2.6.4 - Conflicts and trade - offs between objective and policies

Question 1

Define Trade - off

Answer 1

. where making one choice means losing something else, usually forgoing a benefit or opportunity

. Same as opportunity cost

Question 2

Explain Trade - offs between the macroeconomic objectives

Answer 2

1.) If inflation is high, demand - pull inflation can be reduced by reducing aggregate demand by reducing consumer spending (increasing interest rates) or cutting government spending

However, this would lead to cyclical unemployment and a recession resulting in economic growth being negative

2.) If economic growth is low, it can be increased by raising AD, which lower unemployment.

However, it leads to demand - pull inflation. Additionally, it leads to a rise in imports because an increase in income increases demand. A rise in imports leads to a deterioration in the current account position on the balance of payments

3.) If unemployment is high, it can be reduced by raising AD, which also reduces inequality

However this affects the current account and causes inflation. Also more jobs might come at the expense of the environment if new factories are built

4.) If the value of imports are greater than the value of exports it leads to a current account deficit on the BoP

Imports can be cut by reducing domestic consumption and investment, but this will lead to higher unemployment and a fall in economic growth

5.) If the fiscal or budget deficit due to too much borrowing as a percentage of GDP, it may attempt to current this by increasing tax and cutting government spending

However, this will raise unemployment and lower economic growth

6.) Correcting inequality involves government intervention through redistributing income through taxes.

This would increase the consumption as the marginal propensity to consume is higher at lower levels of income. Furthermore, the human capital would increase due to better access to education and training at higher levels of income, which would reduce unemployment in the long run

However, reducing inequality involves government spending, which would lead to a budget deficit. Furthermore, it could reduce the incentive to work, which would raise unemployment in the long run and reducing long run economic growth

7.) If environment is affected, regulations will be implemented, which would discourage investment due to higher costs. This lower economic growth and increases unemployment.

Question 3

What is the short - run Phillips curve?

Answer 3

Shows a trade - off between two macroeconomic objectives : Low and stable Inflation and low unemployment

1.) When there is low unemployment, workers have more bargaining power to push up wages

. The increase in cost of production is passed onto consumers through an increase in the price of goods causing cost - push inflation

2.) In times of high unemployment, wage growth would be falling due to a weaker bargaining power. Wage growth may even be negative if workers took pay cuts

Question 4

Explain Trade - offs between economic policies

Answer 4

1.) Expansionary monetary and fiscal policy leads to an increase in AD, increasing short run economic growth and reducing unemployment

However, it leads to inflation and deterioration on the current account of the balance of payments. This is because an increase in demand for goods and services will lead to an increase in imports. It will also lead to a budget deficit if there is government spending

Contractionary fiscal and monetary policy and improves the current account position but leads to lower economic growth and higher unemployment

2.) Countries with fiscal deficit will reduce this through contractionary fiscal policy (cutting government spending and increasing taxes).

However, this would lead to higher unemployment and lower growth in the short term

3.) Supply side policies increase the productive potential of the economy, shifting LRAS. In the long run they reduce inflationary pressures

However, supply side policies that encourage investment in capital lead to higher AD in the short run. This increase inflationary pressures in the short run due to demand pull inflation

Also supply side policies that reduce trade union power, reduce minimum wages or cut unemployment benefits are likely to increase income inequality in the short term

4.) Increasing interest rates (monetary policy) would reduce AD, thus reducing inflation.

However this would reduce long - term economic growth. It would also increase the exchange rate due to hot money outflows, which would affect international competitiveness and thus exports.