Economic growth

• Economic growth = an increase in real output / real GDP over time.

• Short-term growth = increase in actual output; shown as a movement from a point inside the PPC towards/on the PPC, or as an increase in AD causing higher real GDP in the AD/AS model.

• Long-term growth = increase in productive capacity / full employment output; shown by an outward shift of the PPC or a rightward shift of LRAS.

• Measurement of economic growth = percentage change in real GDP from one year to the next.

• Formula: economic growth rate = $\frac{\text{current real GDP} - \text{previous real GDP}}{\text{previous real GDP}} \times 100$

• Consequences of growth:

  • higher living standards if growth raises real income per person

  • possible improvement in employment and tax revenues

  • possible environmental damage if growth increases pollution / resource depletion

  • may worsen or improve income distribution, depending on who benefits from growth

This diagram shows economic growth on a PPC/PPF, with the frontier shifting outward. It is useful for distinguishing long-term growth in productive capacity from simple movement from one point to another. In IB Economics, use it when explaining growth in production possibilities. Source

Low unemployment

• Low unemployment is a key macroeconomic objective because unemployment creates personal, social, and economic costs.

• Unemployment rate = percentage of the labour force that is unemployed.

• Formula: unemployment rate = $\frac{\text{number unemployed}}{\text{labour force}} \times 100$

• Difficulties measuring unemployment:

  • hidden unemployment / underemployment

  • people not actively seeking work may be excluded

  • informal sector work is hard to record

• Causes of unemployment:

  • cyclical (demand-deficient): caused by low AD during recession

  • structural: mismatch of skills, location, or industry changes

  • seasonal: linked to seasonal patterns of demand for labour

  • frictional: short-term unemployment while moving between jobs

• Natural rate of unemployment = structural + seasonal + frictional unemployment.

• Costs of unemployment:

  • personal costs: lower income, stress, lower self-esteem

  • social costs: greater inequality, family strain, possible higher crime

  • economic costs: lost output, lower tax revenue, higher welfare spending

Low and stable rate of inflation

• Inflation = a sustained increase in the general price level over time.

• A low and stable rate of inflation is preferred because it reduces uncertainty and protects purchasing power.

• Inflation rate is measured using CPI data.

• Formula: inflation rate = $\frac{\text{CPI in current year} - \text{CPI in previous year}}{\text{CPI in previous year}} \times 100$

• Limitations of CPI:

  • may not reflect all consumers’ spending patterns

  • weighting may become outdated

  • quality changes and new products are hard to capture

  • regional differences may be ignored

• Causes of inflation:

  • demand-pull inflation: AD increases faster than productive capacity

  • cost-push inflation: SRAS decreases due to higher costs of production

• Costs of a high inflation rate:

  • uncertainty for households and firms

  • redistributive effects (hurts fixed-income groups, may benefit borrowers)

  • discourages saving

  • damages export competitiveness

  • may reduce economic growth

  • causes inefficient resource allocation

• Disinflation = a fall in the rate of inflation; prices still rise, but more slowly.

• Deflation = a sustained fall in the general price level.

• Causes of deflation:

  • fall in AD

  • rise in SRAS

• Costs of deflation:

  • deferred consumption

  • more cyclical unemployment and bankruptcies

  • increases the real value of debt

  • may make policy less effective

  • causes uncertainty and inefficient resource allocation

This figure compares the two main inflation diagrams in the syllabus: AD shifting right for demand-pull inflation and SRAS shifting left for cost-push inflation. It is especially useful for evaluation questions asking students to distinguish the cause of inflation from its effects on output and price level. Source

Relative costs of unemployment versus inflation

• IB expects comparison of the relative costs of unemployment and inflation.

• The more serious problem depends on the rate, duration, type, and the economy’s context.

• High cyclical unemployment usually creates severe lost output, hardship, and long-term damage to skills.

• High or unstable inflation creates uncertainty, hurts competitiveness, and can distort decisions.

• Good evaluation: argue that moderate inflation may be less harmful than deep recession and mass unemployment, but very high inflation may become the bigger problem.

Potential conflicts between macroeconomic objectives

• Low unemployment vs low inflation: stimulating AD can reduce cyclical unemployment, but may increase inflation.

• High economic growth vs low inflation: rapid growth can create demand-pull inflation if the economy nears capacity.

• High economic growth vs environmental sustainability: growth can increase pollution, resource depletion, and carbon emissions.

• High economic growth vs equity in income distribution: growth may benefit some groups more than others, widening inequality.

• In evaluation, always mention that policy-makers face trade-offs and must judge which objective matters most in context.

This image shows an empirical Phillips curve, plotting inflation against unemployment. It helps HL students visualize the idea of a possible short-run trade-off between the two macroeconomic objectives. Source

Exam-ready evaluation phrases

• It depends on the time period and the cause of the problem.

• The size of the effect depends on how close the economy is to full employment.

• In the short run, there may be a trade-off, but in the long run this may not hold.

• The impact differs across stakeholders, especially low-income households, firms, and the government.

• A judgment should consider not only efficiency and growth, but also equity and sustainability.