Imagine the economy as a big factory. Full employment means every worker who wants a job has one – the factory is running at its best. Stable prices means the cost of goods and services doesn’t rise too fast – the factory’s price tags stay steady. The government tries to keep the factory running smoothly, but sometimes the two goals can clash.
| Tool | Goal | Example |
|---|---|---|
| Fiscal policy – Government spending | Full employment | Build a new school, 2 % of GDP |
| Fiscal policy – Taxation | Stable prices | Raise income tax by 5 % |
| Monetary policy – Interest rates | Both (balance) | Increase rates by 0.25 % |
The Phillips Curve shows a trade‑off between unemployment (U) and inflation (π). In the short run, moving left on the curve (lower unemployment) often means higher inflation, and vice versa.
📈 Example: If the government boosts spending, unemployment may drop from 5 % to 3 %, but inflation could rise from 2 % to 4 %.
Think of the economy like a room with a thermostat. The temperature is the price level. The heater is government spending; the air conditioner is tax cuts or monetary easing. If you turn the heater on too high, the room gets too hot (inflation). If you turn the air conditioner on too much, the room gets too cold (unemployment). The goal is to keep the room at a comfortable temperature.
Exam Tip: When answering questions about the conflict between full employment and stable prices, remember to:
Inflation rate: \$\displaystyle \pi = \frac{Pt - P{t-1}}{P_{t-1}} \times 100\%\$
Real GDP growth: \$\displaystyle \text{Growth} = \frac{Yt - Y{t-1}}{Y_{t-1}} \times 100\%\$
Quick Check: If the government raises the interest rate by 0.5 %, what is the likely short‑term effect on inflation and unemployment? Write a brief answer using the Phillips Curve concept.