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

This guide follows the Cambridge International AS and A Level Economics (9708) syllabus for examination in 2026, 2027 and 2028. It covers sections 10.1.1 and 10.2.1 to 10.2.5: government macroeconomic objectives and the links between macroeconomic problems, including the traditional and expectations-augmented Phillips curves. Topics 1 to 6 are AS Level content and topics 7 to 11 are A Level content. This unit sits in topic 10, so it is A Level content, assessed through the A Level papers; AS content is assumed knowledge. Every country and figure used below is made up for illustration.

Use it with the revision notes and the practice questions. Related pages: current account of the balance of payments, floating exchange rates and economic growth. Find the rest on the course hub and the checklist, and test yourself with the free diagnostics.

What this unit covers

Section	You must be able to
10.1.1	Explain government objectives for inflation, balance of payments, unemployment, growth, development, sustainability and redistribution of income and wealth
10.2.1	Relate the internal value of money to the external value of money
10.2.2	Relate the balance of payments to inflation
10.2.3	Relate growth to inflation
10.2.4	Relate growth to the balance of payments
10.2.5	Explain the traditional Phillips curve and the expectations-augmented Phillips curve, short run and long run

Paper 4 Section C has macroeconomics essays that need evidence of evaluation, so each section below ends with a chain of reasoning you can turn into evaluation.

10.1.1 Macroeconomic objectives

A government chooses objectives and then picks policies. The usual set is below.

Objective	What it means	Typical measure
Low, stable inflation	Prices rise slowly and predictably	Consumer price index (CPI)
Balance of payments equilibrium	No large, persistent deficit or surplus on the current account	Current account balance, often as a % of GDP
Low unemployment	Close to full employment of labour	Unemployment rate
Economic growth	A steady rise in real GDP, actual and potential	Real GDP growth rate
Development	Better living standards, health, education and freedom of choice	Real GDP per head, composite indices
Sustainability	Meeting present needs without harming future generations’ ability to meet theirs	Resource use, emissions, environmental measures
Redistribution	A fairer spread of income and wealth	Gini coefficient, poverty rates

Worked example: inflation and real wages. A CPI moves from 112.0 to 116.5.

• Inflation = (116.5 − 112.0) / 112.0 × 100 = 4.02%.
• Nominal wages rise 5.0%. Real wage growth = 1.050 / 1.0402 − 1 = 0.94%.
• Wages beat prices, so living standards improved slightly for workers in employment.

Why objectives conflict. Faster growth can raise imports, push up inflation and use more resources. Redistribution through high taxes can weaken incentives. Cutting unemployment can add to inflation (section 10.2.5). A government therefore ranks objectives, and the ranking is a value judgement.

Evaluation chain. An objective is only a target. Ask which measure is used, how reliable the data are, whether the target is for the short or long run, and who gains or loses from pursuing it.

10.2.1 Internal and external value of money

• The internal value of money is its purchasing power inside the country. It falls when the price level rises.
• The external value of money is what the currency buys abroad. The exchange rate shows it.

The two are linked through relative prices. If home inflation is above inflation abroad and the exchange rate does not move, home goods become dearer to foreigners, exports fall and imports rise. That puts downward pressure on the currency, so a falling internal value tends to bring a falling external value.

Worked example. A basket costs 200 units in Country A and 100 units in Country X. The rate is 1 unit of A currency = 0.50 units of X currency.

• Parity: 200 × 0.50 = 100, equal to the price in X.
• A year later, prices in A are up 5% (to 210) and prices in X are up 2% (to 102). The rate is unchanged.
• A’s basket in X currency: 210 × 0.50 = 105. That is 105 / 102 − 1 = 2.94% dearer than X’s basket.
• The rate that restores parity is 102 / 210 = 0.4857, a depreciation of (0.50 − 0.4857) / 0.50 = 2.86%.

The link is not exact. Interest rates, capital flows, speculation and trade policy also move exchange rates. Under fixed or managed rates, the central bank may hold the currency up even as prices rise.

10.2.2 The balance of payments and inflation

Inflation worsens the current account. Higher home prices make exports dearer abroad and imports relatively cheaper at home. How far the balance changes depends on how responsive export and import volumes are to price, measured by the two price elasticities of demand. If both are inelastic, spending on exports may hold up despite falling volumes.

A deficit can feed inflation. A deficit puts pressure on the currency. A depreciation raises the home-currency price of imports. That adds to cost-push pressure in firms that use imported inputs, and it raises the cost of imported consumer goods. If AD is already high, exporters also gain competitiveness and demand rises further.

Worked example. Imports are 25% of a household price index. The currency falls 8% against partners.

• Import prices rise by 1 / 0.92 − 1 = 8.7%.
• Direct effect on the price index: 0.25 × 8.7 = 2.2 percentage points.

Whether the whole effect is passed on depends on the competition importers face and on whether firms accept lower profit margins.

10.2.3 Growth and inflation

Growth and inflation can move together or apart, depending on the cause of growth.

• Demand-led growth near full capacity. If AD rises when spare capacity is low, firms cannot raise output quickly, so prices rise. Growth comes with demand-pull inflation.
• Supply-led growth. Better technology, skills or investment shift long-run aggregate supply to the right. Output rises and costs per unit may fall, so growth comes with low inflation.
• Inflation harms growth when uncertainty discourages investment, savings lose value, or the country becomes uncompetitive. High and volatile inflation is most damaging.
• Cost-push inflation can come with falling output. Prices rise while growth stalls.

Worked example: real versus nominal growth. Country B’s nominal GDP rises from 640 to 678.4 (currency units). Its price deflator rises from 100 to 103.2.

• Nominal growth = 678.4 / 640 − 1 = 6.0%.
• Price rise = 3.2%.
• Real growth = 1.060 / 1.032 − 1 = 2.7%.

Most of the apparent growth was higher prices. Only the 2.7% shows more goods and services produced.

10.2.4 Growth and the balance of payments

• Growth can worsen the current account. Higher incomes raise spending on imports. The size of the effect depends on the income elasticity of demand for imports and on the share of imports in consumption.
• Growth can improve it. If growth is export-led, or if supply-side improvements make home goods cheaper or better, export volumes rise.
• Capital imports. Investment that drives growth may need imported machinery, which widens a deficit first and may narrow it later as output rises.

Worked example. Country P has imports of 360 and exports of 340 (currency units). Income elasticity of demand for imports is 1.4. Real income grows 5%, and exports grow 3% because partners grow slowly.

• Import growth = 1.4 × 5% = 7.0%, so imports = 360 × 1.07 = 385.2.
• Exports = 340 × 1.03 = 350.2.
• The balance moves from −20 to 350.2 − 385.2 = −35.0.

The deficit widens by three quarters even though growth is moderate. This is why fast-growing countries often run deficits until export capacity catches up.

10.2.5 Inflation and unemployment: the Phillips curve

The traditional Phillips curve

This curve shows an inverse relationship between inflation (or originally wage change) and unemployment. It slopes downward and is convex to the origin.

The reasoning:

1. Low unemployment means firms struggle to hire.
2. Firms bid up wages and workers have more bargaining power.
3. Higher wage costs are passed into prices.

So reducing unemployment appears to cost higher inflation, and reducing inflation costs higher unemployment. A government could pick a point on the curve.

Reading a table. Illustrative data: unemployment 3%, 5%, 7% with inflation 5%, 3%, 2%. Moving from 5% to 3% unemployment adds 2 points of inflation, which is a trade-off of 1 point per point. Moving from 5% to 7% saves only 1 point, so each extra point of unemployment buys less disinflation. The curve flattens.

Limits. In the 1970s many economies had high inflation and high unemployment together (stagflation). That could not happen on a stable curve, so the curve must shift.

The expectations-augmented Phillips curve

Workers and firms use expected inflation when setting wages. If wages rise only as fast as expected prices, the real wage does not fall, so unemployment does not stay below its natural level for long.

• Each short-run Phillips curve (SRPC) is drawn for a given expected inflation rate.
• A rise in expected inflation shifts the SRPC upward (outward). A fall shifts it downward (inward).
• The natural rate of unemployment is where actual and expected inflation are equal. At that rate there is no cyclical unemployment.
• The long-run Phillips curve (LRPC) is vertical at the natural rate. There is no long-run trade-off.

Worked example. Take the model: inflation = expected inflation − 0.5 × (unemployment − 5). The natural rate is 5%. In year 0, unemployment is 5% and expected inflation is 2%, so inflation is 2%.

The government raises AD to hold unemployment at 3%. Each year workers expect last year’s inflation.

Year	Expected inflation (%)	Unemployment (%)	Inflation (%)
1	2	3	2 − 0.5 × (3 − 5) = 3
2	3	3	4
3	4	3	5
4	5	3	6
5	6	3	7

Holding unemployment below the natural rate needs accelerating inflation. The economy moves to a higher SRPC each year, so inflation climbs while unemployment stays put. When the government stops, unemployment returns to 5% but inflation stays high until expectations fall.

Moving the curves.

• The SRPC shifts with expected inflation, supply shocks (such as higher oil or import prices) and wage pressure.
• The LRPC shifts left if supply-side policy lowers the natural rate, for example through better training, better labour-market information or less frictional unemployment. It shifts right if the natural rate rises.
• Credible low-inflation policy can lower expectations and reduce the cost of disinflation.

Evaluation chain. The trade-off is real in the short run but unstable. Ask how quickly expectations adjust, whether policy is credible, whether the natural rate itself can be measured, and whether long spells of unemployment raise it. Policy therefore has to combine demand management with supply-side measures.

Common errors

• Drawing the LRPC as a vertical line at zero unemployment. It stands at the natural rate.
• Saying the Phillips curve proves inflation causes unemployment. It is an association, and the causes lie in AD, wages and expectations.
• Using nominal growth as a measure of output growth.
• Treating a currency fall as always good for the current account. Elasticities decide this, and inflation can wipe out the gain.
• Listing links without a reason. Each link needs a short chain of cause and effect.

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.