      • This causes wage deflation in the economy
    • Wage deflation leads to a decrease in inflation from 3%→2%

Policy Conflicts & Trade-offs

  • Similarly to the trade-offs that exist in achieving the different macroeconomic objectives, there are trade-offs & conflicts that occur with the use of demand-side & supply-side policies

Example 1

  • Raising interest rates (contractionary monetary policy), eases demand-side inflationary pressure but raises the cost of borrowing for firms and slows down supply-side investment
    • Tackling short term inflation, delays long term supply-side growth

Example 2

  • An increase in government spending (expansionary fiscal policy) can bring about improvements on the supply-side of the economy in the long-run (LRAS)
    • Conversely, it may cause a shortage in short-run aggregate supply (SRAS) as government spending causes excess demand in the economy, leading to inflation

Example 3

  • Increased environmental policies may lead to a fall in economic growth and lower LRAS
    • Fossil fuel industries have traditionally enabled increases in LRAS

Exam Tip

When assessing demand-side and supply-side policies, it's important to consider them in totality. Government and central banks will use a combination of policies to address economic issues. So, even if the question asks you to evaluate the use of an individual policy (e.g. fiscal policy), you should include alternative policies in your answer.

 

 

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