4.2.3.4 - Conflicts Between Objectives

Question 1

What is a positive output gap

Answer 1

· occurs when the actual level of output is greater than the potential level of output.
· this could be due to resources being used beyond the normal capacity (eg: labour works overtime)
·If productivity is growing, the output gap becomes positive
·this puts upwards pressure on inflation.

Question 2

What is a negative output gap

Answer 2

· occurs when the actual level of output is less than the potential level of output this puts downwards 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.

Question 3

How are output gaps shown

Answer 3

On a cycle of the economy diagram, the trend line and actual GDP are used to show output gaps.

Question 4

How does economic growth conflict with the gov budget deficit

Answer 4

• reducing the budget deficit requires less expenditure and more tax revenue, which would lead to a fall in AD
• as a result of this there will be less economic growth

Question 5

How does economic growth conflict with the environment

Answer 5

• high rates of economic growth are likely to result in high levels of negative externalities such as pollution and the use of non-renewable resources
• this is because more people are able to afford more goods, meaning that the demand for products increases
• more manufacturing is required which is associates with higher levels of carbon dioxide emissions

Question 6

Why is there a conflict between unemployment and inflation

Answer 6

• as economic growth increases, unemployment falls due to ore jobs being crated
• however this causes wages to increase which can lead to more consumer spending
• this usually causes an increase in the average price level as firms push up their prices to maximise profits

Question 7

What diagram is used to display the conflicts unemployment and inflation

Answer 7

• The short run Phillips curve demonstrated the trade off between the two
• long run Phillips curve shows that eventually there will be no trade off

Question 8

What does the short run Phillips curve show

Answer 8

When unemployment increases, inflation will decrease

Question 9

What does the long run Phillips curve demonstrate

Answer 9

• represents no trade off between unemployment and inflation
• states that the level of unemployment will always return to the natural rate of unemployment (NRU)
• when AD shifts out as a way to reduce unemployment, inflation will occur initially
• in the short run workers experience money illusion so don’t realise that their real wage has decreased due to this inflation
• eventually their inflationary expectations adapt, as workers notice a fall in their real wage, so begin to demand for higher wages
• the firms costs increase, so unemployment will rise again
• leading it to return back to NRU

Question 10

implications for the short run Phillips curve

Answer 10

• in the short run, a trade off may exist menacing that unemployment cab be low ever by increasing AD but will be at the cost of a rise in inflation

Question 11

Implications of the long run Phillips curve

Answer 11

• reductions in unemployment will only be temporary until workers adapt their expectations and begin demanding higher wages
• to reduce the NRU, the gov must use supply side policies to reduce inflation as the NRU will be lowered too
  (This can be shown with a classical lras curve)