Macroeconomics essay plans
Evaluate the view that the main objectives of UK government macroeconomic policy can be
achieved without conflicting with each other.
25 marks
Government objectives
Low and stable price level
Low and stable unemployment rate
Balanced current account
Positive and stable economic growth
Conflicts of macroeconomic objectives are inevitable
Cant implement policies to achieve both objectives – one has to be sacrificed
Unemployment vs inflation
o As economic growth increases unemployment falls due to more jobs being created
o This causes wages to increase which leads to more consumer spending and an
increase in the average price level
o Phillips curve
Depreciation in the exchange rate vs inflation
o Imports become more expensive and exports become cheaper which causes
aggregate demand to rise causing demand pull inflation
o Imports become more expensive which increases the price of raw materials causing
cost push inflation
High growth vs inflation
o High growth in in UK export markets mean UK exports increase and become less
competitive and aggregate demand increases causing demand pull inflation because
UK domestic firms can sell to more domestic markets
o When consumer spending increases, imports increase and exports are likely to fall
o Aggregate demand increases faster than aggregate supply as consumer spending
increases due to higher wages especially when there is a positive output gap
Low growth vs the current account
o The current account deficit falls because consumer spending falls
High growth vs the current account
o There is a larger current account deficit because consumers have higher incomes so
consumer spending increases on consumption and imports
o Imports cause a larger outflow of money from the UK
o The UK’s consumers have a higher marginal propensity to import so there is likely to
be more spending on imports which leads to a worsening on the current account
deficit
o Increased domestic economic growth results in a decreased incentive to export as
businesses have a larger domestic market to sell to so there will be less money
entering the UK economy worsening the current account deficit
Conflicts don’t always exist
Unemployment vs inflation
o If additional real disposable income is spent on imports aggregate demand will not
increase as much so demand pull inflation will be less significant especially for the
UK as we have a high marginal propensity to import so there is less of a conflict
, o If there is deflation or lower than 2% inflation then the government will want to
increase inflation to 2% so no conflict will exist
o If economy is operating with spare capacity and a negative output gap then
increased aggregate demand can occur with no change to inflation as factors of
production aren’t scarce so the price does not need to be rationed meaning there is
no conflict
o If supply side economic growth occurs then there could be an increase in
employment without increased inflation as shown on diagrams
Economic growth vs current account deficit
o The effect depends on the level of protectionism put in place by an economy as
marginal propensity to import will be lower in economies with high levels of
protectionist measures such as tariffs and quotas so there will be less of a conflict
o If the country is export led like china then there will be no conflict
o Conflict depends on the exchange rate as deprecation makes imports more
expensive
Conflicts can be limited
Although there inevitably will be trade offs between macroeconomic objectives they can be
limited
Unemployment vs inflation
o If supply side policies are implemented to limit structural unemployment such as
retraining and education then average wages will not increase which will limit
inflationary pressures
o Reducing occupational immobility, improving geographical mobility, stimulating
stronger work incentives
o Better finding for more effective work training Such as training new skills or
expansion of apprenticeships
o Rise in house building keeps property prices lower and encourages more affordable
housing rents
o Active regional policy to improve transport infrastructure
o High minimum wage and welfare reforms to reduce the risk of poverty trap
o Evidence to show that the Phillip’s curve is invalid in times of stagflation where
economies can experience high inflation and high unemployment
Conclusion
Conflicts are inevitable and cannot be stopped in some circumstances without government
intervention
However methods of government intervention can be successful in limiting these potential
trade offs
o Unemployment vs inflation
In some circumstances these conflicts do not exist and so no intervention is needed
On the whole UK macroeconomic objectives cannot be achieved without conflicting with
each other but the extent of the conflict can be limited
, Evaluate the likely impact of a fall in the savings ratio on the performance of the UK economy.
25 marks
The savings ratio
The proportion of disposable income not being spent on consumption
A fall in the savings ratio would mean that less money is being saved and more money is
being spent
Lower short term unemployment
Lead to a lower rate of unemployment
A lower savings ratio indicates that household incomes are higher
Household incomes on the whole would increase due to more people being employed
bringing the unemployment rate down
Workers would in turn demand higher wages from their employers
This would put pressure on their employers to increase their wages which would increase
the costs of production and lead to cost push inflation
Higher inflation
A fall in the savings ratio would lead to demand pull inflation
Aggregate demand increases as a larger proportion of disposable income is spent on
consumption
This shifts the demand curve to the right causing an increase in the price level and an
increase in the quantity demanded
Consumer’s marginal propensity to save is less
Consumer income has increased
The change in price level would have a larger effect on price elastic goods such as watches
than price inelastic goods such as petrol
A fall in the savings ratio would lead to cost push inflation
Aggregate supply decreases as workers demand for higher wages
This leads to an increase in the cost of production of goods which leads to a decrease in
supply and an increase in the price level as a result
This can be shown by a shift to the left in the supply curve
A new equilibrium is reached as a result of the demand pull and cost push inflation
The market
For normal goods with an income elasticity of demand < 1 the change in income would cause
more of these goods such as cars to be produced
For inferior goods with an income elasticity demand of > 1 the change in income would
cause less of these goods to be consumed as the higher incomes would cause consumers to
search for more expensive alternatives as a result
This would lead to more income inequality as poorer households are still unable to afford
luxury goods
However it would also lead to an increase in the standard of living as more expensive
alternatives for inferior goods are being purchased
Higher short term economic growth
A fall in the savings ratio would lead to higher economic growth
Aggregate demand increases shown by a shift to the right in the demand curve
This increases the quantity of goods demanded and increases the price level
In order to meet the quantity demanded firms supply more goods at a lower price which is
shown by a shift to the right in the supply curve
Evaluate the view that the main objectives of UK government macroeconomic policy can be
achieved without conflicting with each other.
25 marks
Government objectives
Low and stable price level
Low and stable unemployment rate
Balanced current account
Positive and stable economic growth
Conflicts of macroeconomic objectives are inevitable
Cant implement policies to achieve both objectives – one has to be sacrificed
Unemployment vs inflation
o As economic growth increases unemployment falls due to more jobs being created
o This causes wages to increase which leads to more consumer spending and an
increase in the average price level
o Phillips curve
Depreciation in the exchange rate vs inflation
o Imports become more expensive and exports become cheaper which causes
aggregate demand to rise causing demand pull inflation
o Imports become more expensive which increases the price of raw materials causing
cost push inflation
High growth vs inflation
o High growth in in UK export markets mean UK exports increase and become less
competitive and aggregate demand increases causing demand pull inflation because
UK domestic firms can sell to more domestic markets
o When consumer spending increases, imports increase and exports are likely to fall
o Aggregate demand increases faster than aggregate supply as consumer spending
increases due to higher wages especially when there is a positive output gap
Low growth vs the current account
o The current account deficit falls because consumer spending falls
High growth vs the current account
o There is a larger current account deficit because consumers have higher incomes so
consumer spending increases on consumption and imports
o Imports cause a larger outflow of money from the UK
o The UK’s consumers have a higher marginal propensity to import so there is likely to
be more spending on imports which leads to a worsening on the current account
deficit
o Increased domestic economic growth results in a decreased incentive to export as
businesses have a larger domestic market to sell to so there will be less money
entering the UK economy worsening the current account deficit
Conflicts don’t always exist
Unemployment vs inflation
o If additional real disposable income is spent on imports aggregate demand will not
increase as much so demand pull inflation will be less significant especially for the
UK as we have a high marginal propensity to import so there is less of a conflict
, o If there is deflation or lower than 2% inflation then the government will want to
increase inflation to 2% so no conflict will exist
o If economy is operating with spare capacity and a negative output gap then
increased aggregate demand can occur with no change to inflation as factors of
production aren’t scarce so the price does not need to be rationed meaning there is
no conflict
o If supply side economic growth occurs then there could be an increase in
employment without increased inflation as shown on diagrams
Economic growth vs current account deficit
o The effect depends on the level of protectionism put in place by an economy as
marginal propensity to import will be lower in economies with high levels of
protectionist measures such as tariffs and quotas so there will be less of a conflict
o If the country is export led like china then there will be no conflict
o Conflict depends on the exchange rate as deprecation makes imports more
expensive
Conflicts can be limited
Although there inevitably will be trade offs between macroeconomic objectives they can be
limited
Unemployment vs inflation
o If supply side policies are implemented to limit structural unemployment such as
retraining and education then average wages will not increase which will limit
inflationary pressures
o Reducing occupational immobility, improving geographical mobility, stimulating
stronger work incentives
o Better finding for more effective work training Such as training new skills or
expansion of apprenticeships
o Rise in house building keeps property prices lower and encourages more affordable
housing rents
o Active regional policy to improve transport infrastructure
o High minimum wage and welfare reforms to reduce the risk of poverty trap
o Evidence to show that the Phillip’s curve is invalid in times of stagflation where
economies can experience high inflation and high unemployment
Conclusion
Conflicts are inevitable and cannot be stopped in some circumstances without government
intervention
However methods of government intervention can be successful in limiting these potential
trade offs
o Unemployment vs inflation
In some circumstances these conflicts do not exist and so no intervention is needed
On the whole UK macroeconomic objectives cannot be achieved without conflicting with
each other but the extent of the conflict can be limited
, Evaluate the likely impact of a fall in the savings ratio on the performance of the UK economy.
25 marks
The savings ratio
The proportion of disposable income not being spent on consumption
A fall in the savings ratio would mean that less money is being saved and more money is
being spent
Lower short term unemployment
Lead to a lower rate of unemployment
A lower savings ratio indicates that household incomes are higher
Household incomes on the whole would increase due to more people being employed
bringing the unemployment rate down
Workers would in turn demand higher wages from their employers
This would put pressure on their employers to increase their wages which would increase
the costs of production and lead to cost push inflation
Higher inflation
A fall in the savings ratio would lead to demand pull inflation
Aggregate demand increases as a larger proportion of disposable income is spent on
consumption
This shifts the demand curve to the right causing an increase in the price level and an
increase in the quantity demanded
Consumer’s marginal propensity to save is less
Consumer income has increased
The change in price level would have a larger effect on price elastic goods such as watches
than price inelastic goods such as petrol
A fall in the savings ratio would lead to cost push inflation
Aggregate supply decreases as workers demand for higher wages
This leads to an increase in the cost of production of goods which leads to a decrease in
supply and an increase in the price level as a result
This can be shown by a shift to the left in the supply curve
A new equilibrium is reached as a result of the demand pull and cost push inflation
The market
For normal goods with an income elasticity of demand < 1 the change in income would cause
more of these goods such as cars to be produced
For inferior goods with an income elasticity demand of > 1 the change in income would
cause less of these goods to be consumed as the higher incomes would cause consumers to
search for more expensive alternatives as a result
This would lead to more income inequality as poorer households are still unable to afford
luxury goods
However it would also lead to an increase in the standard of living as more expensive
alternatives for inferior goods are being purchased
Higher short term economic growth
A fall in the savings ratio would lead to higher economic growth
Aggregate demand increases shown by a shift to the right in the demand curve
This increases the quantity of goods demanded and increases the price level
In order to meet the quantity demanded firms supply more goods at a lower price which is
shown by a shift to the right in the supply curve
