Interrelationships among macroeconomic problems
Interrelationships among macroeconomic problems: build the core model, apply it to evidence and qualify conclusions where outcomes depend on context.
9708 section 10.2; A Level. Checked against Cambridge's 2026–2028 Version 2 (latest version published December 2025) and 2029 Version 1 (published September 2026). Cambridge states that neither version has significant changes affecting teaching. Always follow the syllabus for the candidate's examination year.
Before you begin
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What happens to the internal value of money when the general price level rises?
What you will learn
- Relate the internal and external value of money
- Explain links between inflation and the balance of payments
- Analyse growth–inflation relationships
- Analyse growth–balance-of-payments relationships
- Compare traditional and expectations-augmented Phillips curves
Core model and terms
The internal value of money is its domestic purchasing power and falls as the price level rises. Its external value is reflected in the exchange rate; the direction of appreciation depends on how the rate is quoted. Higher domestic inflation than trading partners can reduce price competitiveness and weaken the current account, while depreciation may raise import prices and add cost-push pressure. Faster growth can increase consumption and imports, but productivity-led capacity growth can improve competitiveness.
Apply and evaluate
Short-run demand-led growth near capacity can raise inflation; investment and productivity growth may expand potential output and ease pressure later. The traditional Phillips curve describes an inverse short-run association between inflation and unemployment, not a permanent policy bargain. The expectations-augmented model allows expectations to shift the short-run curve; in the long run, unemployment returns toward its natural rate, so anticipated inflation does not permanently buy lower unemployment. These relationships depend on shocks, policy credibility, spare capacity and time.
Pause and explain
Which statement best applies interrelationships among macroeconomic problems?
Worked example
Domestic prices rise faster than trading partners’ prices while the currency depreciates. Explain two possible effects on the current account and inflation.
Show the worked solution
- Higher relative prices can weaken export competitiveness
- Depreciation may make exports cheaper to foreign buyers and imports dearer at home
- The same depreciation can raise import costs and inflation, so the current-account outcome depends on elasticities and timing
Answer Higher relative prices can weaken export competitiveness → Depreciation may make exports cheaper to foreign buyers and imports dearer at home → The same depreciation can raise import costs and inflation, so the current-account outcome depends on elasticities and timing
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Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Domestic prices rise faster than trading partners’ prices while the currency depreciates. Explain two possible effects on the current account and inflation.
Give me a hint
Trace competitiveness and import prices separately, then qualify each channel.
Compare my reasoning
- Higher relative prices can weaken export competitiveness
- Depreciation may make exports cheaper to foreign buyers and imports dearer at home
- The same depreciation can raise import costs and inflation, so the current-account outcome depends on elasticities and timing
Higher relative prices can weaken export competitiveness Depreciation may make exports cheaper to foreign buyers and imports dearer at home The same depreciation can raise import costs and inflation, so the current-account outcome depends on elasticities and timing
Look for these in your work
- Higher relative prices can weaken export competitiveness
- Depreciation may make exports cheaper to foreign buyers and imports dearer at home
- The same depreciation can raise import costs and inflation, so the current-account outcome depends on elasticities and timing
A boom raises household income and imports. Explain one possible balance-of-payments pressure and one condition that could offset it.
Give me a hint
Trace income to import demand, then consider export or capacity effects.
Compare my reasoning
- Higher income can raise demand for imports
- The current account may weaken
- Strong export demand or productivity gains may offset the pressure
Higher income can raise demand for imports The current account may weaken Strong export demand or productivity gains may offset the pressure
Look for these in your work
- Higher income can raise demand for imports
- The current account may weaken
- Strong export demand or productivity gains may offset the pressure
Why does the expectations-augmented Phillips curve weaken the claim that governments can permanently choose lower unemployment by tolerating higher inflation?
Give me a hint
Consider how expected inflation changes wage and price setting over time.
Compare my reasoning
- Higher inflation can raise expectations
- The short-run curve may shift upward
- Unemployment tends back toward its natural rate rather than remaining permanently lower
Higher inflation can raise expectations The short-run curve may shift upward Unemployment tends back toward its natural rate rather than remaining permanently lower
Look for these in your work
- Higher inflation can raise expectations
- The short-run curve may shift upward
- Unemployment tends back toward its natural rate rather than remaining permanently lower
A rise in productivity allows output to grow without immediate capacity pressure. Explain why growth and inflation may move differently in this case than during demand-led growth near capacity.
Give me a hint
Compare a shift in productive capacity with a rise in spending against fixed capacity.
Compare my reasoning
- Productivity expands potential output
- Supply can meet more demand with less price pressure
- Demand-led growth near full capacity is more likely to raise inflation
Productivity expands potential output Supply can meet more demand with less price pressure Demand-led growth near full capacity is more likely to raise inflation
Look for these in your work
- Productivity expands potential output
- Supply can meet more demand with less price pressure
- Demand-led growth near full capacity is more likely to raise inflation
Common mistakes
- Treating a correlation in a Phillips curve as a permanent causal trade-off or ignoring how exchange-rate quotation conventions affect appreciation and depreciation.
What can you explain now?
What happens to the internal value of money when the general price level rises?
Compare with the explanation
It falls because each unit buys fewer goods and services
Purchasing power is inversely related to the price level.
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Before moving on, explain the central idea in interrelationships among macroeconomic problems and state one condition that could change its effect.
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