Cambridge International AS and A Level Economics: Objectives and Phillips curve (9708) – Revision Notes

These notes condense sections 10.1.1 and 10.2.1 to 10.2.5 of the Cambridge International AS and A Level Economics (9708) syllabus for examination in 2026, 2027 and 2028. Topic 10 is A Level content (topics 7 to 11), and AS content is assumed knowledge. Full explanations and longer worked examples are in the study guide. Test yourself with the practice questions, then check the course hub, the checklist and the free diagnostics. For background see current account of the balance of payments and floating exchange rates. The figures here are made up.

10.1.1 Objectives at a glance

Objective	Aim	Typical measure
Inflation	Low and stable	CPI annual change
Balance of payments	Avoid large persistent current account deficit	Current account balance, % of GDP
Unemployment	Close to full employment	Unemployment rate
Growth	Steady rise in real GDP	Real GDP growth
Development	Better living standards, health, education	Real GDP per head, composite indices
Sustainability	Protect future generations’ needs	Resource and emissions measures
Redistribution	A fairer spread of income and wealth	Gini coefficient, poverty rate

Key point: objectives conflict, and ranking them is a value judgement. A good answer names the conflict and says which objective a government might put first and why.

Formulas and definitions

Item	Rule
Inflation rate	(new index − old index) / old index × 100
Real growth	(1 + nominal growth) / (1 + inflation) − 1
Real wage growth	(1 + nominal wage growth) / (1 + inflation) − 1
Growth per head	(1 + GDP growth) / (1 + population growth) − 1
Import growth	Income elasticity of demand for imports × income growth
Current account	Goods + services + primary income + secondary income balances
Unemployment rate	Unemployed / labour force × 100
Expectations-augmented Phillips curve (model for practice)	Inflation = expected inflation − a × (unemployment − natural rate)

• Internal value of money: its purchasing power at home.
• External value of money: what it buys abroad, shown by the exchange rate.
• Natural rate of unemployment: the rate at which actual inflation equals expected inflation.

Method in steps: linking two problems

1. Name the starting change (for example higher AD).
2. Say what it does to the first variable (output, prices or incomes).
3. Pass it to the second variable (imports, wages or the exchange rate).
4. State the direction and size, with a condition (elasticities, spare capacity, policy).
5. Judge: short or long run, how likely and how large?

The links, in short

10.2.1 Internal and external value. If home inflation exceeds inflation abroad and the exchange rate stays put, exports become dearer, imports cheaper, and the currency comes under downward pressure. Other forces (interest rates, capital flows, speculation) also move the exchange rate.

10.2.2 BoP and inflation.

• Inflation raises export prices and lowers competitiveness. The effect depends on the price elasticity of demand for exports and imports.
• A deficit can lead to depreciation, higher import prices and cost-push inflation.
• Reminder: imports are 20% of the price index and the currency falls 5%. Import prices rise by 1 / 0.95 − 1 = 5.26%, so the direct effect is 0.20 × 5.26 = 1.05 points.

10.2.3 Growth and inflation.

• Demand-led growth near full capacity gives demand-pull inflation.
• Supply-led growth (shifts in long-run aggregate supply) allows growth with low inflation.
• High, volatile inflation can reduce investment and growth.

10.2.4 Growth and BoP.

• Growth raises incomes and imports (income elasticity matters).
• Export-led growth or better competitiveness can improve the balance.
• Investment may need imported capital goods.

10.2.5 Phillips curves

	Traditional	Expectations-augmented
Shape	Downward-sloping, convex	Short run: downward-sloping; long run: vertical
Message	Trade-off between inflation and unemployment	Trade-off only in the short run, for given expectations
What shifts it	Treated as stable	Expected inflation, supply shocks (SRPC); natural rate (LRPC)
Weakness	Cannot explain high inflation with high unemployment	Depends on how expectations form and the natural rate is hard to measure

Short-run Phillips curve, SRPC: one curve for each level of expected inflation. Long-run Phillips curve, LRPC: vertical at the natural rate.

• Raise expected inflation: SRPC shifts up.
• Lower the natural rate (supply-side policy): LRPC shifts left.
• Hold unemployment below the natural rate: expected inflation keeps rising, so inflation accelerates.

Worked reminder with inflation = expected inflation − 0.4 × (unemployment − 6): if expected inflation is 3% and unemployment is 4%, inflation = 3 − 0.4 × (4 − 6) = 3.8%. At 7% unemployment it is 3 − 0.4 × 1 = 2.6%.

Must-know distinctions

• Nominal vs real: only real growth shows more output.
• SRPC vs LRPC: movement along a curve (short-run trade-off) vs a shift (change in expectations or the natural rate).
• Demand-pull vs cost-push: AD shift vs short-run aggregate supply shift. The Phillips curve fits demand-pull; a cost-push shock moves the curve.
• Internal vs external value: price level at home vs exchange rate.
• Cyclical vs natural unemployment: the natural rate remains when the economy is at its potential.

Small worked reminders

Growth and the balance of payments. Imports are 200 and income elasticity of demand for imports is 1.5. Income grows 4%.

• Import growth = 1.5 × 4% = 6%, so imports = 200 × 1.06 = 212.
• If exports stay at 190, the balance moves from −10 to −22.

Growth per head and development. GDP grows 3.0% and population grows 1%. Growth per head is 1.98%, lower than the headline figure. Growth per head still says little about health, education or how income is shared, which is why development uses wider measures.

Expectations over time. With inflation = expected inflation − 0.4 × (unemployment − 6), natural rate 6%, expected inflation 3% and unemployment held at 4%:

• Year 1: 3 + 0.8 = 3.8%.
• Year 2 (expected inflation 3.8%): 4.6%.
• Year 3 (expected inflation 4.6%): 5.4%. Each year inflation rises by 0.8 points, the gap between the natural rate and actual unemployment multiplied by 0.4.

Evaluation prompts

• Time: is the effect short run or long run? A Phillips trade-off exists for a while, then expectations adapt.
• Size: is the import share, elasticity or spare capacity large enough to matter?
• Cause: demand-led or supply-led growth? Inflation from demand and from costs call for different responses.
• Credibility: do firms and workers believe the inflation target? If so, expected inflation is lower and the cost of disinflation is smaller.
• Measurement: the natural rate cannot be observed directly, so estimates are uncertain.
• Priorities: which objective does the government rank first, and who gains and loses?

Quick self-test

1. A CPI rises from 120 to 124.8. Find the inflation rate.
2. Nominal GDP rises 5.5% and prices rise 3%. Find real growth to 1 d.p.
3. Income elasticity of demand for imports is 2.5. Income rises 2%. Find import growth.
4. Name two possible reasons why high inflation harms growth.
5. Using inflation = expected inflation − 0.4 × (unemployment − 6), with expected inflation 3% and unemployment 7%, find inflation.
6. Real GDP grows 3.0% and population grows 1%. Find growth per head to 2 d.p.
7. State why the long-run Phillips curve is vertical.
8. Give two reasons the traditional Phillips curve may shift.
9. A country has exports of goods 150, imports of goods 170, net services +10 and net income −4. Find the current account balance.
10. In two lines, explain how a trade deficit may lead to inflation.

Answers

1. (124.8 − 120) / 120 × 100 = 4.0%.
2. 1.055 / 1.03 − 1 = 2.4%.
3. 2.5 × 2% = 5%.
4. Uncertainty discourages investment; savings lose value; exports become uncompetitive (any two).
5. 3 − 0.4 × (7 − 6) = 2.6%.
6. 1.03 / 1.01 − 1 = 1.98%.
7. Expectations catch up with actual inflation, so unemployment returns to the natural rate whatever the inflation rate.
8. Changes in expected inflation, supply shocks, changes in the natural rate or union power (any two).
9. 150 − 170 + 10 − 4 = −14, a deficit.
10. A deficit pushes the currency down; import prices rise in home currency and add to costs and the price index.

Where marks are usually lost

• Writing “unemployment falls so inflation rises” with no mechanism (tight labour market, wage pressure, cost pass-through).
• Drawing a long-run Phillips curve that slopes.
• Mixing up movement along an SRPC with a shift of it.
• Using nominal figures when asked for real growth.
• Saying depreciation always improves the current account, with no reference to elasticities or time lags.
• Describing objectives without showing how any two of them conflict.
• Giving only one side. Paper 4 essays need evidence of evaluation, so add a judgement on the short or long run, size, or likelihood.
• Quoting a result without showing the working in a calculation.

Official syllabus

Cambridge International AS and A Level Economics (9708) syllabus for examination in 2026, 2027 and 2028, Cambridge University Press & Assessment, sections 10.1.1 and 10.2.1 to 10.2.5.