Chapter 18: Supply side policy

What is supply side policies

aim to increase long run aggregate supply by increasing quantity and/or quality of factors of production

What are the aims of supply side policies?

• achieve long term economic growth by increasing productive capacity of the economy

• improve competition and efficiency

• reduce labour costs and unemployment

• reduce inflation to increase international competitiveness

• increase firms incentives to invest by reducing costs

What are market based supply side polices?

• reduction in household income tax (Higher income taxes may discourage people from working harder, as they may prefer more leisure time over earning extra income. Reducing income taxes can incentivise people to work harder and become more productive, increasing the economy’s potential output.

• reductions in corporate tax (if firms able to keep more proft, more money for investment, greater investment means more capital so an increase in a FoP

• labour market reforms (reduction in trade union power, reduction/elimination of minimum wages, reduction in unemployment benefits)

• deregulation (reduces costs for firms as they dont have to comply with certains regulations

• privatisation (sale of public gov owned firms to private sector, private owned proft maximising firms be more efficient than gov run firms and so increase potential output of economy

• trade liberalistaion (elimination of subsidies, tariffs and quotas would reduce gov intervention and lead to free trade, meaning exporting firms will need to be more efficient to compete with foreign firms

Limitations of market based supply side policies

• reduction in income tax may not lead to increase in incentive to work as people will have more disposable income and be satisfied

• reduction in income tax may benefit higher wage earners so may be increase in income inequality

• labour market reforms can lead to a reduction in living standards for low income workers (increased income inequality)

• deregulation lead to negative effects for environment, reduction in worker safety, worsening working conditions

• privatisation needs to be done in a transparent manner

• time lags

What are interventionist supply side policies

• investment in human capital (education, training)

• research and development (firms stay up to date with technology)

• direct support for businesses (laws against monopolies)

Limitations of interventionist supply side polices

• always a monetary cost, two problems one is that there is always an opportunity cost, secondly increased expenditure leads to increase in gov debt

• time lags

• diff govs will have diff aims, if changes in gov could be drastic changes tom policy

• controversies may arise concerning what funding should go to what on schools eg arts, english, sports

How are supply and demand side policies connected?

Demand side effects of supply side policy:

• Supply-side policies mainly affect the economy in the long run, but can have short-run demand-side effects.

• Market-based policies: Reducing income and corporation taxes increases AD, encouraging economic growth and reducing unemployment, but may increase inflationary pressure.

• Interventionist policies: Government spending increases AD, creating expansionary fiscal effects.

• Time lags: Demand-side effects can occur quickly, but increasing potential output through supply-side policies usually takes longer.

Supply side effects of demand side policies:

• Lower income taxes: Increase incentives to work harder and become more productive, raising potential output.

• Lower corporation taxes: Encourage investment and research and development (R&D), improving the quantity and quality of factors of production.

• Higher government spending: Spending on infrastructure, education, healthcare and R&D increases AD in the short run and improves productive capacity in the long run.

• Overall: Demand-side fiscal policies can also increase potential output by improving the quantity, quality and productivity of factors of production.