4.2.3.4 Conflicts Between Objectives

Question 1

Relationship Between Inflation and Unemployment

Answer 1

Inverse Relationship between Inflation and Unemployment.
When unemployment falls, workers feel more confident asking for higher pay, leading to increasing costs of production for firms and inflation in prices of goods produced.

Question 2

Implications of Short Run Phillips Curve

Answer 2

Policies that change AD will impact on the objective of inflation and unemployment and there will be a trade-off between the two.

Question 3

Implications of Long Run Phillips Curve

Answer 3

In the long run, this relationship does not hold.
Unemployment will always return to the NRU but at a higher rate of inflation.
Government policy should focus on reducing Inflation through supply side policies, which could also reduce NRU

Question 4

Why did the SRPC break down in the 1970s?

Answer 4

Stagflation enabled monetarists to criticise the SRPC theory and propose the LRPC

Question 5

What is Money Illusion

Answer 5

Workers don’t realise that their real wages have decreased, so they continue consuming as they were

Question 6

What happens when workers realise that their real wages have decreased

Answer 6

Their inflationary expectations adapt and they begin to ask for higher wages

Question 7

Critical Evaluation on Conflicts

Answer 7

1. Government priorities change: In the 1970s and 1980s inflation was seen as the biggest problem; unemployment was higher than now
2. Objectives depend on a country’s stage of development. Emerging countries might target rapid growth and extreme poverty reduction and be prepared to accept a higher rate of inflation
3. Value Judgement matter: Consider the debate over fiscal deficit reduction (Keynesians vs Fiscal Conservatives); or critics of ultra-low interest rates and their effect on savers
4. Some objectives are sub-sets of others - e.g. export led growth improves the balance of payments
5. Some objectives are only conflicting in the short term
6. External shocks can help to relieve conflicts or to worsen them
7. Nothing happens in isolation, most nations are deeply interconnected
8. A government may satisfice - i.e. be satisfied with reasonable outcomes for each objective and tolerate some trade-offs