Conflicts between objectives

There are a number of conflicts between economic objectives, therefore making it difficult to achieve some objectives at the same time.  This leaves governments and policy makers with a trade-off; which objective is the most important?

 

The four traditional macro economic objectives are:

  1. Low and stable inflation
  2. Sustainable economic growth
  3. High levels of employment
  4. A favourable balance on the current account.

 

The main economic objective of the UK Government is achieving a CPI rate of inflation equally 2%.  The two other macroeconomic objectives of the Government are sustainable growth coupled with low unemployment.

 

We will look at a number of different conflicts between objectives; the first three are conflicts between macro economic objectives, and there are two further conflicts with micro economic objectives.

 

Low Unemployment and Low Inflation

Shifting AD outwards will lead to an increase in national income (this is associated with a fall in unemployment), but the opportunity cost of this is an increase in the price level.

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This shows that as unemployment falls the rate of inflation will rise – this is the conflict of objectives that governments face.  The diagram below shows two possible scenarios for an economy:

  • A low increase in AD will lead to A
  • A high increase in AD will lead to B

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We can show the trade off between inflation and unemployment using a Phillips Curve.  On the diagram below A and B reflect the same points on the AD AS diagram above and the table you have just completed.

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The Phillips Curve was first suggested by Prof. Phillips who plotted inflation and unemployment data for the UK from 1861 to 1957.  He found that in the years with low inflation the economy suffered from high unemployment, and when there was low unemployment the economy experienced high inflation.  In other words he found that there was an inverse relationship between unemployment and inflation.

 

This relationship between unemployment and inflation is sometimes described as a trade-off or menu of choices; the government could choose to either have high unemployment and low inflation or low unemployment and high inflation.

 

When the Conservative Government of the 1990s was pursuing a policy of reducing inflation, Norman Lamont, the Chancellor, stated that “unemployment is the price worth paying for lower inflation.”

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Since 1993 there appears to have been a breakdown in the trade off between unemployment and inflation as lower rates of unemployment have been achieved without triggering inflationary pressures.  This has been attributed to the movement towards supply side policies.  Shifting the AS curve to the right will lead to an increase in national income, resulting in a fall in unemployment, without triggering inflationary pressure.

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Economic Growth and Low Inflation

High economic growth will often lead to increasing inflation.  Shifting AD to the right will lead to both economic growth and an increase in inflation; this is known as demand pull inflation.

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We can see that inflation is more likely to occur during periods where there is a positive output gap.

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Economic Growth and a Surplus on the Current Account

High economic growth will often lead to a reduced surplus (or increased deficit) on the current account.  When there is a rise in economic growth consumption will rise.  Much of this extra consumption will be spent on goods from abroad which will lead to the deficit on the current account growing larger (or the surplus being reduced).

Economic Growth and the Environment

We can see the India has enjoyed very high levels of economic growth over recent years.

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The cost of this economic growth has been a significant rise in the level of CO2 emissions.

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China is now the largest producer of CO2 emissions in the world; it overtook the USA in 2006.  The following information relates to 2004’s data.

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Exports count for a quarter of China’s CO2 emissions.  The growth in China’s exports will lead to further increases in CO2 emissions in the future.

 

Cement production is the largest CO2 source among the industrial processes; it contributes about 4% of total global CO2 emissions from fuel use and industrial activities. In China, however, its cement production accounts for 9% of its CO2 emissions.  In 2006, China produced 44% global cement.  This implies that future growth in China will be strong.

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Now that China is the largest producer of CO2 emissions in the world many have called for limits on its growth.  This table highlights that CO2 per capita is significantly lower in China than the UK and USA; those who suggest that unhindered growth in China should be allowed to continue use this as evidence.

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This table points to the fact that China is not achieving its levels of GDP with efficient use of CO2.  China uses a lot more CO2 to produce $1 of GDP than the UK.  Whilst this may lead some to argue for restrictions on growth, others point out that this is simply a result of China being home to much of the world’s manufacturing.  A lot of the GDP is the UK is a result of, low carbon producing, financial services and high technology industries.

Economic Growth and Equality of Wealth and Income

Increases in economic growth can often be accompanied by a reduction in the equality of wealth; the rich get richer and the poor stay poor.  In 2006 the original incomes of the richest 20% of households in the UK were 16 times greater than the poorest 20%: £68,700 compared with £4,200. This ratio between the highest and lowest earners was reduced to four-to-one, £49,300 against £13,500, when tax and benefits has been paid.

 

The trickle down theory is used to describe policies of Presidents Reagan and Bush; their policies focused upon providing economic gains for the wealthy that result in jobs for those on lower incomes.  This idea had previously been described as the horse and sparrow theory by the economist John Galbraith.  He stated that “if you feed enough oats to the horse, some will pass through to feed the sparrows.”  President John F. Kennedy outlined the effect of increasing GDP benefitting all as “a rising tide lifts all boats”.

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Source: New York Times

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 Source: New York Times

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