4.13.2 - Supply-side Policies

Question 1

What are supply-side policies? (SSPs)

Answer 1

Government economic policies which aim to make markets more competitive and efficient, and shift the LRAS curve to the right.

Question 2

What is supply-side economics?

Answer 2

A branch of free-market economics arguing that government policy should be used to improve the competitiveness and efficiency of markets.

Question 3

Why did supply-side economics evolve?

Answer 3

There was a concern during the Keynesian era about the microeconomic effects of demand-side Keynesian fiscal policy.

The central idea of supply-side economics is that a tax cut should be used to create incentives, by altering relative prices of leisure and labour, saving and investment etc. and not to stimulate AD in a Keynesian manner.

Question 4

What are supply-side improvements?

Answer 4

Reforms undertaken by the private sector to increase productivity so as to reduce costs and to become more efficient and competitive.

Question 5

Where do supply-side improvements tend to come from?

Answer 5

• Investment
• Innovation

Often without prompting from the government.

Question 6

What are interventionist supply-side policies?

Answer 6

The government intervening in a market to distort it.

Tends to include government funding of R&D.

Question 7

What are the main interventionist supply-side policies supported by free-market economists?

Answer 7

Government provision of external economies that benefit private-sector firms.

i.e. gov. provision of education, training or investment in infrastructure projects.

Question 8

What are market based SSPs?

Answer 8

The policies that free up markets, promote competition and greater efficiency, and reduce the economic role of the state.

Question 9

What is privatisation?

Answer 9

The shifting ownership of state-owned assets to the private sector.

Question 10

What is marketisation?

Answer 10

Shifting the provision of goods or services from the non-market sector to the market sector.

Question 11

What is deregulation?

Answer 11

Removing previously imposed regulations.

Question 12

What are the main market-based SSPs?

Answer 12

• Tax cuts to provide incentives to work, save and invest
• Cuts in welfare benefits
• Privatisation
• Deregulation
• Marketisation

Question 13

Why do supply-side economists think their method will improve the UK?

Answer 13

• Better incentives for businesses and workers. (tax cuts, welfare cuts)
• Reductions in unemployment and inflation in long-term (due to the underlying rate of growth improving)
• More price competitive goods

Question 14

What prerequisites do supply-side economists need to ensure their methods will work?

Answer 14

Substantial and sustainable increases in labour productivity.

Question 15

What do supply-side economists think about the Laffer Curve?

Answer 15

Agree.

The increase in the tax burden in the Keynesian era raised the avg. tax rate above or beyond the maximum tax revenue, which actually reduced the government’s total tax revenue.

Depending on where the total tax maximising rate of tax is, supply-side economists argue we should reduce taxes to increase total tax revenues.

Question 16

Why do some supply-side economists argue for reduced tax rates according to the Laffer curve?

Answer 16

• Increases total tax revenues (hmm..)
• Improved economic incentives to produce
• A decline in tax avoidance and evasion as there is less incentive to engage in such acts

Question 17

How do supply-side economists believe that economic policy objectives can be met?

Answer 17

By ensuring the aim of all policy sets markets free and promotes entrepreneurship should create the conditions in which other objectives naturally result.

Question 18

How can supply-side policies reduce the natural rate of unemployment?

Answer 18

By improving the supply-side of the economy, it becomes more attractive for firms to employ more labour so AD increases. If income taxes are cut, it becomes more attractive for individuals to supply more labour so AS increases. Both of these:
* Increase the economy’s natural level of employment
* Reduce the long-run Phillips curve so natural levels of unemployment fall
* Increases the LRAS so increases the economy’s output

Question 19

What do most free-market economists think about managing AD?

Answer 19

Monetary policy should be used to manage AD, but only to support supply-side reforms.

The essentials of AD are to make sure there is just enough demand to absorb the extra output produced by the supply-side and maintain public confidence.

Question 20

Why do UK governments now tend to make fiscal policy consistent with, or subordinate to, the needs of monetary policy?

Answer 20

Budget deficits and governmental borrowing have negative implications.

In the short-run, the gov. can sell treasury bills which expand the money supply and may be inflationary.
In the long-run, the gov. needs to increase interest rates to convince institutions to finance a growing budget deficit which discourages investment in capital goods by private-sector firms. (Financial crowding-out)

Question 21

How do supply-side economists think supply-side policies will alleviate inflationary pressures?

Answer 21

Cost-push inflation
* Reduction in business CoP
* Reduction in monopoly profits through increased price competitiveness

Demand-pull inflation
* Productive capacity grows in line with AD

Question 22

How do supply-side economists think supply-side policies will increase global competitiveness?

Answer 22

• There will be increased competitiveness in markets, so firms will remove all x-inefficiency reducing costs.
• Increased competition will cause firms to re-invest profits to produce high-quality goods.

Reductions in price alongside increasing quality of the goods will cause the country to demand more of their own goods, and cause overseas to demand more of the goods from the UK. Improves the BoP.

Question 23

What is expansionary fiscal contractionism?

aka expansionary austerity

Answer 23

The view that cutting public sector spending will free resources for the private sector to use.

A major reduction in governmental spending can expand private-sector spending, resulting in overall economic expansion.

Question 24

What do supply-side economists believe about the ‘trickle-down effect’?

Answer 24

Some believe that the rich will respond to tax cuts by spending more which will trickle down to the poor.

However,
the rich have a lower propensity to consume and spend, so the effects may not be as intended.

Question 25

What do supply-side economists tend to assume about the supply curve of labour?

Answer 25

As wages increase, people supply more labour.

Question 26

How do supply-side economists behave due to the supply curve of labour being upward sloping?

Answer 26

Reduce income tax, as that essentially acts as an increase in wage rates as incentives improve for people to work.

Question 27

What happens if the supply curve of labour isn’t upward sloping?

Answer 27

As you continue to cut income taxes, people will eventually supply less labour as labour is a inferior good and leisure time is a normal good (for most people).

In this way, income tax reductions have the opposite effect.

Question 28

Examples of industrial microeconomic supply-side policies?

Answer 28

• Privatisation
• Marketisation
• Deregulation
• Subsidisation of R&D spending
• Internal markets (in areas where the state is a major producer of a service, the services will have to ‘earn’ their money according to how many people they attract)

Question 29

Examples of labour market microeconomic supply-side policies?

Answer 29

• Lower rates of income tax
• Reducing state welfare benefits relative to average earnings
• Changing unemployment law to reduce the power of TU
• Repealing legislation which limits employers’ freedom to employ
• More flexible pension arrangements
• Improving the training of labour

Question 30

Examples of financial and capital market microeconomic supply-side policies?

Answer 30

• Deregulating financial markets (within reason)
• Encouraging saving
• Promoting entrepreneurship
• Reducing public spending and public-sector borrowing

Question 31

What are the main ways that free-market economists look to promote market conditions through supply-side policies?

Answer 31

• Tax cuts to create incentives to seek profits and work harder
• Privatisation to unleash market forces by taking businesses out of the public sector
• Deregulation to encourage enterprise and increase competition

Question 32

What are the main way that interventionist economists look to promote market conditions through supply-side policies?

Answer 32

• Gov. spending on education and training
• Industrial and regional policy
• Spending on infrastructure
• Subsidising spending on R&D