JC Economics Macroeconomic Policies & Objectives Essay Model Answers
A sample question on the concepts of full employment, types of unemployment (unN) including cyclical unN, structural unN, etc, and its application to macro economic performance and Standard of Living (SOL).
Question
“The main objectives of government policy are often asserted to be full employment, prices, BOP equilibrium and high growth rate.
Discuss some of the difficulties facing a government in its attempt to attain these objectives simultaneously. [25]
JC Economics Essay – Various Macroeconomic Goals
Suggested Solution
I. Briefly explain the importance of the 4 macroeconomic aims
a Full employment Unemployment refers to the number of people who are actively looking for work but are currently without a job. To achieve internal stability, the government will aim to achieve full employment to ensure a stable income for the citizens to enjoy a higher standard of living and thus prevent any negative effects of unemployment. High employment minimizes the payments of social benefits so that the government budget burden can be reduced and resources can be channelled for other areas of development.
b. High and sustainable economic growth
Economic growth is the increase in an economy’s level of real output over time. Government is not only interested in achieving actual economic growth, which is the percentage increase in national output, it is also important for the government to maximize its potential growth, that is, the percentage annual increase in the economy’s capacity to produce. In other words, growth must be sustained over the years and is not just a temporary phenomenon. This is an important. macroeconomic aim for the government as it helps to alleviate other macroeconomic problems such as demand-pull inflation which will result if there is no increase productive capacity of the economy.
C Stable prices (low inflation)
Inflation is a situation where there is a sustained and inordinate increase in the general price level. In other words, there is an increase in the cost of living. It is important for the government to solve inflation problem so that it will not have adverse effects on both the internal and external economy.
d. BOP equilibrium BOP account records all transactions between residents of a country and the rest of the world. If a country has a BOP deficit, especially if it is persistent, there will be pressure for the country’s currency and its exchange rate will depreciate, thus destabilizing the external economy.
2. Explain how the use of demand-management policies to achieve full employment may result in higher inflation
Fiscal policy (FP) involves the use of government spending and/or tax policies to influence the level of aggregate demand (AD) in order to manage and stabilise the economy.
Increase G → increases AD as G directly increases aggregate output at each possible price
Increase G on transfer payments and social welfare increase the disposable income of households and thus increase C → increase AD Decrease income T increase level of disposable income of households → increase C → increase AD at each possible price
Decrease corporate T increase the level of after-tax profits increase Investments (I)→ increase AD
As AD increases → Firms increase their production → firms may need to increase their employment of factors of production, including employment of workers → income increases this induces domestic consumption to increase → stimulate production & income to increase further so increase employment & national income by ‘multiple times → However, although the employment level is increased, as firms need to compete for scarce resources to increase their production level push up the general price level demand-pull inflation
Expansionary monetary policy:
Similarly, expansionary monetary policy can be used to promote employment in the country but this may again lead to demand-pull inflation. Monetary
policy involves changing money supply or interest rates to influence AD in order to manage and stabilize the economy.
• Increase money supply increase the amount of loanable funds available → decrease interest rate lower cost of borrowing with expected returns of investment increases → increase I → remaining the same, the profitability increase AD
•Reduction in interest rate lower cost of borrowing consumers are more willing to borrow on credit basis increase consumption for big ticket items such as cars and houses
•Reduction in interest rate returns from savings are lower opportunity cost of present consumption lower increase C→ increase AD However, as described above, when the economy moves towards full employment, there will be inflationary pressures as competition for resources leads to higher cost and higher general price level. Thus, in the short run, without any rise in productive capacity, the economy will see signs of overheating. Prices of many goods and services will be rising rapidly and inflation rate will now start to increase from OP1 to OP2, resulting in a conflict between full employment and inflation.
The converse can be seen if the government tries to curb a high inflation rate by reducing AD. The fall in demand may lead to unexpected (unanticipated) rise in stocks level. As a result, firms may cut back on production and employment, leading to a rise in unemployment. At the same time, economic growth may start to slow down. Thus, this shows that it is difficult for a government to achieve both full employment and low inflation at the same time as there is a short-run trade-off between the two objectives.
JC Economics Essay – Macro Policies & Conflicts
3. Conflict between economic growth and balance of payment equilibrium It is also difficult for the government to achieve both the aim of economic growth and BOP equilibrium. As the macroeconomic aim of economic growth is achieved, incomes of the citizens will rise. This will lead to higher purchasing power of the citizens including importing more goods and services from overseas. This will lead to a current account deficit, worsening the balance of payment account. As such, the aim of achieving economic growth may lead to a balance of payment disequilibrium in the short run.
For example, if the government tries to increase AD by reducing interest rates (expansionary MP) to stimulate growth, it may inadvertently encourage more imports too. Firms who borrow to invest may end up importing more capital, while households may spend more on imported goods and services instead. If the growth of imports is more than that for exports, this may lead to trade deficit and subsequently a balance of payment disequilibrium, ceteris paribus. Therefore, it may be quite difficult to achieve all macroeconomic objectives at the same time, especially if the government only focuses on demand side management.
JC H2 Econs Essay – Evaluation SOL Concept
However, in the long run, it is possible that many of these objectives can be achieved together. This is because the government does not only focus on demand-side management policies; it is also embarking on supply-side policies. Supply-side policies are policies aimed at increasing the productive capacity and efficiency of an economy. The focus is to increase the ability of the economy to produce more output (increase in AS in long run) and thus achieve potential economic growth as well as price stability in the long run.
Explain the limitations of the supply side policy (SSP)
Conclusion
It is important for the government to maintain the stability of the economy by meeting the 4 macroeconomic objectives. As it is difficult to attain all objectives in the short run, since the goals are conflicting, the government must determine which will be a more important objective to meet.
Therefore, due to the possible conflicts between certain objectives, it means that the government may sometimes have to resort to a host of measures, instead of relying on only one or two. Especially important are those that can help the country increase the aggregate supply and its potential growth in the long run. By doing so, the government will be able to attain these macroeconomic objectives simultaneously, thus promoting stability in the country.