LS13 Supply-side Policies

Question 1

What is supply-side economics

Answer 1

the study of how changes in long run aggregate supply will affect variables such as GDP. The long run aggregate supply curve shows the productive potential of the economy. At any point in time, there is only so much that an economy can produce from a given set of resources.

Question 2

describe the impact of supple side improvements

Answer 2

• firms will invest, TLT more innovation because of technological progress TLT higher productivity per given input
• the quality and productivity of labour will likely rise due to higher capital stock and better skills

Question 3

how do we show the effect of a supply side improvement on a diagram?

Answer 3

on the LRAS curve this is shown through a rightward shift from LRAS1 to LRAS2 (on either classical or Keynesian)
alternatively this can be shown on a ppf diagram (the curve shifts outwards)

Question 4

describe what (government designed) supply side policies aim to do and and how

Answer 4

• supply side policies aim to increase the rate of economic growth
• they can act specifically in supply side markets to remove bottlenecks which would prevent the economy from growing faster
• supply side policies initially impact individual markets, the policies are aimed to improve the microeconomic performance of smaller markets which will in turn improve the macroeconomic performance of the economy

Question 5

what are the two types of supply-side policies?

Answer 5

market based policies
interventionist policies

Question 6

describe market based policies

Answer 6

• designed to remove barriers to the efficient working of free markets
• the barriers would limit output and raise prices
• in a labour market these limits would potentially be reducing the willingness to have a job or take risks
• in a goods market these limits would potentially lead to inefficient production/ high prices/ lack of innovation

Question 7

describe interventionist policies

Answer 7

• these are designed to correct a market failure
• in a free market which underprovides education this could be the government stepping in and providing education
• in firms are short-termist (only focused on short term profits and failing to invest), this could be the government stepping in by encouraging firms to invest

Question 8

describe the assumptions behind the interventionist supply-side policies

Answer 8

the free market economy cannot by
itself achieve the desired results in terms of increasing potential output, and argue that
government intervention in specific areas is required.

Question 9

what are the forms investment in human capital can take?

Answer 9

• training and education
• Improved health care services and access to these

Question 10

describe training and education as an investment in human capital

Answer 10

• . More training/education lead to an improvement in the quality of labour resources, increasing the productivity of labour, which is one of the key causes of economic growth
• education has positive externalities and justifies government intervention

Question 11

describe ‘improved health care services and access to these’ as an investment in human capital

Answer 11

• access to good quality health care services means workers become healthier and more productive.
• this is also another factor leading to improvements in the quality of labour resources, increasing the economy’s potential output.
• Health care also has many positive externalities, justifying government intervention.

Question 12

what forms can the ‘investments in new technology’ take?

Answer 12

• investments in infrastructure

(sub-section) industrial policies:
- support for SMEs
- support for ‘infant industries’

Question 13

describe ‘investments in new technology’ as an interventonist supply side policy

Answer 13

• Research and development (R&D) LT development of
  new technologies, LT new or improved capital goods (physical capital), LT increases in potential output and economic growth.
• R&D has positive externalities, so justifys government intervention.
• government incentives to private sector firms to engage in R&D = tax incentives/granting of patents for the protection of inventions.
• this policy increases government spending which increases AD over the short term and increases in potential output over the longer term shifting LRAS curves to the right.

Question 14

describe ‘investments in infrastructure’ as an interventionist policy

Answer 14

• Infrastructure is a type of physical capital e.g. telecommunications, roads, ports, airports, irrigation
• qualifies as merit/public good, thereby justifying government intervention
• better infrastructure increases efficiencies in production as it lowers costs
• save time, money, and effort spent in transporting goods and services
• effective telecommunications
  permits faster + easier communications, enabling economic activities to be carried out more efficiently
• improves labour productivity.
• also increases AD over the short term

Question 15

describe industrial policies

Answer 15

• Industrial policies are government policies designed to support the growth of the industrial sector of an economy.
• government investments in human capital, new technologies and infrastructure are industrial policies

Question 16

what are two further industrial policies?

Answer 16

• Support for small and medium-sized enterprises or firms (SMEs)
• Support for ‘infant industries’

Question 17

describe ‘Support for small and medium-sized enterprises or firms (SMEs)’

Answer 17

• Governments can provide support which may take the form of tax exemptions, grants, low-interest loans and business guidance.
• This provides support for the private sector, promoting efficiency, more capital formation, more employment possibilities
• therefore, this policy increases AD as well as potential output

Question 18

describe Support for ‘infant industries’

Answer 18

• ‘Infant industries’ are newly emerging industries in developing countries
• government support can be in the form of grants, subsidies, tax exemptions, and tariffs or other forms of protection against exports.
• This also provides support for growth of the private sector and increases in AD and growth in potential output.

Question 19

describe the views of market-based supply-side thinking

Answer 19

• The economy’s real GDP tends automatically towards long-run full employment equilibrium and potential GDP.
• The focus of government policies should therefore be less on stabilisation, and more on creating conditions that allow market forces to work well

Question 20

state some context points about market-based supply-side policies

Answer 20

• early 1980s: influential monetarist/new classical economists in the UK and the US began to emphasise the view that growth in real GDP depends on the supply side of the economy
• This view was adopted by the government headed by Margaret Thatcher in the UK, and by the government under Ronald Reagan in the US

Question 21

which LRAS curve would best represent the theory behind market-based supply-side thinking

Answer 21

classical LRAS

Question 22

EXPLAIN what 3 things market based supply-side policies will be able to achieve and why

Answer 22

• An economy pursuing supply-side policies will be able to achieve rapid growth, price stability and full employment all at the same time.
• These advantages are seen to arise because as the economy tends towards full employment equilibrium, it automatically eliminates recessionary and inflationary gaps
• hence eliminating the problem of unemployment in recessionary gaps, and the problem of inflation in inflationary gaps

Question 23

what are the three sub-sections of market based supply-side policies?

Answer 23

1. Encouraging competition
2. Labour market reforms
3. Incentive-related policies

Question 24

what policies ‘encourage competition’ as part of market based supply-side policies

Answer 24

• privatisation: ownership goes from public to private. increases efficiency as government enterprises are assumed to be inefficient due to bureaucratic procedures, high administrative costs and unproductive workers
• deregulation: elimination / reduction of government regulation. based on the argument that government regulation stifles competition and increases inefficiency
• private financing of public sector projects: in the past these projects would be financed throught he govenrment budget. recently govenrments have been buying the fully completed services from private firms who build, operate and finances the project. this creates competition (firms compete to be selected bby the government). gov selects firms with lowest costs and highest quality
• contracting out to the private sector (outsourcing): , public services are provided by
  private firms based on a contractual agreement between the government and the private service provider. E.g. IT, human resources management, accounting services. private firms compete for contracts = improved efficiency, lower costs of production and improved quality
• restricting monopoly power: involves restricting monopoly power of firms by enforcing anti-monopoly legislation, demerging monopolistic firms into smaller units (they behave more competitively), and preventing mergers between large firms. this may result in increased efficiency, lower costs and improved quality.
• trade liberalisation

Question 25

what policies ‘reform the labour market’ as part of market based supply-side policies

Answer 25

• abolishing minimum wage legislation: . Elimination or reduction reduces unemployment by allowing the equilibrium wage to fall. Increased wage flexibility (downwards) means firms can hire more labour at the lower wage; greater firm profits, as wage costs would be lowered; more investment and economic growth.
• weakening the power of labor/trade unions: they frequently demand wage increases; if weakened, wages will be more responsive, therefore more likely to fall if there is unemployment. This would also lead to increased wage flexibility so same benefits as abolishing minimum wage legislation.
• reducing unempolyment benefits: these perpetuate the ‘unemployment trap’. Therefore, reducing unemployment benefits is expected to lower unemployment, as it would encourage the unemployed to look for work. This could work to reduce the natural rate of unemployment.
• reducing job security: laws that protect workers, make it costly for firms to fire workers because of high levels of compensation that must be paid. reducing workers’ job security by making it easier and less costly for firms to let go workers might increase employment, because firms are more likely to hire new workers if they can fire easily and cheaply. In addition, reducing job security decreases firms’ labour costs (lower firing cost), and increases profits, investment and economic growth.

Question 26

what policies are ‘incentive-related’ as part of market based supply-side policies

Answer 26

• lowering personal inncome taxes: this is part of fiscal policy and influences AD.
  Supply-side economists argue changes in personal income taxes have an even greater impact on AS. Cuts in personal income taxes = higher after-tax incomes = incentive for people to provide more work: this can mean increased hours, increased workers (add to work force), later retirements, decreased/ shortened time in unemployment. this may shift the LRAS curve right, increasing potential output.
• lowering taxes on capital gains and interest income : If these taxes are reduced, they may be more motivated to save, thus increasing the amount of savings available for investment. More investment means a greater production of capital goods and an increase in potential output.
• lowering business taxes: this may increase AD by increasing investment spending. Supply-side economists argue that this is a supply-side measure because increases in the level of after-tax profits means firms have greater financial resources for investment/pursuing technological innovations through more R&D. Both give rise to greater potential output

Question 27

describe deregulation (as a supply-side market based policy which encourages competition)

Answer 27

there are two types:
- economic regulation: involves government control of prices, output, etc. this offers firms protection against competition. this deregulation allows new private firms to monopolistic industries t create competition. this then increases efficiency, lowers costs, and improves quality. Industries affected include transport, airlines, television broadcasting, telecommunications, natural gas, electricity, financial services, etc
- social regulation: protecting consumers against undesirable
effects of private sector activities (negative externalities). E.g. food safety, pollution control. this is being strenghtened in the interests of public safety. Some economists argue this is excessive, costly, and inefficient and unnecessary government interference, and should
therefore be reduced.

Question 28

what are capital gains?

Answer 28

profits from financial investments (such as stocks and bonds) or from buying and selling real estate.

Question 29

what are taxes on interest income?

Answer 29

taxes on income from interest on savings deposits