ib econ- 3.7: supply-side policies

credits: https://www.econinja.net/macroeconomics/3-7-supply-side-policy

what is a supply side policy?

government actions done to increase the aggregate supply of the economy, by improving the quality and quantity of factors of production.

what are the aims of supply side policies?

• to achieve long term growth by increasing productive capacity

• improve competition and efficiency

• reduce labour costs and unemployment through labour market flexibility

• reduce inflation to improve international competitiveness

• increase firms’ incentives to invest in innovation by reducing costs

  ultimately, these all aim to shift the economy’s lras/ppc to the right

what are the two types of supply side policy? what’s the difference between them?

• market based and interventionist

• market based is centred around freeing up markets to make them run more efficiently (basically, removing gov. intervention) - following a more neoclassical perspective

• on the other hand, interventionist policies aim to ensure that market imperfections are fixed by the government - following a Keynesian perspective

what are examples of market based supply side policies that encourage competition?

• deregulation: removing rules and regulations from markets allowing the price mechanism to take over (making things cheaper and more efficient)

• privatisation: sell state-owned businesses to the private sector. these private businesses will then have greater incentive to innovate as they want to profit maximise in a way that gov. businesses don’t care about.

• trade liberalisation: remove barriers for international trade - if countries remove tariffs and quotas then international trade will increase, leading to more competition and efficiency

• anti-monopoly regulations: laws that limit large mergers, sometimes splitting up companies, creating more competition

what are examples of market based supply side policies that focus on the labour market?

• reduce power of labour unions: unions often lobby for higher wages and better working conditions. this is bad for market efficiency as costs of production increase

• reduce unemployment benefits: theoretically incentivises more people to look for work

• abolish minimum wages: function like price floors and create more unemployment than in equilibrium (look at website credited for more info)

what are some examples of market based supply side polices that focus on incentives?

• personal income tax cuts: if less money is taxes, people may be incentivised to work harder as they will get to keep more of that money than before

• business and capital gains tax cuts: encourages more investment because businesses get to keep more of their profits.

what are some examples of interventionist supply side policies?

• facilitate education and training: by improving education levels of a population, new skills can be acquires and people can work better and more productive jobs (especially effective in developing countries)

• improve quality, quantity and access to healthcare: solve many preventable labour-related problems

• encourage research and development: improves productivity and innovation, making the market more efficient as costs of production are decreased if efficiency improves. (may also increase ad as money is injected into the economy)

• provide infrastructure: if a gov. provides water, electricity, internet etc, then companies don’t have to worry about it and can focus on their specialisms.

• implement industrial policies: give tax cuts of grants to a certain industry so it can develop more, creating more supply

what are the demand-side effects of supply-side policies?

• interventionist supply side policies involve gov. spending, which is a component of ad - so such policies will also boost ad

• market based supply side policies include tax cuts on households and businesses, which increases their disposable incomes/profits. this results in more consumption and investment, boosting ad.

what are the supply-side effects of demand side policies?

• some demand side policies such as lowering taxes overlap with supply side policies

• raising interest rates as part of monetary policy increases the cost of investment, inhibiting long run aggregate supply

what are the strengths of market based supply side policies?

• no burden on gov. budget (in fact, privatisation increases gov. revenue)

• improved resource allocation efficiency

• reduced unemployment

what are the strengths of interventionist supply side policies?

• directly target sectors deemed important for growth

• education and training is effective in growing the productive capacity of an economy over time

what are the weaknesses of market based supply side policies?

• equity issues: does not consider wellbeing, only the owners of firms (e.g. abolishing minimum wage)

• time lags

• vested interests: newly privatised firms may not actually be incentivised to provide a better service, they just want the new income

• environmental impact: more negative externalities without regulation

what are the weaknesses of interventionist supply side policies?

• cost: toll on gov. budget and national debt

• time taken to see any changes

• inflation: increase gov. spending may raise inflation levels in the short run as ad shifts to the right, but could then decrease in the ling run as supply effects kick in