Supply side policies Flashcards
what are supply side policies
policies designed to increase the productive capacity of the economy, shifting LRAS to the right
- if successful, then all 4 main macroeconomic objectives will improve
what are the two types of supply side policies
- interventionist supply side policies
- market based supply side policies
what do interventionist supply side policies do
they correct market failure and promote more government intervention in the economy
what do market based supply side policies do
they try to shift LRAS right wards by reducingbarriers for the private sector
3 generic reasons why the LRAS curve would shift to the right
- increase in the quantity of the factors of production
- increase in the quality of the factors of production
- improvement in the productive efficiency of the economy (reduction in long run costs of production)
examples of interventionist SSP
- Investment in Education & Training → Higher Productivity → LRAS & Growth Increase
Governments increase spending on education and vocational training, improving the skills and qualifications of the workforce → A better-skilled labour force is more productive, leading to higher output per worker → This reduces structural unemployment as workers are trained for modern industries → Businesses benefit from a more efficient and innovative workforce, lowering production costs and improving international competitiveness → The LRAS curve shifts right, increasing the economy’s productive capacity, boosting long-term economic growth. - Investment in Healthcare → Healthier Workforce → Higher Productivity & Growth
Governments invest in better healthcare services, including public hospitals, vaccinations, and preventive care → A healthier workforce means fewer sick days, higher labour participation, and greater productivity per worker → Businesses benefit from lower absenteeism, reducing costs and increasing efficiency → Improved worker longevity and well-being increases labour market participation, further raising output → The LRAS curve shifts right, as the economy becomes more productive and efficient, leading to higher economic growth. - Infrastructure Development → Lower Transport & Production Costs → LRAS & Growth Increase
Government investment in roads, railways, ports, and digital infrastructure (e.g., high-speed internet) reduces transportation and communication costs → This makes it cheaper and faster for businesses to move goods, raw materials, and services → Firms experience lower costs and greater efficiency, increasing international competitiveness and profitability → Better infrastructure attracts foreign direct investment (FDI), as multinational companies prefer locations with strong transport and digital networks → The LRAS curve shifts right, expanding the economy’s productive capacity and boosting long-term economic growth. - Research & Development (R&D) Investment → Innovation → Higher Productivity & Growth
Governments fund research institutions, universities, and private sector innovation to encourage technological advancements → New technologies improve efficiency in production, reducing costs and increasing output (dynamic efficiency) → Innovations create new industries and job opportunities, reducing structural unemployment and boosting competitiveness → Countries with strong R&D experience faster technological progress, giving them a competitive advantage in global markets → The LRAS curve shifts right, as the economy grows more productive and innovative, leading to sustained economic growth. - State Support for Key Industries → Industrial Growth → Higher LRAS & Economic Expansion
Governments provide subsidies, grants, or tax breaks to industries that are essential for national economic growth (e.g., renewable energy, semiconductor manufacturing, green technologies) → This helps infant industries develop, allowing them to compete globally → Strategic government support can drive export growth, bringing in foreign currency and reducing trade deficits → As supported industries expand, they create jobs, increase output, and encourage further investment → The LRAS curve shifts right, as the economy experiences higher productivity, employment, and output, leading to stronger long-term growth.
examples of market based SSPs (tax reform)
tax reform :
- lower income tax
Lowering income tax rates increases the incentive for individuals to work, as they get to keep a larger share of their earnings → This leads to an increase in labour force participation and a rise in working hours, particularly among those who may have previously avoided work due to high taxation (e.g., second earners in households) → A larger and more productive workforce leads to higher aggregate supply (LRAS shifts right) → This increases potential output, boosting long-term economic growth.
Cutting Corporation Tax → Increased Investment → Higher Productivity & Growth
Reducing corporation tax increases the post-tax profits that businesses retain → This gives firms more financial resources to invest in capital goods, research & development (R&D), and innovation → Investment in new technology and machinery leads to higher productivity, reducing unit costs → This makes firms more internationally competitive, boosting exports and economic growth → The LRAS curve shifts right, reflecting an increase in productive capacity.
- Lowering Capital Gains Tax → More Entrepreneurship & Start-ups → Innovation & Growth
Reducing capital gains tax (tax on profits from investments, including business sales) makes entrepreneurship and risk-taking more attractive → More individuals and investors are willing to start businesses, as the potential rewards from success are higher → Increased business creation leads to greater innovation, job creation, and higher aggregate supply → Over time, this increases dynamic efficiency, allowing LRAS to shift right, fostering long-term economic growth. - Reducing Indirect Taxes on Investment Goods → Lower Costs → More Capital Formation
Lowering or removing sales taxes (e.g., VAT) on machinery, equipment, and business inputs reduces the cost of investment for firms → This makes it cheaper for businesses to purchase capital goods, leading to higher investment in productivity-enhancing technology → As firms upgrade to more efficient capital stock, unit costs fall, and output per worker rises → This leads to a rightward shift in LRAS, contributing to sustained economic growth.
examples of market based SSPs(labour market reform)
Decrease in welfare:
If unemployment benefits are too high, some individuals may choose not to actively seek work, reducing the available labour supply → Lowering benefits increases the incentive to find employment, leading to a more efficient allocation of labour resources → This reduces structural unemployment and increases the number of people contributing to output → A larger and more active workforce leads to an increase in productive potential, shifting LRAS outward and fostering higher economic growth.
- However, it may increase inequality and reduce the standard of living for vulnerable groups, especially if jobs are scarce or poorly paid.
Reducing Minimum Wage
- Lowering or removing minimum wage laws allows businesses to hire workers at lower costs, which can boost employment opportunities, especially for low-skilled workers.
By reducing employment regulations, businesses face lower hiring costs, making them more willing to recruit new employees → This leads to higher job creation, reducing long-term unemployment and allowing firms to operate more efficiently → With more workers employed, productive capacity increase
- Conversely, it risks increasing in-work poverty and reducing consumer spending due to lower incomes.
Reducing Trade Union Power:
Strong trade unions can increase wage rigidity, making it harder for firms to adjust wages in response to economic conditions → Reducing trade union power allows firms to set wages more flexibly, making it easier to hire workers during downturns → This improves labour market efficiency, reducing real-wage unemployment and ensuring that labour is allocated where it is most needed → A more responsive labour market leads to higher employment, greater efficiency, and an outward shift in LRAS, supporting sustained economic growth.
examples of market based SSPs(competition policy)
- privatisation - Privatized firms often operate more efficiently than their state-owned counterparts due to profit-driven decision-making, leading to cost reductions, streamlined operations, and improved productivity. Privatization encourages innovation as firms seek to differentiate themselves and gain competitive advantages in the market.
- Privatization can attract private investment in infrastructure projects and industries previously monopolized by the state. Private investors may inject capital, technology, and expertise to upgrade infrastructure and expand capacity.
- deregulation - Deregulation promotes competition by removing entry barriers, price controls, and restrictions on market entry and exit.
- Increased competition incentivizes firms to innovate, invest in productivity-enhancing technologies, and adopt best practices to gain market share. Deregulation fosters a dynamic business environment where firms compete based on efficiency, quality, and innovation, driving productivity improvements across industries.
- trade liberalisation
: Increased access to global markets expands export opportunities for domestic firms, allowing them to reach larger customer bases and access foreign inputs and technologies. Export-oriented firms tend to be more productive, innovative, and competitive, driving productivity growth in the economy.
evaluation points for SSPs
- there is no guarantee that the policies will work, so the policies may fail
- a lot of the policies are expensive, risk of wasteful spending
- time lags, eg govt spending on infrastructure could take decades before an infrastructure project is completed
- negative stakeholder impacts - labour market reforms seem very harsh, for those on lower incomes, the reforms could have a very severe impact, also for deregulation, what laws could be taken away or relaxed?
- output gaps - SSPs promoting growth depends on the size of the output gap, what stage of the cycle the economy is in, SSPs would be useless during a recession
- need for targeted SSPS - they need to be used to target issues in the economy
disadvantages of deregulation
- Deregulation can lead to market failures, especially in industries with natural monopolies or significant externalities. Without proper oversight, companies may exploit their market power, resulting in price gouging or reduced quality of service.
- Deregulation can exacerbate negative externalities, such as pollution or unsafe working conditions, relaxing environmental regulations in the energy sector may lead to increased emissions and environmental degradation.
- Deregulating the financial sector may lead to excessive risk-taking and speculative behaviour, as seen in the lead-up to the 2008 financial crisis
- Deregulation can concentrate power and wealth in the hands of large firms or wealthy individuals. Workers might face reduced wages, job insecurity, and fewer protections in a less regulated labor market.
This exacerbates social inequality and can lead to reduced social cohesion. - higher unemployment if labour laws relaxed
examples of how SSps have helped UK economy, market based
One of the most successful privatization examples is the telecommunications industry. In the 1980s, many countries around the world began to privatize their telecommunications industries. The United Kingdom was one of the first countries to do so, and it was a huge success. The privatization of British Telecom (BT) led to an increase in competition, which resulted in lower prices and improved services. The government also received a significant amount of revenue from the sale of BT shares.
- Another successful privatization example is the airport industry. Many countries have privatized their airports, and the results have been impressive. The privatization of airports has led to increased efficiency, better services, and improved financial performance. For example, the privatization of London Gatwick Airport in 2009 resulted in a significant increase in passenger numbers and revenue.
disadvantages of privatisation
Focus on Profit Over Social Welfare → Neglect of Essential Services
Private firms are driven by the profit motive, whereas public firms often operate in the interest of social welfare → When industries like healthcare, rail transport, or utilities are privatised, firms may prioritise cost-cutting and profitability over service quality → This can lead to underinvestment in infrastructure, staff shortages, and lower service reliability → Consumers may face worse quality services, particularly in areas that are less profitable to serve.
Natural Monopolies
Many industries that are privatised (e.g., rail, energy, water) are natural monopolies, meaning that high fixed costs and infrastructure requirements make competition impractical → After privatisation, instead of increasing competition, these industries may simply become privately-owned monopolies, leading to price-gouging, inefficiency, and reduced consumer welfare → Without strong government regulation, firms may engage in excessive profit-seeking behaviour, harming both consumers and businesses that rely on their services.
- This harms allocative efficiency and reduces consumer welfare.
Short-Term Profit Focus
- Privatised firms might focus on short-term profits rather than long-term investments, such as infrastructure development or technological advancements.
- This undermines dynamic efficiency and could lead to deterioration in service quality over time.
Job Losses
3. Job Losses & Poorer Working Conditions → Labour Market Issues
State-owned enterprises often provide secure employment and good working conditions due to government backing → After privatisation, firms seek to reduce costs, which often means cutting jobs, reducing wages, or weakening employment protections → This increases job insecurity and may worsen working conditions → In the long run, this can lead to higher income inequality and social unrest, particularly in industries with high public sector employment.
- This has social and economic consequences, including increased welfare dependency and reduced aggregate demand.
Loss of Government Revenue
- Privatising profitable state-owned enterprises means the government loses a steady income stream from dividends. This may result in higher taxes or reduced public spending elsewhere.
In the long run, this could limit fiscal flexibility and harm economic stability.
Wealth Inequality
- The sale of public assets often benefits wealthy investors or corporations, especially when shares are underpriced during privatisation.
- This concentrates wealth further and reduces opportunities for ordinary citizens to benefit from public resources.
Job Losses & Poorer Working Conditions → Labour Market Issues
State-owned enterprises often provide secure employment and good working conditions due to government backing → After privatisation, firms seek to reduce costs, which often means cutting jobs, reducing wages, or weakening employment protections → This increases job insecurity and may worsen working conditions → In the long run, this can lead to higher income inequality and social unrest, particularly in industries with high public sector employment.
how can an increase in infrastructure help lras
- Point: Increased infrastructure investment creates jobs directly.
- Building and upgrading infrastructure such as roads, bridges, and public transport systems requires labor in construction, engineering, and maintenance.
- As infrastructure projects generate employment, they reduce unemployment, raise income levels, and contribute to higher consumer spending, which boosts overall economic activity and shifts LRAS outward. - Improved transportation networks can boost LRAS.
- Better roads, ports, and railways reduce the time and cost of transporting goods, allowing firms to operate more efficiently.
- Lower transportation costs allow businesses to access a broader market, increase production, and reduce prices, contributing to a rightward shift in LRAS. - Improved access to education and healthcare infrastructure supports a more skilled workforce.
- Investment in schools, universities, and healthcare services can improve human capital, making workers more skilled and healthier.
- A better-trained and healthier workforce increases the potential for higher output per worker, raising overall productive capacity and shifting LRAS outwards. - Infrastructure development attracts (FDI).
- A strong infrastructure foundation attracts foreign investors who seek efficiency and access to growing markets.
- FDI brings new technologies, expertise, and capital, leading to improvements in productivity, economic growth, and a rightward shift in LRAS.
how can an increase in education and training programs help lras
Higher Labor Productivity
Education and training improve workers’ skills and knowledge, enhancing their productivity.
Skilled workers can produce more output in the same amount of time, increasing efficiency and reducing unit labor costs.
Impact: LRAS) shifts outward, enabling higher potential output and sustainable economic growth.
Improved Workforce Flexibility
Training programs can help workers adapt to changing industries and technologies.
By reskilling and upskilling, the workforce becomes more versatile, reducing structural unemployment and better aligning labor supply with demand.
An adaptable workforce increases the economy’s capacity to respond to shocks, enhancing LRAS.
Reduced Income Inequality
Access to education and training can help reduce wage disparities.
With better skills, low-income workers can access higher-paying jobs, improving overall living standards and labor market participation.
A more inclusive labor market increases economic capacity, further contributing to LRAS growth.
Regulatory Frameworks for Innovation
- Governments can establish regulatory frameworks that foster innovation and entrepreneurship by providing clarity, certainty, and incentives for risk-taking.
- Clear and predictable regulations can encourage firms to invest in innovative projects by reducing uncertainty and regulatory risks.
- : Strong intellectual property rights protections incentivize innovation by ensuring that innovators can capture the benefits of their inventions, encouraging further investment in R&D.
- Well-designed regulations can promote competition by preventing monopolistic behaviour and encouraging entry and participation by new firms, fostering dynamic and innovative markets.
real life examples of SSPs being used
- the High Speed 2 (HS2) railway line, which aims to improve connectivity between major cities like London, Birmingham, Manchester, and Leeds.
- The UK government provides funding for apprenticeship programs to support skills development and workforce training, the Apprenticeship Levy requires large employers to invest in apprenticeship training
- For instance, the Financial Conduct Authority (FCA) has established regulatory sandboxes that allow fintech startups to test innovative products and services in a controlled environment. These regulatory frameworks provide clarity and flexibility for innovative businesses while ensuring consumer protection and financial stability.
disadvantages of interventionist ssps
- oppurtunity cost, infrastructure projects can be costly and subject to delays and cost overruns, leading to inefficient allocation of resources and taxpayer money. For example, the HS2 railway project has faced criticism for its escalating costs and environmental impact
- long term sustainability- continuous govt spending on these may lead to public debt, may become unsustainable like HS2
- they do not always acheive their intended goal, eg training programs may not always align with market needs, could lead to a mismatch between skills and job opportunities (occupational immobility)
what is privatisation
involves transferring ownership and control of state owned enterprises to private entities
what is deregulation
involves removing or relaxing government regulations and restrictions on business activities
deregulation chain of analysis
- Point: Deregulation reduces compliance and operational costs for businesses.
- By removing unnecessary regulatory constraints, businesses face lower operational costs, as they no longer have to allocate resources toward meeting regulatory requirements.
- As a result, businesses can reinvest retained profit into innovation and expansion, increased productivity and efficiency, which shifts LRAS outward - Deregulation encourages new firms into the market.
- By lowering barriers to entry, such as licensing requirements or industry-specific regulations, deregulation makes it easier for new businesses to enter the market.
- The influx of new firms increases competition, which drives innovation, better resource allocation, and improved overall efficiency, contributing to a rightward shift in LRAS. - Point: Deregulation improves labor market flexibility.
- By relaxing labor laws and reducing restrictions on hiring and firing practices, deregulation creates a more flexible labor market.
- This flexibility allows businesses to adjust more easily to economic changes and optimize their workforce, boosting productivity and increasing the economy’s potential output, leading to an outward shift in LRAS
privatisation chain of analysis
- The free market and profit incentive drive firms to achieve dynamic and productive efficiency.
- Private firms operate under the pressure of competition and profitability, motivating them to reduce waste, optimize resource use, and invest in innovation to maintain an edge in the market.
- This reduction in inefficiency and better resource allocation increases the economy’s productive potential, leading to an outward shift in LRAS. - Privatization reduces government interference in business operations, promoting market-driven decision-making.
- With less government intervention, firms are free to make decisions based on market signals, allowing them to respond more effectively to consumer demand and market conditions.
- This autonomy enhances efficiency and adaptability, fostering a dynamic economy and potentially increasing long-term economic growth, which can lead to a rightward shift in LRAS - With fewer government regulations, firms have more autonomy to innovate and adapt to market changes.
- When firms are no longer constrained by excessive regulations, they have the flexibility to pursue innovative strategies, develop new products, and streamline operations in response to changing market dynamics.
- These innovations contribute to productivity improvements and better resource utilization, resulting in increased economic output, which shifts LRAS outward.
- Privatization transfers state-owned enterprises (SOEs) to private ownership, subjecting them to market discipline.
- When SOEs are privatized, they are exposed to the competitive pressures of the market, which incentivizes cost reductions, efficiency improvements, and better service quality.
- The market discipline resulting from privatization helps drive productivity improvements and optimal resource allocation, which contributes to a greater potential output and an outward shift in LRAS
