Macroeconomic Objectives: growth, jobs and inflation, IB 3.3

Economic growth as an objective

Economic growth is an increase in real GDP over time, and sustained real GDP per capita growth is the usual objective because it raises average incomes and can reduce poverty. Short-run (actual) growth is an increase in real output using existing capacity, shown as AD moving rightward or a move outward from inside the production possibilities curve. Long-run (potential) growth is an increase in productive capacity itself, shown as a rightward shift of LRAS or an outward shift of the PPC.

Growth is desirable but not costless: it can bring inflation, widen inequality and damage the environment, which is why the syllabus treats it as one objective to be balanced against others rather than a goal to be maximised.

Low unemployment: the four types and how it is measured

Cyclical (demand-deficient) unemployment results from a fall in AD during a recession and is the type demand-side policy targets. Structural unemployment comes from a mismatch between workers' skills or location and the jobs available, caused by occupational and geographical immobility as industries decline, for example UK coal mining or the US manufacturing belt. Frictional unemployment is the short-term joblessness of people moving between jobs, and some always exists. Seasonal unemployment follows predictable annual patterns, as in tourism, agriculture and retail after the Christmas peak.

The measured unemployment rate is the number unemployed and actively seeking work as a percentage of the labour force. It has real limitations: it excludes discouraged workers who have stopped looking (hidden unemployment) and understates underemployment, where part-time workers want full-time hours. A single national figure also hides sharp regional, age and ethnic disparities, and claimant-count measures differ from labour-force survey (ILO) measures.

Low and stable inflation: causes

Inflation is a sustained rise in the general price level, which erodes the real value of money and savings. Demand-pull inflation occurs when AD rises faster than the economy can supply, so too much spending chases too few goods and prices are bid up, typically in a boom near full capacity. Cost-push inflation occurs when rising costs of production, such as higher wages, oil prices or import prices, shift SRAS leftward, raising the price level while cutting output.

Deflation is a sustained fall in the general price level (negative inflation). Malign deflation comes from falling AD and is dangerous because consumers defer spending expecting lower prices, and the real burden of debt rises, as in Japan's lost decades. Benign deflation comes from rising supply, such as technological progress lowering costs. Disinflation is different again: it is a fall in the rate of inflation, so prices are still rising but more slowly.

Measuring inflation with the CPI and its limits

The Consumer Price Index (CPI) tracks the price of a representative basket of goods and services, weighted by household spending patterns, against a base year set to 100. The inflation rate is the percentage change in the index: if CPI rises from 100 to 108, inflation is 8%; if it then rises from 108 to 110, inflation is (110 - 108) / 108 = 1.85%. That fall in the rate from 8% to 1.85% is disinflation, not deflation, because prices are still rising.

The CPI has weaknesses. Fixed basket weights become outdated as consumers substitute away from goods whose prices rise (substitution bias), quality improvements and new products are hard to capture, and a single index is unrepresentative for households with unusual spending, such as pensioners. It also differs from the GDP deflator, which covers all domestic output rather than a consumer basket.

Conflicts between the objectives

The objectives pull against each other. Using demand-side policy to cut unemployment tends to raise inflation, while tightening policy to control inflation raises unemployment and slows growth. Rapid growth can worsen inequality and environmental sustainability, so a low-inflation, high-growth boom is rarely a free lunch.

A real-world illustration is the early 1980s in the United States, when the Federal Reserve under Paul Volcker raised interest rates sharply to break double-digit inflation. Inflation fell steeply, but the cost was a deep recession and unemployment near 10%, a textbook example of the inflation-unemployment conflict.

Common Paper mistakes

Do not treat disinflation and deflation as the same thing: disinflation is a falling inflation rate with prices still rising, deflation is prices actually falling. When you list unemployment types, pair each with the right policy (structural unemployment needs retraining and relocation support, not demand stimulus). If an extract gives CPI data, evaluate the CPI's limitations rather than taking the figure as a perfect measure.

How this is examined

• Paper 2 often provides CPI figures: know inflation rate = (CPI2 - CPI1) / CPI1 x 100, and be ready to explain why a falling rate is disinflation, not deflation.
• When a question asks about types of unemployment, define each and attach an appropriate policy, because the mark scheme rewards the link (structural to retraining, cyclical to demand stimulus).
• If an extract relies on CPI data, bring in substitution bias and quality change as evaluation of the measure.
• For an 'evaluate conflicting objectives' question, argue the inflation versus unemployment trade-off through AD: cutting unemployment by boosting AD tends to raise inflation, while curbing inflation raises unemployment and slows growth.

Key terms

economic growthcyclical unemploymentstructural unemploymentdemand pull inflationcost push inflationphillips curve