2.6.3 Supply-side policies

Question 1

Are supply-side policies short-term or long-term?

Answer 1

Long-term.

They have a long time lag.

Question 2

Aim of supply-side policies?

Answer 2

To expand the productive potential in an economy (by increasing LRAS), or to increase the trend rate of growth.

• Shown by a shift right in the LRAS curve or expansion of PPF.

Question 3

What do supply-side involve?

Answer 3

Supply-side policies involve making structural changes to the economy to allow its ‘individual parts’ to work more efficiently and more productively. For example, they might do this by helping markets function more efficiently, or creating incentives for firms or individuals to become more productive (or more entrepreneurial).

Question 4

Types of supply-side policies

Answer 4

• Free market
• Interventionist

Question 5

Free market supply-side policies

Answer 5

Free market supply-side policies aim to increase efficiency by removing things which interfere with the free market.

Question 6

Examples of free market supply-side policies

Answer 6

• Tax cuts
• Privatisation
• Deregulation
• Policies to increase labour market flexibility.

Question 7

Interventionist supply-side policies

Answer 7

Interventionist supply-side policies are usually aimed at correcting market failure.

Question 8

Examples of interventionist supply-side policies

Answer 8

Government spending on:
- Education
- Subsidies for research and development
- Funding for improvements to infrastructure (e.g. ports than help firms to export their goods)
- Industrial policy (this is policy aimed at developing a particular industry or sector of the economy e.g. through subsidies).

Question 9

Examples of supply-side policies used to encourage competition in the product market

Answer 9

• Deregulation
• Privatisation
• Contracting services out

Question 10

Supply-side policies used to incentive firms to invest

Answer 10

Offer tax breaks if they invest their profits back into the business instead of paying dividends to shareholders.

Question 11

Trade liberalisation

Answer 11

The process of removing or reducing trade barriers, and allowing goods and capital to flow more freely between countries.

Question 12

Supply-side policies in the capital market

Answer 12

Deregulation of financial markets – e.g. The ‘Big Bang’ of 1986 removed a lot of the traditional ‘restrictive practices’ that were felt to have made British financial markets (e.g. banks and stockbrokers) inefficient.

Question 13

Supply-side policies in the labour market

Answer 13

• Reducing unemployment benefits
• Reduce (or reform) income tax
• Improve labour market flexibility
• Reduce regulations on firms
• Improve education and training

Question 14

Benefits of supply-side policies

Answer 14

It makes it easier for a government to achieve its macroeconomic objectives, with fewer conflicts between macroeconomic objectives – which isn’t the case with demand-side policies.

1. For example, unemployment should fall as the economy grows and output expands.
2. And cost-push inflation should be reduced, as greater efficiencies (and lower costs) are achieved.
3. The current account of the balance of payments should also improve because of increased international competitiveness.

Question 15

Negatives of supply-side policies

Answer 15

• They have a significant time lag - so they can’t be used to fix the economy quickly. E.g. it’ll take many years to reform/improve an education system.
• There can be unintended consequences – e.g. the deregulation of financial markets (starting with the ‘big bang’ in 1986) led to excessive risk-taking in financial markets, which contributed towards the recent recession.
• Supply-side policies can be unpopular and unfair:
  1) For example, benefits cuts can lead to the poorest people in society worrying about their ability to cope financially.
  2) Greater flexibility in the labour market and trade union reforms could lead to some people having less job security.

So while a government may hope that improved economic performance will lead to greater prosperity overall in the long term, it can be very difficult in the short term to introduce some of these policies.

Question 16

Demand-side policies are needed alongside supply-side policies

Answer 16

Supply side policies aim to make an economy more able to supply products. But for maximum benefit there needs to be a demand for those products – this means appropriate demand-side policies are necessary alongside supply-side policies.
Nowadays, supply-side and demand-side policies are often used together, but to achieve different aims:
1. Supply-side policies create long-term growth.
2. Demand-side policies stabilise the economy in the short term.

Question 17

Why should demand-side policies and suppyly-side policies be used together?

Answer 17

The effects are more likely to be more long-lasting.

In this diagram, for example:
1. Tax breaks encouraging firms to invest have created greater demand for labour (i.e. the ADL curve shifts right too).
2. Increased incentives to work have created a greater supply of labour (i.e. the ASL curve shifts right too).
3. The overall effect is that the equilibrium position in the labour market has moved to the right (meaning employment has risen, and that the natural rate of unemployment should fall).
However, demand-side policies can still be useful in tackling short-term surges in unemployment.