OCR A Level Economics: Policy conflicts and the evolution of macroeconomic policy (H460) – Revision Notes

These notes condense the topics Policy conflicts and Approaches to policy and macroeconomic context (Component 2, Macroeconomics) in the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. For fuller explanations, use the study guide. Then try the practice questions. Other links: the OCR Economics hub, the checklist, the Phillips Curve and schools of thought notes and the free diagnostics. All figures are invented.

Key terms

• Policy conflict (trade-off): pursuing one objective moves another away from its target.
• Spare capacity: actual output below potential output. Conflicts are weaker here.
• Stagflation: rising inflation together with rising unemployment.
• Sticky wages and prices: slow to fall when demand falls.
• Adaptive expectations: forecasts based on past outcomes. Rational expectations: forecasts use all available information.
• Credibility: belief that policy-makers will do what they announce.
• Policy mix: several instruments used together.

The five trade-offs at a glance

Conflict	Chain in short	Eases when
Unemployment and inflation	AD up, jobs up, wage pressure, prices up	Spare capacity; supply-side gains; low expectations
Growth and inflation	AD-led growth uses capacity, bottlenecks, prices up	Long-run AS shifts right
Inflation and balance of payments	Higher prices than rivals, dearer exports, cheaper imports, deficit	Currency floats down; productivity rises
Growth and balance of payments	Income up, imports up (marginal propensity to import)	Exports grow alongside; import substitution
Growth and income and wealth equality	Gains concentrated at the top; asset prices rise	Broad-based job growth; redistribution; skills

Describe diagrams in words: for example, AD shifts right along a steep SRAS, so the price level rises with little extra output.

Method: writing a conflict answer

1. State the two objectives and the instrument.
2. Give the chain, step by step.
3. Say if spare capacity exists.
4. Give the consequence for each group.
5. Name a way to reduce the conflict and its limits.
6. Judge: depends on size, cause (demand or supply shock), time and who bears the cost.

Formulas and reminders

Item	Rule	Example (invented)
Output gap %	(actual − potential) ÷ potential × 100	(679 − 700) ÷ 700 = −3.0%
Real exchange rate change	(1 + domestic inflation) ÷ (1 + foreign inflation) − 1, nominal rate fixed	1.03 ÷ 1.01 − 1 = 2.0%
Import change	marginal propensity to import × change in income	0.2 × 50 = 10
Real interest rate	(1 + nominal) ÷ (1 + expected inflation) − 1	1.05 ÷ 1.03 − 1 = 1.9%
Output-price split of AD growth	price ≈ AD growth ÷ (1 + e); output ≈ AD growth × e ÷ (1 + e)	6% with e = 2: price 2%, output 4%
Quantity theory	MV = PY; inflation ≈ (1 + money growth)(1 + velocity change) ÷ (1 + output growth) − 1	1.04 ÷ 1.015 − 1 = 2.5%
Recovery needed after a fall of x	1 ÷ (1 − x) − 1	after −25%: 33.3%

Resolving or reducing conflicts

Method	Strength	Weakness
Supply-side policy	Raises capacity and lowers the natural rate	Slow, costly, uneven
Policy mix	Matches instruments to targets	Interaction, coordination
Prioritise one objective	Clear, credible	Sacrifices another
Exchange rate change	Helps the external balance	Import prices rise
Redistribution	Offsets inequality	Incentive effects, cost
Timing	Act when capacity allows	Lags, uncertain output gap

Evaluation hooks: short run against long run; size of spare capacity; demand-pull against cost-push; credibility; who pays.

Worked reminders

Jobs against inflation (Country A, invented). The labour force is 40 million. Unemployment falls from 7.0% to 5.5%: 1.5% × 40 million = 600,000 more people employed. If inflation rises from 2.0% to 3.5% on the way, each extra 100,000 jobs cost 0.25 points of inflation. Always state both sides of the exchange.

Growth against the external balance (Country G). GDP is 500, the marginal propensity to import is 0.4, and GDP grows 4% (a rise of 20). Imports rise by 8. Exports rise by 5. The balance moves by 5 − 8 = −3, so the deficit widens by 3.

Growth against equality (Country H). Two equal-sized groups: mean incomes 5,000 and 40,000. They grow 1% and 4%, giving 5,050 and 41,600. The mean rises from 22,500 to 23,325, up 3.7%. The ratio of richer to poorer rises from 8.00 to 8.24, so growth came with wider inequality.

Fixed exchange rate (Country I). Prices rise 5% at home and 1% abroad: 1.05 ÷ 1.01 − 1 = 4.0% loss of price competitiveness, with no currency movement to offset it.

Must-know distinctions

• Demand-pull inflation (spare capacity used up) against cost-push (supply shock): the first fits a demand-side trade-off, the second shifts the whole trade-off.
• Short-run against long-run trade-off: expectations can remove the long-run one.
• Nominal against real: wages, interest rates, exchange rates and debts.
• Adaptive against rational expectations: the second gives credible announcements more power.
• Cyclical against structural unemployment: only the first responds well to demand policy.

Debates

• Wage and price flexibility. Flexible: markets clear and unemployment is temporary (neo-classical). Sticky: demand shocks leave lasting unemployment (Keynesian). A big wage cut also cuts spending.
• AS flexibility. The more elastic AS is, the more of an AD rise shows in output. Steep AS near capacity turns it into prices. Supply-side measures raise elasticity.
• Expectations. Higher expected inflation lowers the real interest rate and raises wage claims. Credible announced policy changes behaviour sooner under rational expectations.

Why approaches changed

Episode	Problem	Response and lesson
Great Depression	Output and prices fell, mass unemployment, wages did not restore full employment	Keynes: deficient AD; government should act; debt-deflation raises real debts
Keynesian demand management, 1970s	Supply shocks and wage claims: inflation and unemployment together	AD expansion fuelled inflation; trade-off unstable; cost-push matters
Monetarism, 1980s	Inflation and weak confidence in demand management	Money supply control, expectations, supply-side reform; velocity unstable; cost in jobs
2007-08 crisis and aftermath	Bank losses, credit freeze, deep recession	Low rates, quantitative easing, stimulus then consolidation, tighter bank rules

Pattern to remember: each approach was shaped by the problem of its day. Mass unemployment favoured demand management. Inflation with unemployment favoured control of money, expectations and supply. A banking collapse brought unusual central bank tools and a lasting argument about the right balance between stimulus and consolidation. In an answer, name the circumstance, the policy response, and one limit of that response.

Quick self-test

1. Define a policy trade-off.
2. Output is 679 and potential output is 700. Calculate the output gap.
3. Domestic prices rise 3% and foreign prices 1%, with a fixed nominal rate. Calculate the change in the real exchange rate, to 2 d.p.
4. The marginal propensity to import is 0.2 and income rises by 50. What happens to imports?
5. Nominal interest is 5% and expected inflation 3%. Calculate the real rate, to 2 d.p.
6. Nominal AD rises 6% and AS elasticity is 2. Estimate the price and output changes.
7. With MV = PY, money grows 4%, velocity is constant and output grows 1.5%. Estimate inflation, to 2 d.p.
8. A debt of 150 is fixed in money terms. Prices fall 10%. What is its real value, to 1 d.p.?
9. After a 25% fall in output, what rise restores the old level, to 1 d.p.?
10. State two supply-side policies that reduce the growth and inflation conflict.
11. Why did demand management lose support in the 1970s?
12. Give two features of the policy response after 2007-08.

Answers

1. A situation in which pursuing one objective moves another away from its target.
2. (679 − 700) ÷ 700 = −3.0%.
3. 1.03 ÷ 1.01 − 1 = 1.98% (competitiveness worsens).
4. Imports rise by 0.2 × 50 = 10.
5. 1.05 ÷ 1.03 − 1 = 1.94%.
6. Price 6 ÷ 3 = 2%, output 6 × 2 ÷ 3 = 4%.
7. 1.04 ÷ 1.015 − 1 = 2.46%.
8. 150 ÷ 0.9 = 166.7.
9. 1 ÷ 0.75 − 1 = 33.3%.
10. For example, education and training, and investment in infrastructure or capital, shifting long-run AS right.
11. Supply shocks and wage pressure produced inflation and unemployment together, and AD expansion fed inflation.
12. For example, policy rates cut very low with quantitative easing, and tighter regulation of bank capital.

Where marks are usually lost

• Naming a trade-off with no step-by-step chain.
• Ignoring spare capacity, so the conflict seems the same at all times.
• Saying the Phillips Curve is always stable or always broken, without saying when.
• Treating supply-side policy as quick and free.
• Listing historical events without linking them to why the approach changed.
• Mixing up wage growth and price inflation, or nominal and real values.
• Concluding with a summary instead of a judgement tied to the question.
• Giving percentages with no working or unit.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. Topics: Policy conflicts; Approaches to policy and macroeconomic context.