AQA A-level Economics: Conflicts between macroeconomic objectives and the Phillips curve (7136) – Revision Notes

These notes condense the AQA AS and A-level Economics specification (7135 and 7136), version 1.3, sub-section “Possible conflicts between macroeconomic policy objectives” (4.2.3.4 in the combined PDF, 3.2.3 on the AQA website and this site’s map). For full explanations and longer worked examples, read the study guide. Then try the practice set, check the AQA A-level Economics hub and the checklist, and take a free diagnostic. Recap AD/AS first in the AD/AS guide. All figures below are invented for illustration.

Key definitions

Term	Meaning
Output gap	Actual output minus potential output, usually as a percentage of potential output
Negative output gap	Actual below potential: spare capacity, cyclical unemployment, weak inflationary pressure
Positive output gap	Actual above potential: stretched capacity, scarce labour, strong inflationary pressure
Short-run Phillips curve (SRPC)	Downward-sloping curve of inflation against unemployment, drawn for given expectations and cost conditions
Long-run Phillips curve	The L-shaped, or vertical, curve at the long-run (natural) rate of unemployment
Stagflation	Rising prices with weak output and high unemployment together
Monetarist/supply-side view	Long-run output and unemployment depend on supply-side factors, so the main objectives are compatible in the long run

Method cards

Output gap. Gap % = (actual − potential) / potential × 100. Example: potential 500, actual 485, so (485 − 500)/500 × 100 = −3.0%.

Trade-off ratio on a Phillips curve table. Change in inflation divided by change in unemployment between two points. Example: unemployment 5% to 4%, inflation 3.0% to 4.5%, so 1.5 points of inflation for 1 point of unemployment.

Expectations-augmented rule (illustrative form). Inflation = expected inflation − slope × (unemployment − long-run rate). With expected inflation 3%, slope 0.5 and long-run rate 6%: at 5% unemployment, inflation = 3 − 0.5 × (5 − 6) = 3.5%. At 6% unemployment, inflation = 3.0%.

Drawing the curves.

1. Axes: unemployment horizontal, inflation vertical.
2. SRPC: downward sloping, convex, with points labelled.
3. Long-run curve: a vertical line at the long-run rate.
4. Show shifts with a second curve and arrows, not by redrawing.

inflation %
   |          |  long-run curve (vertical)
   | *        |
   |    *     |
   |        * |     SRPC slopes down
   +----------+------ unemployment %
          long-run rate

Output gaps and pressures

• Negative gap: lower AD relative to capacity, firms shed labour, unemployment high, wage growth weak, inflation low or falling.
• Positive gap: AD above capacity, firms struggle to hire, wages rise, prices rise, current account weakens as imports are sucked in.
• Potential output cannot be observed, so every gap is an estimate. Policy based on a bad estimate can overheat the economy.
• A fall in the gap does not by itself prove demand-deficiency; check whether the supply side shifted.

Why conflicts arise (AD/AS chains)

1. Demand-led growth: AD rises, output rises, unemployment falls, price level rises, imports rise, current account worsens.
2. Cost-push shock: short-run AS shifts left, price level up, output down, unemployment up. A change in AD can fix only one problem.
3. Tight policy to cut inflation: AD falls, output falls, unemployment rises.
4. Other objectives (budget balance, equity) can conflict too, and their weight changes over time.

Phillips curves compared

Feature	Short-run Phillips curve	Long-run (L-shaped, vertical) curve
Slope	Downward	Vertical
Trade-off	Yes, between inflation and unemployment	None
Expectations	Held constant	Fully adjusted
Moves along it	Demand changes	Not applicable
Shifts	Cost-push, expected inflation, productivity	Supply-side changes in the long-run rate
Policy meaning	Demand policy can choose a point	Demand policy cannot change the long-run rate

Why the curve shifts. When unemployment is held below the long-run rate, inflation exceeds expectations, then expectations rise, wages rise, and the SRPC shifts up. Worked reminder: long-run rate 6%, slope 0.5, unemployment held at 4.5%, starting expected inflation 2%: inflation runs at 2.75%, 3.5%, 4.25%, 5.0%. It rises by 0.75 points a year.

Cost of disinflation. Same curve, inflation 8%, unemployment held at 10%: inflation falls to 6%, 4%, 2%, taking three years and 12 point-years of excess unemployment. A credible commitment that cuts expectations early shortens this.

Policy: short run and long run

Situation	Short-run response	Long-run response
Negative gap	Expansionary fiscal or monetary policy	Supply-side measures to raise productivity and the economy’s capacity
Positive gap	Contractionary policy	Credible low inflation target, supply-side expansion
Stagflation	Choose which problem to ease; avoid cheap fixes	Cut costs through supply-side action; restore credibility
Growth against current account	Accept a temporary deficit; target export capacity	Improve competitiveness through investment and skills

Reminder on required stimulus: gap of −40 and multiplier of 1.6 gives an injection of 40/1.6 = 25. If potential was overstated, the same injection can leave the economy above potential.

Monetarist/supply-side view and evaluation

• Claim: in the long run AD affects only the price level; output and unemployment rest on the supply side. Low, stable inflation helps investment and growth, so the objectives fit together.
• Support: the vertical curve, the lesson of wage and price rises once expectations adjust, and gains from productivity-raising reforms.
• Against: the long run can be long; sticky wages mean a negative gap may persist; long unemployment can damage skills and raise the long-run rate; supply-side policies are slow, uncertain and may widen inequality; external shocks create conflicts that remain.
• Judgement: depends on the size of the gap, how credible policy is, how quickly expectations adjust, and the time horizon.

Must-know distinctions

• Movement along the SRPC (caused by a change in AD) against a shift of the SRPC (caused by cost-push shocks, expectations or productivity).
• Cyclical unemployment (linked to the output gap) against the long-run rate (linked to supply-side factors such as skills and incentives). Demand policy targets the first; supply-side policy targets the second.
• Demand-pull inflationary pressure (positive gap) against cost-push pressure (left shift of short-run AS). The first fits the Phillips curve trade-off well; the second produces stagflation.
• A supply-side policy (government action, such as training) against a supply-side improvement (which may come from private-sector innovation and investment).

Worked reminder: growth against the current account

Country R (illustrative): GDP 1,000, deficit 10. GDP rises by 40. Marginal propensity to import 0.3, so imports rise 0.3 × 40 = 12. Exports rise 5. Net change 5 − 12 = −7, so the deficit becomes 17. Growth of 4.0% has widened the deficit from 1.0% to about 1.63% of GDP.

Evaluation prompts to carry into essays

• How big is the gap, and how reliable is the estimate of potential output?
• Is inflation demand-pull or cost-push?
• How quickly do expectations adjust, and is the policy credible?
• How long is the “long run”, and who bears the cost in the meantime?
• Could a supply-side measure ease the conflict, and how soon would it work?

Quick self-test

1. Define a positive output gap.
2. Potential output is 2,000 and actual output is 2,090. Calculate the output gap.
3. Which axis shows inflation on a Phillips curve?
4. Unemployment falls from 5% to 4% and inflation rises from 3.0% to 4.5% along an SRPC. State the trade-off ratio.
5. What does a cost-push shock do to the SRPC?
6. Where is the long-run, L-shaped curve drawn?
7. Expected inflation is 3%, slope 0.5, long-run rate 6%. Find inflation at 5% unemployment.
8. Find inflation at 6% unemployment in the same case.
9. Prices rise from an index of 150 to 156 while output falls from 1,000 to 980. Find both percentage changes and name the situation.
10. Why can demand policy not cure stagflation?
11. Give one free-market and one interventionist supply-side policy.
12. State the monetarist/supply-side view in one sentence.

Answers

1. Actual output above potential output.
2. (2,090 − 2,000)/2,000 × 100 = 4.5%.
3. The vertical axis.
4. 1.5 points of inflation per point of unemployment.
5. It shifts outward (up and right).
6. As a vertical line at the long-run rate of unemployment.
7. 3 − 0.5 × (5 − 6) = 3.5%.
8. 3.0%, equal to expected inflation.
9. Prices up 4.0%, output down 2.0%: stagflation.
10. Raising AD helps output but lifts prices more; cutting AD helps prices but deepens the output loss.
11. Free-market: tax cuts, privatisation, deregulation. Interventionist: spending on education and training, industrial policy, subsidised research.
12. In the long run, output and unemployment depend on the supply side, so the main objectives are compatible.

Where marks are usually lost

• Putting unemployment on the vertical axis.
• Describing a shift of the SRPC as a movement along it.
• Saying the long-run curve shows no inflation, when it shows no trade-off.
• Giving a gap in units without dividing by potential output.
• Listing conflicts with no AD/AS chain explaining them.
• Writing a one-sided answer to an evaluate question with no judgement.
• Ignoring the time dimension when contrasting short and long run.
• Forgetting that estimates of potential output are uncertain.

Official syllabus

AQA AS and A-level Economics (7135 and 7136), specification for first teaching from September 2015, version 1.3, 29 June 2022, published by AQA. Combined PDF section 4.2.3.4.