2.6.4 Conflicts and trade-offs between objectives and policies

Question 1

What does the SRPC represent?

Answer 1

The (negative) trade-off between achieving inflation and unemployment objectives within an economy in the short-run (both are stable in the long-run)

Question 2

What happens when there is a positive output gap? (SRPC)

Answer 2

If there is a POG due to rising AD creating derived demand for workers, then cyclical unemployment will fall - with more incomes being earned, demand pull inflationary pressures rise as firms increase their prices to earn more profit.

A smaller pool of surplus workers means that wages rise to attract the most skilled, as such cost-push inflation also rises when unemployment falls.

Question 3

What happens when there is a negative output gap? (SRPC)

Answer 3

If there is a NOG due to a decrease in AD, cyclical unemployment will rise. With less incomes being earned, there are less demand-pull inflationary pressures and firms decrease their prices to maintain profit margins (attract cons.).

A larger pool of surplus workers means that wages fall as they are willing to accept lower wages, causing falling cost-push inflation.

Question 4

Eval. of the flatter SRPC

Answer 4

A flatter SRPC, showing less of a trade-off between inflation and unemployment, can occur due to:
- reduced trade union power: less rising wages
- globalisation: avg. costs kept lower for domestic firms
- improved worker flexibility and incentives (SSPs)
- impact of skilled/unskilled migration on the labour market and labour costs

Question 5

Why are there fewer policy trade-offs in the long-run?

Answer 5

• there are time to make adjustments/implement new policies
• as LRAS(Q2CELL) shifts outwards, this means that CoP, prices and inflation falls
• when SSPs are being used, there is less chance of policy conflict (usually caused by demand-side)

However, there can still be trade-offs, depending on the objective.