25 Marker Economics Model Answer AQA style – Objective trade-offs

Here is a question, essay plan and model answer for a question on trade-offs between macroeconomic objectives.

The question and model answer are written in the style of AQA Economics A Level.

Question

The question features a short introductory paragraph, followed by the question in bold.

The UK Government has made economic growth its number one mission, aiming to return to annual economic growth of 2.5%. Depending on how economic growth is achieved, there can be trade-offs between economic growth and other macroeconomic objectives.

Question: Evaluate the extent to which there are trade-offs between macroeconomic objectives. (25 marks)

Essay plan

Here is a plan for the essay:

• Intro:
  • List key four macro objectives and add other possible objectives.
• Analysis paragraph 1:
  • Short-run economic growth can be associated with a rise in AD.
  • This leads to higher inflation, creating a trade-off.
  • Higher inflation can also reduce the current account deficit.
  • The multiplier effect exacerbates these trade-offs.
• Evaluation point 1:
  • Depends on the level of spare capacity. Refer to Keynesian AS curve.
• Analysis paragraph 2:
  • Long-run economic growth can be associated with a shift right in LRAS.
  • This economic growth occurs alongside lower inflation and reducing the current account deficit.
  • Example of long-run economic growth privatisation.
• Evaluation point 2:
  • Long-run economic growth could increase unemployment in some regions and lead to greater inequality.
• Conclusion:
  • Trade-offs exist but can mostly be managed or only occur in certain conditions.
  • In the long run, trade-offs can be avoided with supply-side policies. In the short run, trade-offs are possible.
  • Long run trade-offs between economic growth and inequality can be managed through use of extra government revenue on training or welfare.

Model answer

Introduction

The four main macroeconomic objectives include sustained economic growth, low and stable inflation, low unemployment and a satisfactory balance of payments. Other possible macroeconomic objectives for the government could include protecting the environment, reducing inequality, or lowering the government’s debt-to-GDP ratio. I will argue that conflicts between macroeconomic objectives can mostly be avoided, but are possible in the short run.

Analysis paragraph 1

There is a trade-off between economic growth and low inflation. Short-run economic growth may occur because of a boost to aggregate demand, such as the UK Government increasing its spending on defence to 2.5% of GDP by 2027. This boosts aggregate demand, as G is a component of AD: AD = C + I + G + X – M. Also there is a multiplier effect. This means a change in a component of AD leads to an even greater change in AD and real GDP. For example higher government spending increases business revenues and profits for firms that receive the investment funds, increasing incomes of workers. These workers then spend more in local areas, thus increasing consumption and AD. Altogether AD shifts right from AD to AD2. This boosts economic growth, leading to higher real GDP from Y to Y2. At the same, this also causes inflation, with the price level rising from PL to PL2. This is demand-pull inflation, which could increase inflation rate above the Bank of England’s 2% 1pp inflation target. Higher inflation can increase the price of exports (relative to other economies), reducing export demand and increasing the UK’s current account deficit. So short-run economic growth can lead to trade-offs.

Evaluation paragraph 1

However this depends on the position of the economy on the Keynesian AS curve. On the flatter part of the Keynesian AS, real GDP is lower. Here, a given increase in real GDP only leads to a small increase in price level and inflation. As there is high spare capacity, an increase in aggregate demand does not raise wages, costs and hence prices very much – workers have low bargaining power as unemployment is high, so cannot ask for much higher wages. So the trade-off between economic growth and low inflation is less likely when there is high spare capacity.

Analysis paragraph 2

Under long-run economic growth, there may not be a trade-off between the four primary macroeconomic objectives. Long-run economic growth occurs when the long-run aggregate supply (LRAS) increases. For example, consider the market-based supply-side policies put in place under Thatcher’s government in the 1980s, such as privatisation of the water, airline and steel industries. Privatisation means the government selling a state-owned firm to the private sector. A private firm has the incentive to maximise profits to satisfy shareholders and to survive in the face of competition. So to increase profits, the privatised firm may cut average costs and become more efficient. This increase in productivity shifts the LRAS right from LRAS to LRAS1.This increases real GDP from Y to Y1, so the rate of economic growth increases. There is an extension in AD as a result, resulting in higher demand for labour, as labour demand is derived demand. So employment rises. Also the price level falls from PL to PL1, helping to achieve low, stable inflation. The lower price level makes exports more price competitive relative to imports. This increases export demand and reduces the size of the current account deficit. Also as there are more goods and services being produced, there is greater tax revenue for the government from VAT and corporation tax, helping to reduce the budget deficit and slow the growth of national debt. 

Evaluation point 2

However long-run economic growth, using market-based supply-side policies, may lead to higher unemployment in certain sectors and may increase inequality. While privatisation may increase efficiency, firms may achieve increased efficiency by firing some workers, increasing the unemployment rate. Over 100,000 jobs have been lost at BT following its privatisation. Meanwhile, by reducing costs, firm profits increase, increasing payments to the CEO and shareholders of the company, contributing to inequality.  So long-run economic growth does not necessarily increase living standards for all.

Conclusion

Overall there are conflicts between macroeconomic objectives to some extent, but most conflicts can either be managed or are subject to changes in macroeconomic conditions. For example conflicts between economic growth and low, stable inflation can be managed through supply-side policies over time. Policies to achieve long-run economic growth often come with time lags, such as the time taken to build the railway for HS2. So in the short run, trade-offs are possible between economic growth and low inflation due to shifts in AD. Trade-offs between economic growth and low inequality could be managed by the government. Economic growth boosts tax revenue for the government, which can be spent on retraining workers or welfare payments to reduce inequality.

Commentary on the answer

The answer scores highly on all criteria:

• A well-organised answer that uses technical terms.
• Application of economic theory and real world examples to the question.
• High level analysis, including chains of reasoning and use of diagrams.
• Evaluation that links to the question and a solid conclusion.

As a result, this answer would likely score full marks or close to this.

For this question, other possible points include, but are not limited to:

• Trade-off between environment and economic growth.
  • How this depends on the sectors driving growth (energy intensive vs green sectors) or the types of policies used to protect the environment (subsidies vs taxes).
• More on the trade-off between economic growth and inequality. For example the importance of globalisation, automation or the gig economy. But this may be offset by government policy such as welfare and training spending (a valid question is whether there has been enough government support to offset such problems).
• The Phillips curve link between unemployment and inflation.
• Expectations augmented Phillips curve and how this may lead to no trade-off in the long run.
• Tariffs to reduce the current account deficit versus the increase in inflation that results. Higher unemployment could occur in the case of retaliation. These arguments could also be reversed in the case of globalisation.
• Other valid points.

I have chosen to structure this particular essay using two long analysis points. You could also choose to structure your essay with three slightly shorter analysis points too. As long as your answer meets all the criteria, it can score highly with both structures.

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