2.6.3 potential policy conflicts and trade-offs Flashcards
What does the Phillips curve show?
That there is a trade off between the level of unemployment and the inflation rate.
As economic growth increases, unemployment falls due to more jobs being created. However, this causes wages to increase, which can lead to more consumer spending and an increase in the average price level.
How can the extent of the trade off between inflation and unemployment be limited?
If supply side policies are used to reduce structural unemployment, which will not increase average wages.
When does a negative output gap occur?
When the actual level of output is less than the potential level of output.
What are the effects of a negative output gap?
It puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy.
What is a positive output gap?
It occurs when the actual level of output is greater than the potential level of output.
What can cause a positive output gap?
Due to resources being used beyond the normal capacity, such as if labour works overtime.
What are the effects of the positive output gap?
It puts upwards pressure on inflation. Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.
What is the trade off between economic growth and the current account?
During periods of economic growth, consumers have high levels of spending. In the UK consumers have a high marginal propensity to import, so there is likely to be more spending on imports. This leads to a worsening of the current account deficit.
However. export-led growth such as China and Germany, means a country can run a current account surplus and have high levels of economic growth.
What is the trade off between economic growth and the government budget deficit?
Reducing a budget deficit requires less expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result there will be less economic growth.
What is the trade off between economic growth and the environment?
High rates of economic growth are likely to result in high levels of negative externalities, such as pollution and the usage of non-renewable resources. This is because of more manufacturing, which is associated with higher levels of carbon dioxide emissions.
What are some issues governments may face in managing the macro-economy? [6]
- Potential policy conflicts and trade-offs
- Environment vs competitiveness
- Progressive taxes vs inflation
- Fiscal vs monetary policy
- Interest rate vs inequality
- Politically unpopular to decrease size of government deficit
What are free market economies also known as?
Laissez-faire economies.
What are free market economies?
Where governments leave markets to their own devices, so the market forces of supply and demand allocate scarce resources.
There is no government intervention.
What is the theory of free market economist Adam Smith>
The invisible hand of the market can be applied to free market economies and price mechanism, which describes how prices are determined by the ‘spending votes’ of consumers + businesses.
What did famous free market economist Friedrich Hayex argue?
That government intervention makes the market worse. For example, shortly after the 1930s crash, he argued the Fed caused the crash by keeping interest rates low + encouraging investments not economically worthwhile.
What are the advantages of a free market economy? [4]
- Firms likely to be efficient as they have to provide goods + services demanded by consumers
- Firms also likely to lower average costs + make better use of scarce resources, overall output of the economy increases
- Bureaucracy from government intervention is avoided
- Some economists argue the freedom gained from having a free economy leads to more personal freedom
What are the disadvantages of a free market economy? [4]
- Ignores inequality, tends to benefit those who hold most of the wealth
- Could be monopolies, which could exploit the market by charging higher prices
- Could be the overconsumption of demerit goods, which have large negative externalities
- Public goods are not provided in a free market, such as national defence. Merit goods, such as education are underprovided
What is a command economy?
Where the government allocated all of the scarce resources in an economy to where they think there is a greater need.
How did Karl Marx see the free market?
As unstable, he saw profits created in the free market as coming from the exploitation of labour, and by not paying workers to cover the value of their work.
What are the advantages of a command economy? [4]
- Might be easier to coordinate resources in times of crises, such as wars
- The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities
- Inequality in society could be reduced, and society might maximise welfare rather than profit
- Abuse of monopoly power could be prevented
What are the disadvantages of a command economy? [3]
- Governments fail, as do markets, and they may not be fully informed for what to produce
- They may not necessarily meet consumer preferences
- Limits democracy and personal freedom
What is a mixed economy?
This has features of both command and free economies, and is the most common economic system.
What is the balance of different economies around the world?
The UK is considered quite central, with the US acting slightly more free.
