Conflicts between Economic Objectives

Question 1

Governments make Trade-offs between their objectives

Answer 1

1. Remember… most governments have the same four main macroeconomic objectives
   - strong economic growth
   - reducing unemployment
   - keeping inflation low
   - maintaining an equilibrium in the balance of payments
2. They may also have other objectives, such as:
   - A more equal distribution of income and wealth,
   - Protecting the environment
   - Maintaining economic stability
   - Improving productivity and international competitiveness
3. However, trying to achieve one of these objectives may make it more difficult to achieve another - in other words, there may be conflicts between policy objectives.
4. In the short run, governments decide which objectives they think are the most important for them and accept that these decisions may have an adverse effect on their other objectives - i.e. they make trade-offs between their objectives.
5. Governments may have to use short-term policies to correct sudden problems, such as a major unemployment caused by a severe recession. In a scenario like this the government may accept that inflation will result from a policy designed to reduce unemployment quickly because it’s more importnat to get ppl back to work.

Question 2

Changes in Aggregate Demand are likely to cause Conflict between objectives

Answer 2

1. Short run economic growth is caused by the AD curve shifting to the right. This could be due to an increase in any of the components of AD (C+I+G(X-M).
2. For example, if the AD curve shifts to the right from AD to AD1 then there will be an increase in output from Y to Y1 and, as a result, there will be a decrease in unemployment (because of derived demand for labour).
3. However, a shift to the right of the AD curve will also => in an increase in the price level from P to P1. Higher prices may also => a lack of competitiveness internationally, meaning a decrease in exports, a rise in imports and therefore a worsening in the current account of the b of p.
4. So, in this case, an increase in AD will only help the government to achieve two of its macroeconomic objectives.
5. However, a shift to the LRAS curve will enable a goverment to achieve all four of the main macroeconomic objectives at the same time.
6. For example, if the LRAS curve shifts to the right to LRAS1 then this will => to an increase in output (from y to y1) and reduce unemployment. The price level will also fall (from P to P1) and this will improve the country’s competitiveness - improving the balance of payments.
7. this suggests that if the government only used demand-side policies to achieve its macroeconomic objectives then this would => conflict between the objectives. However, supply-side policies are more likely to help a government achieve their four main macroeconomic objectives in the long run.

Question 3

Learn the Main Causes of Conflict between the Macroeconomic objectives:
1. Inflation and Unemployment

Answer 3

• When unemployment is reduced and the economy begins to approach full capacity, there are fewer spare workers, so demand for workers increases - esp for skilled workers. This will => to an increase in wages and the extra cost of this may be passed on by producers to consumers in the form of higher prices => cost-push inflation.
• Low unemployment may => consumers to spend mroe because they feel more confident in their long-term prospects. This may => prices to rise due to demand-pull inflation.
• So reducing unemployment makes it more difficult to keep inflation at the preferred low rate.

Question 4

Main causes of conflict between the Macroeconomic Objectives:
2. Economic growth and environmental protection

Answer 4

Economic growth can put a strain on the environment. For example:

• New factories and increases in production can raise levels of air and water pollution, as well as increase the amount of waste that needs disposing of.
• Economic growth will tend to increase the use of natural resources - this can be a major problem if these resources are non-renewable.
• Ecosystems might be damaged or even destroyed by the construction of new factories, housing, etc - in the most extreme cases, this can => the extinction of certain animals or plants.

Question 5

Main causes of Conflict between the Macroeconomic Objectives:
3. Economic growth and inflation

Answer 5

1. A rapidly economic growing economy can => large increases in prices, due to an increase in demand. This will cause a higher than desirable level of inflation.
2. Similarly, attempts to keep inflation low can restrict growth. E.g. if interest rates are kept high to reduce inflation by discouraging spending, this can restrict economic growth.

Question 6

Main causes of Conflict between the Macroeconomic Objectives:
4. Inflation and Equilibrium in the Balance of Payments

Answer 6

1. Sometimes the govt’s objectives for low inflation and equilibrium in the b of p will be compatible, but at other times they’ll conflict.
2. E.g. if inflation is low, this implies that prices are rising slowly. If prices rise more slowly than those in other countries, then exports to other countries will increase and imports will decrease. This would increase a surplus on the b of p, but reduce a b of p deficit.
3. However, low inflation is often maintained by high interests rates. High interest rates encourage foreign investment, which increases demand for the domestic currency - increasing its value. This will make exports more expensive and imports cheaper, so exports will decrease and imports will increase. This would reduce a surplus on the b of p, but make a deficit worse.

Question 7

Main causes of Conflict between the Macroeconomic Objectives:
5. Economic growth and a reduction in wealth inequality

Answer 7

1. Economic growth can increase inequality, as not everyone benefits equally from a growing economy.
2. E.g. as an economy grows, highly skilled workers may become more in demand, while the demand for low-skilled workers (e.g. those who carry out more manual tasks which can be done by machines instead) may fall.
3. Governments can choose to use increased tax revenue from economic growth to decrease this inequality by:
   - Increasing welfare payments
   - Using progressive taxes (i.e. where the rich pay a higher rate than the poor)
   - Increasing the minimum wage in line with increases in the average wage.
4. However, increasing taxes or welfare payments may damage future economic growth. E.g.
   - High taxes may be a disincentive for individuals and businesses to earn and grow.
   - Extra welfare payments may not encourage ppl to work.
5. Supply-side policies that help ppl back to work and reduce geographical and occupational labour immobility would encourage growth, while reducing the welfare budget and unemployment.