2.6.3 - Supply Side Policies Flashcards
Define Supply Side policies
Policies aimed at increasing the productive potential or LRAS of the economy
What happens to economic growth, unemployment, inflation and trade position when LRAS Increases?
(AD fixed)
Economic Growth - Potential and actual economic growth increase from YFE1 to YFE2. This is because with greater demand in the economy, firms respond by increasing their output. This increase in output is an increase in real GDP, which is an increase in economic growth
Unemployment - Decreases, as labour is derived demand, derived from the demand of goods and services. As demand increase, firms will need more workers for extra output, thus reducing unemployment
Inflation - Cost push inflation decreases from P1 to P2. This is because there is less pressure on factors of production, reducing the rate of prices rises
Trade position - Trade position is likely to improve. This is because with a lower inflation rate, exports are more competitive, increasing the demand and thus revenue brought in by them.
- These are some of the benefits caused by supply side policies. USE the interventionist and market based supply side policies advantages first, then add on this flashcard notes
Define two type of supply - side policies
- ) Market based policies - aimed to removing barriers to free markets, because barriers limit output, reduce efficiency and raise prices.
. It involves reducing the role of the government
2.) Interventionist policies - aimed at correcting market failure in free markets through government intervention.
Supply - Side policies Evaluation / Cons
1.) Supply side polices are expensive to implement, e.g. infrastructure, which means a huge opportunity cost
To fund these supply side policies, cuts may have to be made elsewhere
Furthermore, if money has been borrowed, taxes will have to rise, which affects tax payers in the long run
2.) Supply side policies take a long time to have an effect on productivity and efficiency ; there is a time lag
Improvements in education or training decades before an improvement in the productive capacity of the economy
This means there is little short term impact, which means unemployment and lack of economic growth in the short run
3.) Whether supply side policies are effective depends on the initial level of economic activity. If the economy is already operating with large levels of spare capacity (e.g. excess labour and capital), it is far more effective to use up this spare capacity with expansionary demand side policies to increase actual growth
Supply side policies merely increase the potential output of the economy, leaving actual growth and other macroeconomic variables unchanged
There is no needed for a greater labour force or capital stock; what is needed is for spare capacity to be used up by actual demand side growth NOT supply side potential growth
If spare capacity is not reduced, unemployment and actual growth will be low
4.) Market based supplied side policies can have a negative impact on stakeholders, For example, deregulations can harm workers through lowering safety standards or removal of minimum wages
5.) Although cost - push inflation falls due to less pressure on factors of production, demand pull inflation can rise if there is more workers, reduced taxes, etc.
This is shown by AD shifting with LRAS on a graph
Name market - based and supply side policies
(Remember that shifts in LRAS are caused by quantity / quality changes in the four factors of production because they change the productive potential or productive efficiency of the economy)
(Factors of production - Land, labour, capital, entrepreneurship)
1.) Increasing incentives through reducing taxation (market - based)
2.) Promote Competition (market - based)
3.) Reform the labour market (market - based)
4.) Improve skills and quality of labour force
( interventionist policies )
5.) Improve infrastructure (interventionist policies )
- After analysis of each policy, explain the positive impact of a shift of LRAS on economic growth, unemployment, inflation and trade position.
Explain increasing incentive
(Market - based )
1.) Reducing income taxes increases the incentive to work harder as less income will be taxed away. This means the human capital improves due to more training and working, thus increasing the productivity of labour.
Furthermore, lower income taxes provide an incentive for those of a working age currently inactive to start working and enter the labour force
This increases the quantity and quality of labour, shifting LRAS from LRAS1 to LRAS2, increasing the productive potential of the economy
2.) Reducing corporation tax means firms have greater retained profit to fund investment, such as new factories, new technology, R&D, etc. [Application]
This increases the marginal propensity to invest, thus increasing investment, which improves the quantity and quantity of capital stock, whilst also improving the productive efficiency of the economy. This shift LRAS to the right.
3.) Incentives to work will be low if welfare benefits are too high in relations to wages from a job, hence welfare benefits reduce the level of LRAS as more workers remain inactive [Use as Evaluation to welfare benefits]
Cutting welfare benefits would encourage workers to take on jobs for income, which increases the quantity of workers, which shifts LRAS to the right, increasing the productive potential of the economy
Explain promoting competition (market - based)
1.) Deregulation involves reducing laws and government standards e.g. safety laws, working conditions, paternity laws [Application]
This reduces the cost of production for firms. At the same time barriers to entry are reduce, which increasing competition thus incentivising maximum efficiency
This improves the productive efficiency of the economy, which increase LRAS
2.) Privatisation is the transfer of assets from the public sector to the private sector
It results in more firms entering the market to make a profit, which increases competition. This incentivises maximum efficiency, where firms aim to lower costs of production as much as possible due to the profit motive. This increases productive efficiency, which increases LRAS
3.) Trade liberalisation involves removal of trade barriers such as tariffs and quotas, promoting global competition
Global competition and the profit motive incentives maximum efficiency where firms lower costs of production as much as possible. This increases the productive efficiency, increasing LRAS
Explain reforming labour market
(market based )
1.) Reducing trade union power reduces the cost of production for firms. This is because trade unions bargain for higher wages, work breaks, longer holidays, etc. , which raises the cost of production
By limiting such action, efficiency in the labour market improves, thus improving productive efficiency, which increases LRAS
2.) Reducing minimum wages rates reduces the cost of production of firms. By limiting regulation, efficiency in the labour market improves, increasing the productive efficiency of the economy. Furthermore there will be less unemployment as there is more demand for labour as wage costs are low. This increases LRAS
However, minimum wages encourage firms to invest into capital to replace workers or train workers to be more productive, which could improve LRAS
3.) Relaxing migrations rules increases inward migration increases the size of the labour force, which decreases wage costs due to a higher supply of labour. Furthermore, it improves the skills and therefore productivity of the labour force, which increases human capital and improves the quality of the labour force
This reduces the cost of production of firms and increases the quantity and quality of labour, which increases LRAS, increasing the productive potential of the economy
Explain improving the skills and quality of the labour force (interventionist)
1.) Government spending on education and training such as apprenticeships, school curriculum reform, etc will improve the skills and therefore productivity of the labour force, improving human capital. This reduces structural unemployment by providing skills to fill job vacancies, improving the quality of labour and thus LRAS from LRAS1 to LRAS2
However, government spending on training and training is a long run effect and has little to no impact on the short run. Furthermore, government spending is a burden to the tax payer. It can also lead to a budget deficit if spending exceeds revenue
Explain Improving infrastructure (interventionist policy )
. Includes for example, spending on transport infrastructure, improving roads, airports, train lines, etc.
This reduces the cost of production for firms as transporting goods and services becomes quicker, easier and more efficient. This increases the productive efficiency whilst also boosting competitiveness increasing LRAS from LRAS1 to LRAS2
. Government spending on infrastructure increases the quantity and quality of the capital stock. This increases LRAS from LRAS1 to LRAS2, thus boosting the productive potential of the economy
