If a government could simply choose fast growth, full employment, low inflation and falling debt, every government would. They cannot, because the objectives pull against each other. Understanding those trade-offs is what separates a description from an evaluation.
📚 What you need to know
Policy decisions create trade-offs: getting closer to one objective often means moving away from another.
The big four conflicts: growth vs inflation, growth vs the environment, growth vs equality, and low unemployment vs low inflation.
The short-run Phillips curve (SRPC) shows the inflation and unemployment trade-off.
The long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment — no trade-off in the long run.
Movements along the SRPC come from changes in AD; the whole curve shifts when expected inflation changes.
Examiners want the full chain of reasoning, not just the name of the conflict.
The four conflicts you must know
Conflict
The chain of reasoning
Growth vs inflation
Faster growth moves the economy towards full employment → resources become scarce → firms bid up wages and input prices → demand-pull inflation rises above target
Growth vs the environment
More output needs more energy and raw materials → more pollution and negative externalities → non-renewable resources are used up faster
Growth vs equality
In a boom, profits usually rise faster than wages → owners of capital gain more than workers → the income gap widens even as everyone gets richer
Low unemployment vs low inflation
As unemployment falls, workers become scarce → they can negotiate higher pay → wage inflation feeds into general inflation
Debt reduction vs growth and jobs
Austerity means higher taxes and lower spending → AD shifts left → output falls and unemployment rises, at least in the short run
If a question says “explain a trade-off”, the marks are in the arrows, not the labels. Write out every link: what happens first, what that causes, and what that causes in turn.
The Phillips curve
The most famous trade-off has its own diagram. Plot inflation against unemployment and, in the short run, the two move in opposite directions.
The vertical LRPC sits at the natural rate. Anywhere left of it, unemployment is below its natural level and inflation is being pushed up.
Reading the diagram in three moves
🧩 What happens when AD is boosted
The economy starts at A: unemployment at the natural rate, inflation at 3%.
The government boosts AD. Firms produce more, so they hire more workers.
Unemployment falls to 3% and inflation rises to about 5%: a movement left along SRPC₁ to point B.
But workers now notice that prices have risen, so their real wages have fallen.
They demand higher pay. Firms face higher costs, so they cut employment and raise prices.
Unemployment returns to the natural rate at point C, on the higher curve SRPC₂.
Net result: the same unemployment as at the start, but higher inflation. The trade-off was temporary.
The same logic runs in reverse. If AD falls, unemployment rises above the natural rate in the short run; eventually workers accept lower wage growth, and the economy returns to the natural rate at a lower rate of inflation.
The key sentence. In the short run there is a trade-off between inflation and unemployment. In the long run there is none — the only way to cut unemployment permanently is to lower the natural rate itself, using supply-side policy such as retraining or better job matching.
How governments try to escape the trade-offs
Trade-off
Way round it
The catch
Growth vs inflation
Supply-side policy: growth from higher AS raises output and lowers prices
Slow, expensive, and results are uncertain
Unemployment vs inflation
Cut the natural rate through retraining and better job information
Structural change takes years
Growth vs the environment
Green technology and carbon pricing
Raises costs now for benefits that arrive later
Growth vs equality
Progressive taxes and targeted transfers
May weaken incentives and is politically contested
Debt vs growth
Borrow only for capital projects that raise future GDP
Hard to judge which projects will actually pay off
Worked example
WORKED EXAMPLE
Explaining a trade-off in full
An economy is growing at 6% a year with unemployment at 2.5%. Explain the likely conflict with the inflation objective.
Step 1: identify where the economy isGrowth well above the 2 to 3% sustainable rate and unemployment below the natural rate suggest a positive output gap.Step 2: build the chainRapid growth → economy near full employmentLabour and raw materials become scarceWorkers can negotiate higher wagesHigher costs and strong demand push prices upStep 3: connect it to the objectiveInflation is likely to overshoot the 2% targetStep 4: evaluateThis need not happen if growth is coming from the supply side. Rising productivity can deliver 6% growth with stable or falling prices — so check the cause of the growth before predicting inflation.
💡 Exam tip
Write the trade-off as a chain with arrows. Each link in the chain is a mark.
Label the Phillips curve axes as inflation rate and unemployment rate — not price level and output.
Say clearly that the trade-off exists in the short run only. That single sentence is worth a lot.
Use the natural rate to explain why the LRPC is vertical.
Supply-side improvements are the standard answer to “how can a government avoid this trade-off?”.
Bring in equity and the environment as well as inflation. Most students only remember the Phillips curve one.
⚠️ Common mix-up
Putting price level on the Phillips curve axis. It is the rate of inflation, which is why the axis can go below zero.
Shifting the SRPC when AD changes. A change in AD causes a movement along it. The curve shifts when expected inflation changes.
Claiming the trade-off is permanent. In the long run the economy returns to the natural rate.
Saying growth always causes inflation. Supply-side growth need not.
Naming a conflict without explaining it. Description alone scores very little.
Forgetting that policies have costs. Every escape route in the table above has a catch.
Up next: Demand-Side Policies (Monetary and Fiscal Policy) — how governments and central banks actually try to move AD, and what each tool can and cannot do.
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