3.3 Supply Side Policies

Question 1

1) How does government spending on education contribute to shifting the LAS curve to the right?

Answer 1

Government spending on education, such as apprenticeship schemes, adult re-training, and school curriculum reform, aims to improve the skills and productivity of the labor force, thereby raising human capital. By providing skills to fill job vacancies in the economy, it reduces structural unemployment and increases the quality of labor. Consequently, it shifts the LAS curve from LRAS1 to LRAS2, representing an expansion in the economy’s productive potential.

Question 2

2) How does government spending on infrastructure contribute to shifting the LAS curve to the right?

Answer 2

Government spending on infrastructure, including transport infrastructure improvements like roads, airports, ports, runways, train lines, and rail electrification, reduces production costs for firms. By making the transportation of goods and services quicker, easier, and more efficient, it enhances productive efficiency. Moreover, it boosts competitiveness, leading to an expansion of LAS from LRAS1 to LRAS2, as the economy’s productive potential increases.

Question 3

3) What is the impact of government spending on infrastructure on the capital stock and productive potential?

Answer 3

Government spending on infrastructure increases both the quantity and quality of the capital stock in the economy. This is achieved through the construction of new schools, hospitals, railway lines, roads, and electricity infrastructure. By expanding the capital stock, it contributes to an increase in the productive potential of the economy. As a result, the LAS curve shifts from LRAS1 to LRAS2, indicating an expansion in the economy’s productive capacity.

Question 4

4) How do subsidies or tax allowances offered by governments incentivize firms to invest?

Answer 4

Governments offer subsidies or tax allowances to increase the incentive for firms to invest. These incentives encourage firms to spend on new capital, upgrade machinery, build new factories, improve technology, engage in research and development, and invest in innovation. By stimulating investment, both the quantity and quality of the capital stock in the economy improve. This, in turn, enhances productive efficiency, shifting the LAS curve from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 5

1) How does reducing the marginal rate of income tax contribute to shifting the LAS curve to the right?

Answer 5

Reducing the marginal rate of income tax provides individuals with a higher incentive to work harder. When the marginal rate of income tax is reduced, individuals are able to keep a larger portion of their earned income, which increases the reward for their efforts and productivity. This, in turn, leads to an increase in the quantity and quality of the labor force. Those who were previously inactive in society may also be motivated to start working and fill available job positions, further expanding the labor force. As a result, the LAS curve shifts from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 6

2) How does reducing corporation tax contribute to shifting the LAS curve to the right?

Answer 6

Reducing corporation tax provides firms with increased incentives to invest. With lower tax burdens, firms have higher levels of retained profit, which can be used to fund investment activities. This includes spending on new capital, upgrading machinery, building new factories, improving technology, engaging in research and development, and investing in innovation. By increasing investment, both the quantity and quality of the capital stock in the economy improve. Additionally, productive efficiency is enhanced. Consequently, the LAS curve shifts from LRAS1 to LRAS2, indicating an expansion in the economy’s productive potential.

Question 7

3) How does reducing the power of trade unions contribute to shifting the LAS curve to the right?

Answer 7

Reducing the power of trade unions leads to a decrease in production costs for firms. Trade unions often negotiate for higher wages, longer worker breaks, longer holidays, and longer maternity/paternity leave, all of which increase costs for firms. By limiting the ability of trade unions to take such actions, the efficiency of the labor market improves. This improvement in labor market efficiency enhances productive efficiency in the economy, resulting in a shift of the LAS curve from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 8

4) How does reducing or abolishing minimum wages contribute to shifting the LAS curve to the right?

Answer 8

Reducing or abolishing minimum wages reduces production costs for firms in industries such as retail, leisure, hospitality, recreation, supermarkets, and domestic services. By removing regulations related to minimum wage, the efficiency of the labor market improves. This improvement in labor market efficiency enhances the productive efficiency of the economy, leading to a shift of the LAS curve from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 9

5) How does reducing unemployment benefits contribute to shifting the LAS curve to the right?

Answer 9

Reducing unemployment benefits increases the incentive for inactive individuals to find work and reduce their dependency on welfare. As a result, these individuals enter the labor force, increasing the quantity of labor available in the economy. This increase in labor supply leads to an expansion of the LAS curve from LAS1 to LRAS2, indicating an increase in the economy’s productive potential. By incentivizing workforce participation, reducing unemployment benefits contributes to improving the overall productive efficiency of the economy.

Question 10

6) How does privatisation contribute to shifting the LAS curve to the right?

Answer 10

Privatisation of industries introduces a profit motive, attracting more firms to enter the market and increasing competition. The profit maximization objective incentivizes firms to achieve maximum efficiency by lowering their production costs to offer lower prices than their competitors. This drive for efficiency enhances the productive efficiency of the economy. As a result, the LAS curve shifts from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 11

7) How does deregulation contribute to shifting the LAS curve to the right?

Answer 11

Deregulation involves reducing laws and government-imposed standards, such as environmental, health and safety, product safety, maternity/paternity, working conditions, and planning regulations. This reduction in regulations significantly lowers production costs for firms. Simultaneously, reducing the legal barriers to market entry enhances competition, motivating firms to strive for maximum efficiency to remain competitive. Both factors contribute to improving the productive efficiency of the economy. Consequently, the LAS curve shifts from LAS1 to LRAS2, indicating an increase in the economy’s productive potential.

Question 12

8) How does trade liberalisation contribute to shifting the LAS curve to the right?

Answer 12

Trade liberalisation involves the removal of trade barriers, such as tariffs and quotas, promoting global competition and freeing up trade. The intense competition in the global market compels producers to strive for competitiveness. The profit maximization objective drives firms to minimize production costs in order to offer lower prices compared to their rivals. This pursuit of efficiency enhances the productive efficiency of the economy. Thus, trade liberalisation leads to a shift of the LAS curve from LRAS1 to LRAS2, representing an increase in the economy’s productive potential.

Question 13

Q1) How does successful supply-side policies leading to an increase in LAS affect growth?

Answer 13

Growth. Potential and actual growth increases from FE1 to FE2. This is because with greater demand in the economy, firms respond by increasing output. This increase in output is an increase in real GDP, which is an increase in economic growth.

Question 14

Q2) What is the impact of successful supply-side policies on unemployment?

Answer 14

Unemployment decreases. This is because labour is a derived demand, derived from the demand for goods and services. As the demand for goods and services is high, firms will need more workers to produce extra output, thus reducing unemployment.

Question 15

Q3) How does successful supply-side policies affect demand-pull inflation?

Answer 15

Inflation. Demand-pull inflation decreases from P1 to P2. This is because with an increase in output and aggregate demand resulting from successful supply-side policies, there is a reduced pressure on prices, thereby reducing the rate at which the prices of goods and services rise.

Question 16

Q4) How does a lower inflation rate due to successful supply-side policies impact the trade position?

Answer 16

Trade Position. The trade position in the economy is likely to improve. This is because with a lower inflation rate, exports are more competitive, increasing the demand for them and the revenue brought in by them.

Question 17

Q1) What are the drawbacks and costs associated with implementing supply side policies?

Answer 17

Supply side policies are very expensive to implement. Consider government spending on infrastructure which reduces the costs of production of firms, improving the efficiency of business operations. Spending on improving the road network or building bridges etc. will cost millions if not billions of pounds. There is a huge opportunity cost involved here. If money has been borrowed, taxes will have to rise in the future burdening future taxpayers. Perhaps to fund these supply side policies, cuts have been or will have to be made elsewhere in the economy (such as on policing or healthcare/education). This will have negative implications on those who rely on the day to day function of such services.

Question 18

Q2) What is the time frame for supply side policies to have an impact on productivity?

Answer 18

Supply side policies also take a very long time to have an effect on productivity and efficiency. Any improvements in the education system or training schemes for example can take anywhere between 5 and 15 years before an improvement in productivity occurs that increases the productive capacity of the economy. This does severely reduce their short term impact.

Question 19

Q3) What are the uncertainties associated with the effectiveness of supply side policies?

Answer 19

Added to the above problem is the fact that supply side policies are not guaranteed to work. There is no guarantee that the government providing subsidies to firms will lead to an increase in research and development and then new technology which will boost LAS. Firms may decide to use the subsidy to deleverage (pay off debts) or pay greater dividends to shareholders or increase savings. There is also no guarantee that competition policies such as privatisation will actually reduce costs and increase efficiencies if competition does not increase post privatisation. Thus given the risk of policies not working, coupled with the expense of such policies, not only will there be no benefit in achieving the macroeconomic objectives, but future taxpayers will have to bear the cost of the policies through higher taxes without any benefit from them.

Question 20

Q4) Under what conditions would demand-side policies be more effective than supply side policies?

Answer 20

Whether supply side policies will be effective or not depends on the initial level of economic activity. If an economy is already operating with large levels of spare capacity, for example excess labour and capital, it will be more effective for expansionary demand side monetary or fiscal policies to stimulate aggregate demand using up this spare capacity to increase actual growth. Supply side policies will merely increase the potential output of the economy, leaving actual growth and the other macroeconomic variables unchanged. In this case, there is no need for a greater labour force or capital stock. What is needed is for spare capacity that does exist to be used up, i.e., actual, demand side growth, not supply side potential growth.

Question 21

Q5) What are the potential negative impacts of market-based supply side policies on key stakeholders?

Answer 21

Market-based supply side policies can have a negative impact on key stakeholders. For example, deregulation can harm workers who may suffer from worse and dangerous working conditions and consumers through lower product safety standards. The general population will suffer from the costs of pollution if environmental policies are relaxed. The poor will suffer without minimum wages, strong trade unions, and a welfare state. These negative stakeholder impacts cannot be ignored and may make such market-based supply side policies politically too sensitive, even if they are likely to increase potential growth in the economy.