Macroeconomic objectives and policy conflicts
Key terms
Define each term.
Multiple choice
Circle the correct answer.
A country's unemployment rate falls from 8% to 7% while the number of people employed is unchanged. The most likely explanation is:
A government successfully raises economic growth. Which macroeconomic aim is most likely to be harmed as a result?
Why is the conflict between economic growth and price stability weaker in a deep recession than near full capacity?
Worked problems
Show your working.
Calculating an unemployment rate from population data. A country has a population of 40 million. Of these, 24 million are in the labour force and 22.2 million are employed. Calculate the number unemployed and the unemployment rate. Then explain why the rate would fall if discouraged workers stopped looking for work.
Chains of reasoning
The steps are in the wrong order. Write the letters in the order that makes a linked chain.
How pursuing growth undermines price stability
- A Unit labour costs rise, so firms raise prices to protect their margins.
- B Firms increase output to meet the extra orders, and real GDP rises.
- C As output approaches capacity, spare resources become scarce and the AS curve steepens.
- D The government uses expansionary fiscal or monetary policy to raise growth and cut unemployment.
- E Aggregate demand shifts right as consumption, investment and government spending rise.
- F Firms competing for a shrinking pool of available labour bid wages up faster than productivity is growing.
- G If the central bank then tightens policy to restore price stability, the growth gained is partly given back.
- H The price level rises more quickly, so the inflation objective is missed even as the growth and employment objectives are met.
Diagrams
Draw a production possibility curve with capital goods on one axis and consumer goods on the other. Mark two points, one with high consumer goods output and one with high capital goods output. Then sketch where each economy's PPC would sit several years later.
Draw an AD/AS diagram with an AS curve that is flat at low output and steepens towards full capacity. Show the same rightward shift of AD twice: once starting from deep recession, once starting near capacity. Label the change in real output and in the price level in each case.
Answers
Macroeconomic aims: The main objectives a government pursues for the economy as a whole: economic growth, low unemployment, price stability, a stable balance of payments position and a fairer distribution of income.
B. If employment is unchanged, no new jobs have been created. The rate can only fall if the labour force shrinks, which happens when discouraged workers stop actively seeking work. The headline figure improves while the underlying position does not.
B. Rising incomes increase spending on imports as well as on domestic output, so the current account tends to deteriorate as growth rises. Unemployment usually improves alongside growth rather than conflicting with it, which is why those two aims are the pair that most often move together.
B. With unemployed labour and idle capital available, firms can meet extra demand by producing more without bidding up input costs. The AS curve is flat over that range, so the AD shift becomes output rather than prices. The conflict emerges only as the economy approaches its capacity limit.
Step 1. Find the number unemployed. Unemployed = labour force - employed = 24.0m - 22.2m = 1.8 million.
Step 2. Apply the unemployment rate formula. Unemployment rate = (1.8 / 24.0) x 100 = 7.5%.
Step 3. Note what the denominator is. The rate is calculated against the labour force of 24 million, not the population of 40 million. Dividing by 40 million would give 4.5%, which is a common and heavily penalised error.
Step 4. Explain the discouraged worker effect. Someone who gives up looking for work leaves the labour force. Both the numerator and the denominator fall: unemployed becomes 1.7m and the labour force becomes 23.9m, giving 7.1%. The rate has improved while the number of people out of work is unchanged and the situation is arguably worse, since a discouraged worker is further from employment than an active jobseeker.
Step 4 is the point of the question. The unemployment rate can fall for a bad reason, which is why examiners like data-response questions that pair the rate with the participation rate or with total employment.
D, E, B, C, F, A, H, G
- The government uses expansionary fiscal or monetary policy to raise growth and cut unemployment.
- Aggregate demand shifts right as consumption, investment and government spending rise.
- Firms increase output to meet the extra orders, and real GDP rises.
- As output approaches capacity, spare resources become scarce and the AS curve steepens.
- Firms competing for a shrinking pool of available labour bid wages up faster than productivity is growing.
- Unit labour costs rise, so firms raise prices to protect their margins.
- The price level rises more quickly, so the inflation objective is missed even as the growth and employment objectives are met.
- If the central bank then tightens policy to restore price stability, the growth gained is partly given back.
The final step is what makes this a conflict rather than a side effect. The two objectives are not merely in tension: the instrument used to fix one actively reverses the other. AO2 is 40% of the written papers and this chain is reusable across most policy-conflict questions.
This is the growth-now-against-growth-later conflict in a single picture. The economy choosing more consumer goods enjoys higher living standards today but its curve shifts out less. The one choosing capital goods sacrifices present consumption for a larger curve later. Neither choice is wrong, which is exactly why it is a conflict rather than a mistake.
The conflict is not constant, it varies with the starting position, and this diagram shows why. In deep recession the shift is nearly all output and almost no inflation, so growth and price stability barely conflict at all. Near capacity it is nearly all price level. Candidates who say the severity of the conflict depends on the output gap, and use this to say so, are reasoning as the examiner wants.