2.6 - Conflicting trade offs between objectives and policies

Question 1

Economic Growth vs. low and stable inflation

Answer 1

• Rapid economic growth can lead to inflationary pressures as demand outstrips supply.
  > increase in demand for G/S may be greater than economy’s ability to produce those G/S - demand pull inflation

Question 2

Low Unemployment vs. low and stable inflation

Answer 2

Policies to reduce unemployment, such as lowering interest rates, can increase inflation.

Question 3

Economic Growth vs. Environmental Sustainability

Answer 3

Economic growth often increases pollution, negative externalities and the depletion of non-renewable resources. The higher the growth, the faster the depletion

Question 4

Economic Growth and Inequality

Answer 4

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

Question 5

Economic Growth and Balanced Budget

Answer 5

Economic growth driven by expansionary fiscal policy often requires a budget deficit

Question 6

Economic Growth and Balancing the Current Account

Answer 6

Economic growth usually leads to higher incomes which leads to an increase in imports by households thereby worsening the current account balance - trade deficit?

Question 7

Low Unemployment and Low Inflation

Answer 7

• The closer an economy moves to full employment the less workers will be available for hire and wage inflation will help increase overall inflation
• Policies to reduce unemployment, such as lowering interest rates, can increase inflation

Question 8

Unemployment vs. Balanced Budget

Answer 8

Reducing unemployment may require government spending, leading to budget deficits.

Question 9

The Short-run Phillips Curve

Answer 9

• 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

Question 10

Policy Conflicts and Trade-offs

Answer 10

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

Question 11

Phillips curve (short-run)

Answer 11

• A curve that shows the relationship between inflation and unemployment in the short run.
• The original downward-sloping Phillips Curve showed that there was a trade-off between inflation and unemployment.

Question 12

The Long-run
Phillips Curve

Answer 12

• A vertical Phillips Curve.
• This shows that in the long-run there is no
  trade-off between inflation and unemployment.
• You cannot reduce
  the unemployment rate without inflation increasing.

Question 13

NAIRU

Answer 13

The Non-Accelerating Inflation Rate of Unemployment. The rate of unemployment at which the inflation rate is stable – if it falls lower,
inflation begins to accelerate.