2.6.3 - supply side policies Flashcards
what are supply side policies?
government attempts to increase aggregate supply (long run productive potential of an economy) via improved productivity, investment and innovation
how is the LRAS shifted right?
through an increase in the quality or quantity of FOPs
how can the quantity of FOPs be increased?
-bigger workforce/average weekly hours worked
-importing more raw materials
-increase in capital stock = investment
INVESTMENT is the most important determinant rate of the LR economic expansion
how can the quality of FOPs be increased?
-increasing the amount of capital per worker on capital/output ratio results in greater output per worker, higher productivity
-technological advancements
what is human capital?
skills and expertise of workers acquired through education and training. increases productivity leading to higher output.
what do monetarists argue about monetary policy?
monetary policy can only influence inflation in the long run, not growth or employment. supply side policies must be adopted to increase output and reduce unemployment. they advocate market-orientated supply-side policies to encourage private enterprise, provide incentives and reward initiative
what are market-based supply-side policies?
they limit government intervention and are designed to remove anything that prevents the free market from working efficiently. it allows the market forces of supply and demand to eliminate disequilibrium in the market
what are some examples of market based supply side policies?
- reducing income tax/corporation tax rates
- deregulating or privatising the public sector
- reducing or abolishing the national minimum wage and trade union power
- reforming the benefits system to encourage workers to take available jobs
- encouraging free trade
how does increasing incentives work as a supply side policy?
- the government can increase the size of the workforce, increasing output
- reduced benefits/taxes increase the opportunity cost of being unemployed
- reduction in benefits may prevent the unemployment trap, where low income workers end up in the same or a worse position when they work due to the benefits lost
- women could be offered free childcare and flexible hours
- taxes on firms when they take on new staff, decrease incentives for firms to employ, reducing these taxes may increase employment
- removing the minimum wage incentivises firms to employ more
- they may increase incentives for firms to invest eg. by lowering taxes so that they see a bigger return on investment
- the change in tax may have little impact on people’s incentive to work
- reduced tax for high income earners and reduced benefits may increase income inequality
How can competition be promoted as a market-orientated supply-side policy?
- privatisation = selling nationalised companies to private sectors
- deregulation = reducing restrictions on businesses which restrict entry to the market, increasing competitiveness
- competition policy prevents monopolies and makes cartels illegal
- competition ensures firms are efficient as they have to offer a cheaper or better quality service to compete
- however, deregulation and privatisation may lead to poorer quality services, may cause environmental destruction if there is deregulation in environmental regulations.
How can reforming labour markets be used as a market-orientated supply-side policy?
- by increasing retirement age, there will be more people employed, increasing output
- labour market could be made more flexible to make it more efficient as it can respond to changes in demand or population changes
- they may achieve this through weakening unions, they push up wages leading to reduced employment and lower output, limiting AS
- businesses have attempted to be more flexible by changing employment contract eg. zero-hour
- flexibility could be increased through higher mobility of labour = improved information about job vacancies, improved flexibility of pensions and improved geographical mobility. In order to improve geographical mobility, the government plans to improve affordability of housing by cutting VAT and relaxing planning laws
- if minimum wage is set above the equilibrium level, it causes unemployment due to real-wage inflexibility
- reduction of benefits increases incentive to work
- these methods should reduce unemployment and waste of resources, increasing the labour force and output levels in the economy
- however, trade unions are very weak in the UK so reducing their power may have little impact. Also, reducing benefits lowers AD if people are unable to get jobs, causing further unemployment. Reduced benefits have a multiplier effect, so AD will fall massively due to reduced consumption. If minimum wage was removed, income inequality would worsen, reducing AD.
what are the problems caused by supply-side policy?
- pressure on the fiscal budget, expensive = causes a deficit, need for more borrowing
- increased income inequality, changes to taxes and subsidies = reducing benefits to reduce purchasing power and standard of living, inhibits growth via multiplier effect
- labour market policy can distort regional markets causing disequilibrium = government failure
- time lags between policy implementation and effect on economy = take 1-2 years to improve human capital or reduce occupational immobility
- very difficult to shift LRAS = hard to improve quality of FOPs
- not feasible if economy is stagnating
- may cause inflation due to increasing AD
- unemployment may not be reduced by increasing LRAS, unless there is a larger increase in AD
- may widen the distribution of income
- likely to only create low-paid jobs
What are interventionist supply-side policies?
policies designed to correct market failure, governments take actions to achieve goals in the market
why are interventionist supply-side policies used?
- to promote competition = a stricter government competition policy could help reduce the monopoly power of some firms and ensure smaller firms can compete
- to reform the labour market = governments could try and improve the geographical mobility of labour by subsidising the relocation of workers and improving the availability of job vacancy information
- to improve skills and quality of the labour force = the government could subsidise training or spend more on education, this also lowers costs for firms since they have to train less workers. spending more on healthcare helps improve the quality of labour force, contributing towards higher productivity
- to improve infrastructure
= governments could spend more on infrastructure
what are some examples of interventionist supply side policies?
- increased government spending on education/training
- increased government spending on healthcare
- increased government spending on infrastructure
- stricter government competition policy
- policies to reduce geographical immobility of labour, eg. improving information on job vacancies and subsidising worker relocation
how can improving skills and quality of the labour force be used as a supply side policy?
- increased spending on education and training to create a better educated workforce, increases efficiency and labour mobility, leading to higher output.
- there could be regulation introduced forcing businesses to train their staff more, to keep them up with developments
- an increase in high skilled migrants improves the quality of the workforce, decreased skills shortages within the economy
- overall, this increases efficiency and production levels, may lead to further innovation in technology
- however, improving education may have no impact if the skills learnt are not relevant to the workforce.
- increased education incurs an opportunity cost, there will be a time lag to see the full effects
How can improving infrastructure be used as a supply side policy?
- offering tax incentives or subsidies on investment
- the government could spend money improving infrastructure themselves eg. HS2, Crossrail
- new technology may be developed and more is invested in buying new technology. This increases efficiency of production, increasing output
- however, offering tax breaks or subsidies may impact the government budget if they lose tax revenue or incur an opportunity cost. some firms may not invest the money and use the scheme as a method of tax evasion
Evaluation of supply side policies
- they are able to both increase output and decrease prices
- they are longer term policies and cause economic growth
- they are directed at increasing exports, improving the balance of payments
- the Keynesian LRAS curve shows that there is no impact when LRAS is elastic and demand-side policies are needed to fix problems in the short run
- not all policies actually increase supply, some cause conflicts
- often, the government will spend more money or decrease tax revenue, leading to a budget deficit
- may have undesirable impacts on AD, causing inflation or unemployment
- they take a long time to have an impact on output, less useful
