Supply-Side Policies

Question 1

Supply-side policies aim to Increase the economy’s Trend Growth Rate

Answer 1

1. The aim of supply-side policies is to expand the productive potential of an economy, or to increase the trend rate of growth, as shown in these diagrams.
   * Look at diagrams*
2. Supply-side policies are about the government creating the right conditions to allow market forces to create growth, as opposed to the government creating growth directly by, for example, increasing its spending.
3. Supply-side policies involve making structural changes to the economy to allow its ‘individual parts’ to work more efficiently and more productively. E.g. they might do this by helping markets function more efficiently, or creating incentives for firms or individuals to become more productive (or more entrepreneurial).
4. Supply-side policies can be divided into free market and interventionist policies:
   - Free market supply-side policies aim to increase efficiency by removing things which interfere with the free market. They include tax cuts, privatisation, deregulation, and policies to increase labour market flexibility.
   - Interventionist supply-side policies are usually aimed at correcting market failure. They include govt spending on education, subsidies for research and development, funding for improvements to infrastructure, and industrial policy (policy aimed at developing particular industry or sector of the economy, e.g. through subsidies).
5. The effects of supply-side policies are generally microeconomic - i.e. their direct effects are usually on individual workers, firms or markets. However, these changes can have a powerful macroeconomic effect.
6. Supply-side policies can make an economy more robust and flexible.

Question 2

Supply-side policies can Increase the Efficiency of various Markets

Answer 2

Here are some examples of supply-side polciies that might be used in different kinds of markets:

1. The product market
   a) create incentives for firms to invest, e.g:
   - offer firms tax breaks if they invest profits back into the business instead of paying dividends to shareholders.
   b) trade liberalisation - this means removing or reducing trade barriers, and allowing goods and capital to flow more freely between countries.
   c) encourage competition, e.g:
   - Deregulation can => improved efficiency in a market
   - Privatisation may be effective if nationalised industries are inefficient.
   - Contract services out - this means the govt asks private firms to bid to carry out services on its behalf.
   - Provide extra support for new and small firms, or make it easier to set up a new company.
2. The Capital Market
   - Deregulation of financial markets - e.g. the ‘Big Bang’ of 1986 removed a lot of the traditional ‘restrictive practices’ that were felt to have made British financial markets inefficient.
3. The Labour Market
   - Reduce unemployment benefits - to create incentives for people to take a job than live on benefits. Making it easier for people to find out about what jobs are available can also help.
   - Reduce (or reform) income tax - introducing progressive taxation with the aim of creating more incentives for people to work (e.g. by ensuring that ppl dont become worseoff if they take a job or earn a pay rise).
   - Improve education and training:
   - E.g. apprenticeships allow people to learn practical skills while gaining relevant qualifications.
   - Improvements in education will not only allow employees to become more productive, but can also => to greater occupational mobility.
   - Improve labour market flexibilty - e.g. through trade union reforms, or by making it easier for firms to make workers redundant when times are tough.
   - Reduce regulations on firms -> this would reduce firms’ non-wage costs and may encourage them to employ more workers.

Question 3

Suitable Demand-side policies are needed alongside supply-side policies

Answer 3

1. Supply-side policies aim to make an economy more able to supply products. But for maximum benefit there needs to be a demand for those products - this means appropiate demand-side policies are also necessary.
2. Nowadays, supply-side and demand-side policies are often used together, but to achieve different aims:
   a) Supply-side policies create long-term growth.
   b) Demand-side policies stabilise the economy in the short term.

Example - Tackling unemployment

• Using an expansionary fiscal policy to boost AD might reduce unemployment. However, a supply-side economist would say that reducing unemployment in this way doesn’t change the natural rate unemployment. So when the effects of your expansionary fiscal policy end, unemployment is likely to return to its ‘pre-boost equilibrium’.
• A supply-side approach to this problem might be to try to reduce the NRU itself, i.e. create a new equilibrium position in the labour market. The hope is that this effect is likely to be more long-lasting. In the diagram, for example:
• Tax breaks encouraging firms to invest have created greater demand for labour.
• Increased incentives to work have created a greater supply of labour.
• The overall effect is that the equilibrium position in the labour market has moved to the right (meaning unemployment has risen, and that the NRU should fall).
• However, demand-side policies can still be useful in tackling short-term surges in unemployment.

Question 4

There are huge potential Benefits of supply-side policies

Answer 4

Increasing the economy’s trend growth rate makes it easier for a government to achieve its macroeconomic objectives, with fewer conflicts between objectives - which isn’t the case with demand-side policies.

• For example, unemployment should fall as the economy grows and output expands.
• And cost-push inflation should be reduced, as greater efficiencies (and lower costs) are achieved.
• The current account of the balance of payments should also improve because of increased international competitiveness.

Question 5

Supply-side policies are Not Perfect in every way

Answer 5

1. It can take a long time to see the results of supply-side policies, so they can’t be used to fix the economy quickly. For example, it’ll take many years to see the effects on an economy’s labour supply that occur from improvements in education.
2. There can be unintended consequences - e.g. the deregulation of financial markets led to excessive risk-taking in financial markets, which contributed towards the recent recession.
3. Supply-side policies can be unpopular, and there are also concerns about whether some are inequitable.
   - For example, benefit cuts are lead to the poorest people in society worrying about their ability cope financially.
   - Greater flexibility in the labour market and trade-union reforms could => some ppl having less job security.
4. So while a government may hope that improved economic performance will => greater prosperity overall in the long term, it can be very difficult in the short term to introduce some of these policies.