“Economic policy objectives”
Alevel Economics
What are Government Economic Objectives?
Government economic objectives are the key goals that a government aims to achieve to improve the overall
performance of the economy and ensure economic stability and growth. They are the targets of macroeconomic
policy, pursued through fiscal, monetary, and supply-side measures.
The Main Macroeconomic Objectives (The “Big 4”)
1. Economic Growth
a. Definition: Sustained increase in the real GDP of a country over time.
b. Why it matters: Raises living standards, creates jobs, and increases tax revenue for public services.
2. Low and Stable Inflation
a. Definition: Keeping the general price level rising slowly and predictably (target: ~2% CPI in the UK,
set by the Bank of England).
b. Why it matters: Avoids the harms of high inflation (e.g. loss of purchasing power) and deflation (e.g.
demand stagnation).
3. Low Unemployment / Full Employment
a. Definition: Achieving a situation where all those willing and able to work at current wage rates can
find employment.
b. Why it matters: Reduces poverty, increases output, and lessens strain on welfare systems.
4. Balance of Payments Stability
a. Definition: Avoiding large current account deficits or surpluses, ensuring sustainable international
trade and finance.
b. Why it matters: Prevents excessive borrowing from abroad and maintains exchange rate stability.
Other Government Objectives
In addition to the traditional macroeconomic goals of growth, low inflation, full employment, and balance of payments
stability, modern governments also pursue a range of secondary objectives to ensure long-term economic and social
stability. One key objective is environmental sustainability, which involves tackling climate change, reducing carbon
emissions, and promoting the use of renewable energy sources to achieve targets like the UK’s legally binding
commitment to net-zero emissions by 2050. Governments also aim for a more equitable distribution of income and
wealth, using tax and welfare policies to address poverty and inequality. This is important for maintaining social
cohesion and reducing the negative externalities of inequality, such as poor health and reduced economic participation.
Another objective is fiscal sustainability, ensuring that public debt and budget deficits remain at levels that are
manageable in the long term to avoid burdening future generations. Finally, governments may focus on improving
productivity and international competitiveness through investment in education, innovation, and infrastructure. These
wider objectives reflect the evolving priorities of policymakers in a globalised and environmentally conscious world.
How a PPF Shows Economic Growth
A Production Possibility Frontier (PPF) shows the maximum possible output combinations of two goods or services
an economy can produce when all resources are fully and efficiently employed.
Economic growth occurs when there is an increase in the productive capacity of the economy, allowing more goods
and services to be produced over time. On a PPF diagram, this is illustrated by an outward shift of the curve.
This outward shift happens because of factors such as:
, • An increase in the quantity or quality of factors of production (e.g. more labour through immigration or
improved education and training).
• Technological progress that makes production more efficient.
• Investment in capital goods (factories, machines, infrastructure) which raises future productive potential.
For example, if an economy invests heavily in renewable energy technologies, it may be able to produce more both of
good X (say, healthcare) and good Y (say, education), moving from a point on the original PPF to a point on the new,
expanded PPF.
This outward shift reflects long-run economic growth because the economy’s capacity to produce has increased.
Economic Growth
Economic growth refers to the sustained increase in a country’s real Gross Domestic Product (GDP) over time,
meaning the total value of goods and services produced in the economy adjusted for inflation is rising. It is a
fundamental government objective because growth generally leads to higher living standards, increased employment
opportunities, and greater government revenue to fund public services. There are two types of economic growth:
short-run growth, which occurs when an economy moves closer to its existing productive capacity (for example, by
using idle resources during a recession), and long-run growth, which involves an outward shift of the economy’s
production possibility frontier (PPF) due to increases in productive capacity. Long-run growth is driven by
improvements in factors such as labour supply (population growth, migration), labour productivity (education, skills,
training), capital investment (factories, machinery), technological advancements, and institutional factors like better
governance and infrastructure. However, growth can also bring challenges such as environmental degradation,
inflationary pressures if demand outstrips supply and rising inequality if the benefits of growth are unevenly
distributed. Therefore, policymakers aim for sustainable economic growth that balances expansion with social and
environmental considerations to ensure prosperity for current and future generations.
The Economic Cycle and Its Link to Economic Growth
The economic cycle (also called the business cycle) refers to the natural fluctuations in economic activity that an
economy experiences over time. It consists of alternating periods of expansion (growth) and contraction (recession)
around the economy’s long-run trend of growth. During the expansion phase, economic output (real GDP) rises,
unemployment falls, and consumer confidence improves. This is often accompanied by increased investment and
spending. Conversely, during the contraction phase, economic output declines, unemployment rises, and spending
slows, sometimes leading to a recession if the downturn is prolonged.
The economic cycle is important because short-run economic growth happens when the economy moves from a
trough (low point) to a peak (high point) along the existing production possibilities; essentially making better use of
available resources. However, this is different from long-run economic growth, which refers to an increase in the
economy’s productive capacity itself (an outward shift of the PPF). Governments try to smooth the economic cycle
through fiscal and monetary policies to reduce the severity of recessions and avoid overheating during booms, aiming
for steady and sustainable growth. Understanding the economic cycle helps policymakers balance other objectives like
low inflation and full employment since these can be affected by where the economy is in the cycle.
Output Gaps
An output gap is the difference between an economy’s actual output (real GDP) and its potential output (the maximum
sustainable level of output an economy can produce when all resources are fully employed without causing inflation).
• A positive output gap occurs when actual output exceeds potential output. This happens when the economy is
producing beyond its sustainable capacity, often due to high demand and over-utilisation of resources. While
it can lead to temporarily higher growth and lower unemployment, it also tends to cause demand-pull inflation
because resources are scarce, and prices are pushed up. This situation is often seen during economic booms.
, • A negative output gap happens when actual output is below potential output. This means the economy is
operating below full capacity — there is unused labour (higher unemployment) and capital (factories,
machines idle). Negative output gaps are common during recessions or downturns and indicate
underperformance in the economy, leading to lower income, higher unemployment, and sometimes
deflationary pressures due to weak demand.
The size of the output gap is a critical indicator for policymakers. A large negative output gap signals a need for
stimulative fiscal or monetary policy to boost demand and close the gap, while a positive output gap warns of
overheating, where contractionary policies might be necessary to cool inflation.
Output gaps also affect the inflationary environment and are closely monitored by central banks when setting interest
rates. Economies rarely operate exactly at their potential output because of shocks, changing demand, and structural
shifts, making output gaps a dynamic concept crucial for managing short-run economic performance.
Negative Output Gap & Unemployment (Spare Capacity)
A negative output gap means actual output is below potential output. In this situation:
• Firms cut back production due to weak demand.
• Unemployment rises because there is less need for labour.
• Spare capacity exists in the economy (idle factories, unemployed workers).
• With underused resources, deflationary pressure may emerge since firms have little power to raise prices and
may even cut prices to attract consumers.
This is why negative output gaps are associated with cyclical (demand-deficient) unemployment.
Positive Output Gap & Inflation (Overheating)
A positive output gap occurs when actual output exceeds potential output. Here:
• Firms operate beyond normal capacity (e.g., workers doing overtime, machines running at full tilt).
• Labour shortages can emerge, causing wages to rise.
• Rising wages and input costs lead to demand-pull and cost-push inflation as firms pass costs to consumers.
• Unemployment tends to be below the natural rate (NRU) because labour is in high demand.
This reflects the trade-off between unemployment and inflation illustrated by the short-run Phillips curve — as the
economy moves closer to or beyond full capacity, unemployment falls, but inflation accelerates.
Real-World Example: UK COVID-19 Recession
In 2020, during the COVID-19 pandemic, the UK economy experienced a large negative output gap as GDP
contracted by nearly 10% — the biggest decline in over 300 years. Businesses shut down, unemployment rose to
5.2%, and spare capacity widened. Despite this, deflation didn’t materialise because of government stimulus (furlough
scheme) and supply chain disruptions which kept some prices high.
By contrast, in 2022–2023, after a rapid recovery, the UK began facing a positive output gap with demand
outstripping supply, tight labour markets, and inflation surging to over 10% (well above the Bank of England’s 2%
target).
Benefits of Economic Growth
Economic growth — defined as a sustained increase in real GDP — brings a range of potential benefits for
individuals, firms, and governments. These benefits, however, depend on how growth is achieved and how its rewards
are distributed.
Alevel Economics
What are Government Economic Objectives?
Government economic objectives are the key goals that a government aims to achieve to improve the overall
performance of the economy and ensure economic stability and growth. They are the targets of macroeconomic
policy, pursued through fiscal, monetary, and supply-side measures.
The Main Macroeconomic Objectives (The “Big 4”)
1. Economic Growth
a. Definition: Sustained increase in the real GDP of a country over time.
b. Why it matters: Raises living standards, creates jobs, and increases tax revenue for public services.
2. Low and Stable Inflation
a. Definition: Keeping the general price level rising slowly and predictably (target: ~2% CPI in the UK,
set by the Bank of England).
b. Why it matters: Avoids the harms of high inflation (e.g. loss of purchasing power) and deflation (e.g.
demand stagnation).
3. Low Unemployment / Full Employment
a. Definition: Achieving a situation where all those willing and able to work at current wage rates can
find employment.
b. Why it matters: Reduces poverty, increases output, and lessens strain on welfare systems.
4. Balance of Payments Stability
a. Definition: Avoiding large current account deficits or surpluses, ensuring sustainable international
trade and finance.
b. Why it matters: Prevents excessive borrowing from abroad and maintains exchange rate stability.
Other Government Objectives
In addition to the traditional macroeconomic goals of growth, low inflation, full employment, and balance of payments
stability, modern governments also pursue a range of secondary objectives to ensure long-term economic and social
stability. One key objective is environmental sustainability, which involves tackling climate change, reducing carbon
emissions, and promoting the use of renewable energy sources to achieve targets like the UK’s legally binding
commitment to net-zero emissions by 2050. Governments also aim for a more equitable distribution of income and
wealth, using tax and welfare policies to address poverty and inequality. This is important for maintaining social
cohesion and reducing the negative externalities of inequality, such as poor health and reduced economic participation.
Another objective is fiscal sustainability, ensuring that public debt and budget deficits remain at levels that are
manageable in the long term to avoid burdening future generations. Finally, governments may focus on improving
productivity and international competitiveness through investment in education, innovation, and infrastructure. These
wider objectives reflect the evolving priorities of policymakers in a globalised and environmentally conscious world.
How a PPF Shows Economic Growth
A Production Possibility Frontier (PPF) shows the maximum possible output combinations of two goods or services
an economy can produce when all resources are fully and efficiently employed.
Economic growth occurs when there is an increase in the productive capacity of the economy, allowing more goods
and services to be produced over time. On a PPF diagram, this is illustrated by an outward shift of the curve.
This outward shift happens because of factors such as:
, • An increase in the quantity or quality of factors of production (e.g. more labour through immigration or
improved education and training).
• Technological progress that makes production more efficient.
• Investment in capital goods (factories, machines, infrastructure) which raises future productive potential.
For example, if an economy invests heavily in renewable energy technologies, it may be able to produce more both of
good X (say, healthcare) and good Y (say, education), moving from a point on the original PPF to a point on the new,
expanded PPF.
This outward shift reflects long-run economic growth because the economy’s capacity to produce has increased.
Economic Growth
Economic growth refers to the sustained increase in a country’s real Gross Domestic Product (GDP) over time,
meaning the total value of goods and services produced in the economy adjusted for inflation is rising. It is a
fundamental government objective because growth generally leads to higher living standards, increased employment
opportunities, and greater government revenue to fund public services. There are two types of economic growth:
short-run growth, which occurs when an economy moves closer to its existing productive capacity (for example, by
using idle resources during a recession), and long-run growth, which involves an outward shift of the economy’s
production possibility frontier (PPF) due to increases in productive capacity. Long-run growth is driven by
improvements in factors such as labour supply (population growth, migration), labour productivity (education, skills,
training), capital investment (factories, machinery), technological advancements, and institutional factors like better
governance and infrastructure. However, growth can also bring challenges such as environmental degradation,
inflationary pressures if demand outstrips supply and rising inequality if the benefits of growth are unevenly
distributed. Therefore, policymakers aim for sustainable economic growth that balances expansion with social and
environmental considerations to ensure prosperity for current and future generations.
The Economic Cycle and Its Link to Economic Growth
The economic cycle (also called the business cycle) refers to the natural fluctuations in economic activity that an
economy experiences over time. It consists of alternating periods of expansion (growth) and contraction (recession)
around the economy’s long-run trend of growth. During the expansion phase, economic output (real GDP) rises,
unemployment falls, and consumer confidence improves. This is often accompanied by increased investment and
spending. Conversely, during the contraction phase, economic output declines, unemployment rises, and spending
slows, sometimes leading to a recession if the downturn is prolonged.
The economic cycle is important because short-run economic growth happens when the economy moves from a
trough (low point) to a peak (high point) along the existing production possibilities; essentially making better use of
available resources. However, this is different from long-run economic growth, which refers to an increase in the
economy’s productive capacity itself (an outward shift of the PPF). Governments try to smooth the economic cycle
through fiscal and monetary policies to reduce the severity of recessions and avoid overheating during booms, aiming
for steady and sustainable growth. Understanding the economic cycle helps policymakers balance other objectives like
low inflation and full employment since these can be affected by where the economy is in the cycle.
Output Gaps
An output gap is the difference between an economy’s actual output (real GDP) and its potential output (the maximum
sustainable level of output an economy can produce when all resources are fully employed without causing inflation).
• A positive output gap occurs when actual output exceeds potential output. This happens when the economy is
producing beyond its sustainable capacity, often due to high demand and over-utilisation of resources. While
it can lead to temporarily higher growth and lower unemployment, it also tends to cause demand-pull inflation
because resources are scarce, and prices are pushed up. This situation is often seen during economic booms.
, • A negative output gap happens when actual output is below potential output. This means the economy is
operating below full capacity — there is unused labour (higher unemployment) and capital (factories,
machines idle). Negative output gaps are common during recessions or downturns and indicate
underperformance in the economy, leading to lower income, higher unemployment, and sometimes
deflationary pressures due to weak demand.
The size of the output gap is a critical indicator for policymakers. A large negative output gap signals a need for
stimulative fiscal or monetary policy to boost demand and close the gap, while a positive output gap warns of
overheating, where contractionary policies might be necessary to cool inflation.
Output gaps also affect the inflationary environment and are closely monitored by central banks when setting interest
rates. Economies rarely operate exactly at their potential output because of shocks, changing demand, and structural
shifts, making output gaps a dynamic concept crucial for managing short-run economic performance.
Negative Output Gap & Unemployment (Spare Capacity)
A negative output gap means actual output is below potential output. In this situation:
• Firms cut back production due to weak demand.
• Unemployment rises because there is less need for labour.
• Spare capacity exists in the economy (idle factories, unemployed workers).
• With underused resources, deflationary pressure may emerge since firms have little power to raise prices and
may even cut prices to attract consumers.
This is why negative output gaps are associated with cyclical (demand-deficient) unemployment.
Positive Output Gap & Inflation (Overheating)
A positive output gap occurs when actual output exceeds potential output. Here:
• Firms operate beyond normal capacity (e.g., workers doing overtime, machines running at full tilt).
• Labour shortages can emerge, causing wages to rise.
• Rising wages and input costs lead to demand-pull and cost-push inflation as firms pass costs to consumers.
• Unemployment tends to be below the natural rate (NRU) because labour is in high demand.
This reflects the trade-off between unemployment and inflation illustrated by the short-run Phillips curve — as the
economy moves closer to or beyond full capacity, unemployment falls, but inflation accelerates.
Real-World Example: UK COVID-19 Recession
In 2020, during the COVID-19 pandemic, the UK economy experienced a large negative output gap as GDP
contracted by nearly 10% — the biggest decline in over 300 years. Businesses shut down, unemployment rose to
5.2%, and spare capacity widened. Despite this, deflation didn’t materialise because of government stimulus (furlough
scheme) and supply chain disruptions which kept some prices high.
By contrast, in 2022–2023, after a rapid recovery, the UK began facing a positive output gap with demand
outstripping supply, tight labour markets, and inflation surging to over 10% (well above the Bank of England’s 2%
target).
Benefits of Economic Growth
Economic growth — defined as a sustained increase in real GDP — brings a range of potential benefits for
individuals, firms, and governments. These benefits, however, depend on how growth is achieved and how its rewards
are distributed.
