Supply-side policies Flashcards
What is meant by a marginal tax rate
rate of tax on the extra pound you earn
Why might reducing tax rates support supply side economists
reducing taxes acts as incentive as cost of leisure goes up so people work more to substitute out of leisure
Market based policies define
limit the intervention of the government and allow the free market to eliminate imbalances through supply and demand
Interventionist policies define
rely on the government intervening in the market
How do market based policies work
To increase incentives: reducing income tax and corporation tax to encourage spending and investment
To promote competition: by deregulating or privatising the public sector, firms can compete in a competitive market which should also help improve economic efficiency
To reform the labour market: reducing national minimum wage will allow free market forces to allocate wages and the labour market should clear. Reducing trade union power makes employing workers less restrictive and increases the mobility of labour making the labour market more efficient.
Interventionist policies aim to
To promote competition: a stricter government competition policy could help reduce the monopoly power of some firms and ensure smaller firms can compete too
To reform the labour market: governments could try and improve the geographical mobility of labour by subsidising the relocation of workings 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 lowering cost for firms since they have to train fewer workers. Spending more on healthcare improves quality of labour force contributing towards higher productivity
To improve infrastructure: governments could spend more on infrastructure e.g. schools and roads
Supply side policies effects on a diagram
LRAS curve shifts to right showing increase in productive potential of economy i.e. maximum output of economy at full employment has increases
Keynesian: LRAS shift so where curve up begins draw another curve up (not below only to the side so don’t draw the straight bit again)
Classical: completely vertical LRAS shift to the right
Strengths of supply-side polcies
Only polciies which can deal with structural unemployment because the labour market can be directly improved with education and training
Weaknesses of supply-side policies
Demand-side policies are better at dealing with cyclical unemployment since they can reduce the size of the negative output gap and shift the AD curve to the right
Significant time lags associated with them
Market based supply-side policies like reducing tax rates could lead to a more unequal distribution of wealth
Productivity =
output per input per period of time
Depicting supply-side policies
Classical: shift in AS
Keynesian: shift in AS and Yfe
PPF: shift
Labour market participation =
number of people between 16 and 64 who are working or are seeking work
Why might the reduction of the additional tax rate to 45% by the previous government have been supported by supply side economists?
Reducing taxes acts as an incentive to work because the cost of leisure goes up so people work more to substitute out of leisure
Supply side policies aim at
increasing productive capacity so at any price level there is a greater output produced
Size of workforce roughly =
30 million
Labour market supply side policies =
Invest in education to improve quality of workforce and so increase aggregate supply
Incentives to work by cutting marginal rates of tax so workers have more incentive to work an extra hour as the cost of leisure is more (tax less, disposable income increases, cost of leisure increases, so take less leisure, so work more)
Cut benefits (JSA or Universal credits), economically inactive have an incentive to work
Reduce trade union power - monopolist - can restrict supply to keep wages higher - reducing power improves competition
Evaluating labour market supply side policy of cutting benefits
Poverty trap - marginal rate of tax for low incomes is very high and no benefits + higher % tax so less disposable income so not worth getting a job to claim benefits as income would be less
Gordon Brown implemented tax credits for when people left benefits so their wages were increases for low paid jobs to prevent poverty trap however did not really work
Laffer curve
Shows impact of incentives to work on tax revenue
As taxes increased from low levels, tax revenue received by the government would also increase. However, as tax rates rose, there would come a point where people would not regard it as worth working so hard. This lack of incentives would lead to a fall in income and therefore a fall in tax revenue. The logical end-point is with tax rates at 100% where no one would bother to work and so tax revenue would become zero.
Tax revenue y axis, tax% x axis, curve -x^2 from 0 to 100%
Universal credits =
benefits adjusted according to if you work or not to prevent poverty trap
Evaluating reducing trade union power supply-side policies
However there trade unions there to defend income and conditions of work
Supply side policies in the product market
Privatisation - (transferring ownership of firm from public to private sector) profit motive drives up productive efficiency - firms can compete in a competitive market which should also help improve economic efficiency e.g. British gas/rails/telecoms
Deregulation - get rid of regulations makes it easier for firms to supply goods e.g. GM crops
Evaluating deregulation in product market
Banking sector had regulations of credit removed so made credit to stimulate investment however bubble burst causing financial crisis 2008
Need regulations to prevent negative externalities so these worsen
Supply side policies in the capital market
Capital investment - cut corporation tax, increase profits, 75% of investment comes from profit, investment increases, productivity increases
Evaluating supply side policies
Time lags - investing in education takes a very long time until the whole workforce is affected and productivity increases (around 35 years)
Inflation - invest in infrastructure, productivity increases, aggregate supply increases, downwards pressure on prices however incomes tend to increase causing increase in aggregate demand and inflationary pressure so prices stay the same
Costs - massive costs of investing in infrastructure, big changes in government spending cause small incentives
Difficulties in forecasting - cannot tell whether A-level reforms or the change to the benefit system to universal credits will be beneficial
Supply side policy 20 marker
Supply-side policies are policies that increase productivity in order to increase aggregate supply through interventionist and market based policies e.g. investing into education
Causes increase in aggregate supply (Classical/Keynesian) diagram pushing price levels (2.3% 2017) (1.5% 2014)
Point 1) Invest in education, improve quality of workers, improve productivity, increase aggregate supply
Ev1) Takes 40 years to see effect as all workforce need to go through new system so time lag to see effect
Point 2) Decrease universal credits/benefits/marginal rate of tax, incentive to work as increase cost of leisure, people work more, productivity increases, aggregate supply increases
Ev2) If people cannot get a job due to illness then they have less money from benefits so their standard of living decreases + poverty trap
Point 3) Privatisation - public->private sector e.g. British gas, profit incentive, firms cut wages and increase working hours, productivity increases, aggregate supply increases
Ev3) Private firms are profit driven leading to irresponsible manufacturing i.e. damaging the environment with pollution thus increase negative externalities plus working conditions worsen as workers work more for less
Interventionist vs market based supply side policies
Interventionist policies rely on government intervention whereas market-based policies limit the intervention of the government and allow the free market to eliminate imbalances through supply, demand and the price mechanism.
Interventionist supply-side policies
invest in human capital
invest in infrastructure
invest in new technology
Market based policies
Competition:
- deregulation
- privatisation
- anti-monopoly regulations
Labour market:
- reduce trade union power
- reduce unemployment benefits
- remove minimum wages
Incentive related:
- cutting income tax
- cutting corporation tax
