Potential policy conflicts and trade-offs

What is the short-run trade-off between unemployment and inflation?

As economic growth increases, unemployment falls, leading to higher wages and higher consumer spending, which increases inflation.

What does the Phillips Curve illustrate?

It shows an inverse relationship between unemployment and inflation in the short run.

How can supply-side policies limit the trade-off between unemployment and inflation?

They reduce structural unemployment without raising wages significantly, preventing inflation.

Why does economic growth lead to inflationary pressures?

If aggregate demand (AD) rises faster than aggregate supply (AS), inflation occurs, especially when there is a positive output gap.

What is a negative output gap?

When actual output is less than potential output, leading to unused resources and lower inflation.

What is a positive output gap?

When actual output exceeds potential output, causing inflationary pressures due to resource overuse (e.g., overtime work).

How do positive output gaps impact rapidly growing economies like China and India?

They experience high inflation due to rising demand and resource overuse.

How does economic growth affect the current account in the UK?

Higher consumer spending leads to more imports, worsening the current account deficit.

Why do countries like China and Germany experience growth with a current account surplus?

Their growth is export-led, meaning they sell more than they import.

How does reducing a budget deficit impact economic growth?

It requires lower government spending and higher taxes, which reduces aggregate demand and slows growth.

How does economic growth impact the environment?

More manufacturing leads to higher carbon emissions, pollution, and depletion of non-renewable resources.

What is a policy trade-off?

When achieving one macroeconomic goal negatively affects another.

What are some examples of policy trade-offs?

• Environment vs Competitiveness: Green taxes may make domestic firms less competitive.

• Progressive Taxes vs Inflation: Higher VAT can increase inflation.

• Fiscal vs Monetary Policy: Expansionary fiscal policies can lead to higher interest rates and inflation.

• Interest Rates vs Inequality: Low interest rates benefit borrowers but harm savers.

What are some other issues governments face in managing the economy?

• Political constraints: Tax increases and spending cuts are unpopular.

• Time lags: Supply-side policies (e.g., education) take years to show results.

• External factors: Global recessions, financial crises, and international interest rates can limit policy effectiveness.

What is a free-market economy?

An economy where resources are allocated by supply and demand with minimal government intervention.

What are the advantages of a free-market economy?

• Efficiency: Firms must compete to provide the best goods/services.

• Lower bureaucracy: No excessive government interference.

• Greater personal freedom.

What are the disadvantages of a free-market economy?

• Inequality: The rich benefit the most.

• Monopoly power: Firms may exploit consumers.

• Market failures: Overconsumption of demerit goods and lack of public goods.

What is a command economy?

An economy where the government controls resource allocation (central planning).

What are the advantages of a command economy?

• Better resource allocation in crises (e.g., wars).

• Reduces inequality by providing basic necessities.

• Prevents monopoly abuse.

What are the disadvantages of a command economy?

• Government failure due to lack of market signals.

• Inefficiency and lack of incentives for innovation.

• Restricted personal freedoms.

What is a mixed economy?

A mix of free-market forces and government intervention to correct market failures.

How do mixed economies allocate resources?

• What to produce: Consumer & government preferences.

• How to produce: Profit-seeking firms & government policies.

• For whom to produce: Combination of purchasing power & government intervention.

What are unintended consequences in economic policies?

Unexpected reactions by consumers and firms that undermine the policy’s goal. E.g. Raising the minimum wage may aim to improve living standards, but firms may respond by hiring fewer workers, leading to higher unemployment.