Conflicts & Trade-Offs Between Objectives & Policies (Edexcel A Level Economics A)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Trade-offs Between Macroeconomic Objectives

  • 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

Trade-off

Explanation

Economic Growth and Inflation

  • Increasing economic growth causes the economy to move closer to full employment. Prices for remaining resources are bid up leading to inflation which may outpace the target inflation rate of 2%

Economic Growth and Environmental Sustainability

  • Economic growth often increases pollution, negative externalities and the depletion of non-renewable resources. The higher the growth, the faster the depletion

Economic Growth and Inequality

  • During periods of high economic growth, the profits the owners of the factors of production receive are disproportionate to any increase in workers' wages leading to greater inequality

Economic Growth and Balanced Budget

  • Economic growth driven by expansionary fiscal policy often requires a budget deficit

Economic Growth and Balancing the Current Account

  • Economic growth usually leads to higher incomes which leads to an increase in imports by households thereby worsening the current account balance

Low Unemployment and Low Inflation

  • The closer an economy moves to full employment the less workers will be available for hire and wage inflation will help increase overall inflation

Examiner Tips and Tricks

You are usually examined on trade-offs and conflicts in longer essay questions. In your responses, be more precise than general. For example, do not write vaguely about contractionary monetary policy, but focus on a specific contractionary monetary policy tool (e.g. increasing interest rates) - and then logically explain the conflicts or trade-offs that will develop. 

Short-run Phillips Curve

  • 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

2-6-4-short-run-phillips-curve-_edexcel-al-economics
The Short-run Phillips Curve illustrates the relationship between changes to aggregate demand (AD), inflation and 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 and unemployment falls from 4%→3%

    • The remaining labour in the market is scarcer and 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 and unemployment rises from 4%→5%

    • Labour is more abundant and 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%

Policy Conflicts and Trade-offs

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

Examiner Tips and Tricks

When assessing demand-side and supply-side policies, it's important to consider them in totality. The government and central banks will use a combination of policies to address economic issues. So, even if the question asks you to evaluate the use of an individual policy (e.g. fiscal policy), you should include alternative policies in your evaluation.

Last updated:

You've read 0 of your 5 free revision notes this week

Sign up now. It’s free!

Join the 100,000+ Students that ❤️ Save My Exams

the (exam) results speak for themselves:

Did this page help you?

Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.