Government Aims and Fiscal Policy: Question 1
Syllabus 4.1
In Halvern, the unemployment rate fell to a record low of 3% over the course of one year. Over the same year, firms competed hard to hire from an increasingly scarce pool of workers, wages rose quickly, and the rate of inflation increased from 2% to 6%.
Which pair of the government's macroeconomic aims does this situation best illustrate as being in conflict?
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Worked solution
Step 1: Recall the macroeconomic aims and the conflicts between them
Governments generally pursue six macroeconomic aims: economic growth, full employment (low unemployment), stable prices (low inflation), balance of payments stability, a fairer distribution (redistribution) of income, and environmental sustainability. These aims can pull against each other, and three conflicts come up especially often:
- Full employment and stable prices
- Economic growth and environmental sustainability
- Full employment and balance of payments stability
Step 2: Match the scenario to a conflict
In Halvern:
- Unemployment fell to a record low of 3%. A sign the government’s full employment aim was being strongly achieved.
- To attract scarce workers, firms raised wages quickly.
- Higher wage costs fed through into higher prices, and inflation rose from 2% to 6%. The stable prices aim was undermined.
This is the classic mechanism behind the conflict between full employment and stable prices: pushing unemployment very low tightens the labour market, forcing wages (and therefore prices) up.
Step 3: Why the other options are wrong
- A: nothing in the scenario compares economic growth with environmental damage.
- C: no data on trade, exports or imports, or on how income is shared between groups, is given.
- D: the scenario is about wages driving inflation, not about how income is distributed between households.
Final answer
The scenario best illustrates a conflict between full employment and stable prices, option B.