What has been the relationship between the four macroeconomic objectives of low employment, low inflation, rapid and sustainable growth and the avoidance of current account balance of payments deficits in the UK over the past 20 years.

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UNE100C1- Economic principles and applications.

Question 1 : What has been the relationship between the four macroeconomic objectives of low employment, low inflation, rapid and sustainable growth and the avoidance of current account balance of payments deficits in the UK and one other country and one other EU country over the past 20 years? To what extent can the relationship be explained in terms of aggregate demand? 

                                                                        (50 marks)

There are four macroeconomic objectives; low unemployment, low inflation, rapid and sustainable growth and the avoidance of current account balance of payments deficits which are interrelated. They can be explained in the context of aggregate demand in the short run and all vary with the course of the business cycle. In the boom phase, growth is high and unemployment is falling, but inflation is rising and the current account of the balance of payments is moving into deficit. During recession the reverse is true.

Aggregate demand is the total level of spending in the economy and can be calculated using the following formula.

AD = C + I + G +X – M

Aggregate supply is the total amount of output in the economy.

Unemployment refers to those people who do not have a job but are willing to except a job at the at the current wage rates. At times of high unemployment, government spending rises whilst tax revenue falls. As a consequence the public sector borrowing requirement (PSBR) increases. To make up the difference the government has to pay interest on this borrowing. The Keynesian approach to reducing unemployment has been to adopt policies aimed at increasing aggregate demand. The government should increase government spending, reduce taxes or reduce interest rates in order to increase consumer spending and therefore increasing demand. The natural rate of unemployment is more formally known as the (NAIRU), non-accelerating inflation rate of unemployment which can be maintained without increasing the inflation rate.

Inflation is known as an increase in the general level of prices in an economy that is sustained over a period of time. Such that after a period of time, you need more money to buy the same amount of a particular good or service as before. There are many causes of inflation such as cost-push and demand-pull inflation and the wage price spiral.

Cost-push inflation is a general increase in prices which is caused by the increase in various factor input costs, such as rising prices for imported raw materials. Another cause is raising labour costs caused by wage increases, which are greater than productivity increases. On a wider scale prices will generally increase so workers wages will now buy less. This will increase demand for further wage increases leading to additional price increases; this is often known as the wage price spiral. Cost push-inflation may also be due to higher indirect taxes imposed by the government.

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Demand Pull inflation occurs when total demand for goods and services exceeds total supply. This type of inflation happens when there has been excessive growth in aggregate demand and there is an inflationary gap. Demand-pull inflation is often monetary in origin this is because the authorities allow the money supply to grow faster than the ability of the economy to supply goods and services.

Demand-pull inflation occurs when demand is high relative to supply, inflation exceeds expectations. We can illustrate demand-pull inflation using the aggregate demand and supply model. For instance a rise in aggregate demand from ...

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