Edexcel A Level Economics A:复习笔记2.6.4 Conflicts & Trade-offs Between Objectives & Policies

• Policy decisions by governments often create a trade-off in the macroeconomic objectives
• Achieving one objective may come at the cost of worsening progress in another objective

An Explanation of the Common Trade-offs That Exist Between the Macroeconomic Objectives

• The Short-run Phillips Curve (SRPC) 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

The Short-run Phillips Curve illustrates the relationship between changes to aggregate demand (AD), inflation & unemployment

Diagram Analysis

• The economy is initially in equilibrium at AP1YFE
• At this point, unemployment is at 4% and inflation is at 3% and this is considered to be full employment (YFE)
  • There is always some unemployment due to the frictional and structural unemployment that exists
• An increase in AD from AD1→AD2 causes a positive output gap (YFE-Y2)
  • With an increase in output the demand for labour rises & unemployment falls from 4%→3%
  • The remaining labour in the market is scarcer & workers are able to negotiate higher wages
    • This causes wage inflation in the economy
  • Wage inflation leads to an increase in inflation from 3%→4%
• A decrease in AD from AD1→AD3 causes a negative output gap (YFE-Y3)
  • With a decrease in output the demand for labour falls & unemployment rises from 4%→5%
  • Labour is more abundant & to get hired workers have to accept lower wages
    • This causes wage deflation in the economy
  • Wage deflation leads to a decrease in inflation from 3%→2%

• Similarly to the trade-offs that exist in achieving the different macroeconomic objectives, there are trade-offs & conflicts that occur with the use of demand-side & supply-side policies

Example 1

• 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

Example 2

• 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

Example 3

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