Using the data and your own economic knowledge, assess the extent to which it is likely
that the UK economy will be able to continue to grow without experiencing conflicts with
the other main objectives of macroeconomic policy. (25 marks)
The government’s main objectives aside from growth are to maintain a balance of payments,
reduce unemployment and reduce inflation. These objectives are worked on through the
employment of macroeconomic policies, however these policies can benefit one objective but
be a detriment to another simultaneously, and often this makes for a tough balancing act for the
government.
Firstly, short-run growth leads to increased aggregate demand (AD) fuelled by the multiplier
effect, as more people are in employment, increasing output and disposable income spent on
goods. If the economy is at full capacity and AD begins to exceed aggregate supply (AS), firms
may increase prices because of the demand incentive, and thus there is heavy upward pressure
on prices, which may result in a rise in the general price level. Demand-pull inflation will almost
always occur with a short run boost to GDP. There will also be cost-push inflation as the price of
raw materials will also go up in demand-pull, then firms will have higher costs and shift this cost
onto their prices and thus the consumer. Inflation can however be combated, if this growth is
accompanied by a boost to the supply-side of the economy. If work is incentivised and firms
become more efficient in production then the labour supply and output will be able to keep up
with AD, and with a right shift in the production possibility boundary (PPB) this will lead to long-
run growth. With a healthy supply-side the economy should not reach full capacity, and thus
inflation will be prevented. It is however hard for the government to boost the supply side in
response to a sudden, short-run boost in demand.
Another conflict comes with the higher disposable incomes generated by growth, and people will
spend this income at least partly on more imported goods from overseas, with increased imports
the balance of payments deficit will increase, as imports are a component. On the other hand,
this issue is easily preventable through the use of taxation. Governments can discourage the
purchase of imported goods through trade tariffs and when the goods are purchased the
government will generate tax revenue, which will in turn close the gap in the balance of trade
payments account. In addition, a healthy supply-side would boost international competitiveness
allowing the demand for exports to increase, potentially keeping up with the increased demand
for imports.
Finally, a rise in GDP means that the labour force will demand higher wages. Inflation will bring
higher prices, and firms will have to raise wages in order to keep up with that. Eventually this
upward pressure will become so extreme that firms cannot afford to employ many people on
such high wages, and thus in the long run growth can lead to unemployment as people are laid
off, and the government aim to make unemployment as low as possible (the natural rate being
4%). Of course if inflation is prevented as discussed above, then real wages will rise with a
proportionate response to any changes in a firm’s profits, and thus there will be no illusion
created by higher prices, and firms will be able to afford a steady work force, preventing
unemployment.
that the UK economy will be able to continue to grow without experiencing conflicts with
the other main objectives of macroeconomic policy. (25 marks)
The government’s main objectives aside from growth are to maintain a balance of payments,
reduce unemployment and reduce inflation. These objectives are worked on through the
employment of macroeconomic policies, however these policies can benefit one objective but
be a detriment to another simultaneously, and often this makes for a tough balancing act for the
government.
Firstly, short-run growth leads to increased aggregate demand (AD) fuelled by the multiplier
effect, as more people are in employment, increasing output and disposable income spent on
goods. If the economy is at full capacity and AD begins to exceed aggregate supply (AS), firms
may increase prices because of the demand incentive, and thus there is heavy upward pressure
on prices, which may result in a rise in the general price level. Demand-pull inflation will almost
always occur with a short run boost to GDP. There will also be cost-push inflation as the price of
raw materials will also go up in demand-pull, then firms will have higher costs and shift this cost
onto their prices and thus the consumer. Inflation can however be combated, if this growth is
accompanied by a boost to the supply-side of the economy. If work is incentivised and firms
become more efficient in production then the labour supply and output will be able to keep up
with AD, and with a right shift in the production possibility boundary (PPB) this will lead to long-
run growth. With a healthy supply-side the economy should not reach full capacity, and thus
inflation will be prevented. It is however hard for the government to boost the supply side in
response to a sudden, short-run boost in demand.
Another conflict comes with the higher disposable incomes generated by growth, and people will
spend this income at least partly on more imported goods from overseas, with increased imports
the balance of payments deficit will increase, as imports are a component. On the other hand,
this issue is easily preventable through the use of taxation. Governments can discourage the
purchase of imported goods through trade tariffs and when the goods are purchased the
government will generate tax revenue, which will in turn close the gap in the balance of trade
payments account. In addition, a healthy supply-side would boost international competitiveness
allowing the demand for exports to increase, potentially keeping up with the increased demand
for imports.
Finally, a rise in GDP means that the labour force will demand higher wages. Inflation will bring
higher prices, and firms will have to raise wages in order to keep up with that. Eventually this
upward pressure will become so extreme that firms cannot afford to employ many people on
such high wages, and thus in the long run growth can lead to unemployment as people are laid
off, and the government aim to make unemployment as low as possible (the natural rate being
4%). Of course if inflation is prevented as discussed above, then real wages will rise with a
proportionate response to any changes in a firm’s profits, and thus there will be no illusion
created by higher prices, and firms will be able to afford a steady work force, preventing
unemployment.
