Unit 13.6 Flashcards
What are supply side policies
Policies designed to increase the productive capacity of the economy, shifting LRAS to the right
Aims of supply-side policies
Sustainable economic growth
Low unemployment
External balance of the current account balance of payments
Low inflation or price stability
How does supply side achieve economic growth
Supply-side policies are often viewed as a long-term strategic set of policies to facilitate future economic growth over a period of time. For example, increasing the numbers in university education to improve the skill level of the labour force may take 10 to 20 years to have a significant effect on the growth of the economy.
Increasing productive capacity:
To achieve long-term economic growth, supply-side policies are often targeted at improving the productive potential of the economy. This means using policies that increase potential output, shifting the production possibility curve and long-run aggregate supply curve of an economy outwards.
What are the three market-based supply-side policies?
Market-based supply-side policies can be grouped under three headings:
Encouraging competition (This is based on the assumption that more competition between businesses increases economic efficiency)
Labour market reforms to increase efficiency of to boost worker productivity
Incentive-related policies to increase efficiency, investment and innovation.
Explain the different market based policies to achieve long run economic growth
Deregulation of Markets: This approach can stimulate long-term growth by allowing businesses more freedom to innovate and by reducing compliance costs, which can lead to increased investment and expansion activities.
Privatisation of Industries: The transfer of state-owned enterprises to the private sector often leads to improvements in efficiency and customer service, driving economic growth by making industries more competitive and innovative.
Trade Liberalisation: By opening up markets to international competition, countries can specialize in the production of goods and services where they have a comparative advantage, leading to more efficient resource allocation and growth in the long run.
Monopoly and Competition Regulation: Preventing monopolies promotes a competitive market environment, leading to more consumer choices, lower prices, and the incentive for businesses to innovate, contributing to economic growth.
Reducing the Power of Trade Unions: While trade unions play a vital role in protecting workers’ rights, reducing their power can prevent delays and costs associated with industrial action, leading to more flexible labor markets and thus supporting long-term economic growth.
Changes in Taxation: Lower taxes can increase the disposable income for consumers and the retained earnings for businesses, incentivizing spending and investment, which are key drivers of economic growth.
strength of market-based supply-side policy to achieve economic growth
Market Efficiency: Market-based supply-side policies use the power of the market to achieve economic growth. The interaction of private business and consumers might be more powerful in affecting economic growth in the long run than interventionist supply-side policies.
Reduced Government Spending: These policies typically do not require the same level of government expenditure as interventionist approaches, potentially easing public financial burdens.
Non-inflationary: The market-based approach is less likely to cause inflation, standing in contrast to expansionary demand-side policies that can increase inflationary pressures.
Weaknesses of market based policy to achieve economic growth
Delayed Effectiveness: A market-based approach can work in the long run, but it is relatively ineffective compared to expansionary demand-side policies in achieving an increase in the current rate of economic growth. The market-based approach will not be as effective in a recession when a government needs to respond quickly to a fall in economic growth.
Environmental Concerns: If the deregulation aspect of the market-based approach involves reducing environmental laws, it can have a negative effect on the environment.
Impact on Low-Income Workers: The market-based approach can have a negative impact on low-income workers who may see their incomes and working conditions negatively affected if the government decides to decrease minimum wages and cut back on employment protection.
Income Inequality: If the market-based policy involves reducing income and corporation tax, this could widen income inequality in the country.
Vulnerable Industries: Trade liberalisation involves a country reducing trade barriers, which leads to some industries being exposed to low-cost foreign competition which could cause business failure and unemployment.
Risk of Private Monopolies: Privatisation of certain industries may lead to private sector monopolies which may cause prices to rise. In the energy and public transport markets, this can have a particularly negative impact on the consumer.
Strength of market-based supply-side policy to reduce unemployment
Labor Market Flexibility: Market-based supply-side policies can make the labour market more dynamic and reactive to change. For example, reducing regulations can make it easier for firms to take on workers more quickly when they are expanding.
Job Creation: There is evidence that the private sector is better at creating jobs than the public sector.
Increased Productivity: The increased incentives associated with market-based supply-side policies can increase worker productivity.
Weakness of market-based supply-side policy to reduce unemployment
Impact on the Unemployed: Market-based supply-side policies can have harsh effects on the unemployed. If unemployed people cannot find jobs in a recession, then cutting their benefits will lead to increased poverty.
Job Security and Worker Protection: Decreasing employment regulation can reduce the protection workers have in their jobs, which in turn leads to greater job insecurity and can cause the exploitation of workers.
Wage Adjustments by Employers: Reducing direct tax might mean unscrupulous employers reduce pay rates because they know workers are going to receive a rise in their disposable income.
Minimum Wage Legislation: Taking away minimum wages legislation means pay rates will fall in certain industries, which can lead to greater levels of poverty.
Strength of market-based supply-side policy to reduce inflation
Inflation and National Income: The market-based supply-side approach can reduce the average price level and inflation in the long run at the same time that national income increases. Contractionary demand-side policies reduce inflation, but often at the cost of falling national income.
Economic Efficiency and Competition: Increasing economic efficiency and competition in markets through market-based supply-side policies can create the conditions for price stability in the long run.
Weakness of market-based supply-side policy to reduce inflation
Immediate Policy Response: A market-based supply-side approach is a long-run approach to achieving price stability and often a rise in inflation requires an immediate policy response. Governments normally use contractionary fiscal and monetary policy to achieve this.
Negative Consequences: Reducing inflation using a market-based approach can have negative consequences in terms of inequality, workers’ rights, and increased foreign competition.
Talk about market-based supplied policies to reduce inflation
Monopoly and Competition Regulation: Increasing competition and reducing the power of monopolies through market-based supply-side policies can enhance efficiency and lower prices. This effect is shown when the long-run aggregate supply increases from LRAS to LRAS1, causing the average price level to decrease and reducing inflation.
Reducing the Power of Trade Unions: Trade union activities can lead to higher wages, increasing business costs and potentially causing cost-push inflation. Policies aimed at diminishing the influence of trade unions can prevent wage-induced cost increases.
Changes in Taxation: Lowering direct and indirect taxes can decrease business costs and enhance efficiency, which, in turn, alleviates inflationary pressures. A reduction in VAT, for example, can directly lower the average price level.
Privatisation of Industries: Privatising key sectors can boost the economy’s efficiency, leading to lower consumer prices and reduced inflation. The privatisation of energy sectors is especially impactful due to the significant role of gas and electricity costs in consumer and business expenditures.
Deregulation of Markets: Reducing or removing business regulations can increase efficiency and decrease business costs, setting the stage for lower prices and diminished inflation.
Talk about market-based supplied policies to approach unemployment
Direct tax and benefits:
Reducing direct taxation creates a greater incentive for workers to take available jobs which can reduce the amount of unemployment. If governments reduce unemployment benefits this also increases the incentive for workers to accept jobs. A combination of lower direct tax and reduced benefits makes the opportunity cost of not accepting a job higher because the difference between someone’s income in work increases relative to the transfer payments they might receive if they are out of work.
Trade unions:
Reducing the power of trade unions takes away some of the impediments that prevent firms from hiring new workers. This is particularly true where trade unions negotiate wages above their market equilibrium level and cause the quantity demanded of labour to fall.
Minimum wages:
Minimum wages can cause a disequilibrium in the labour market, which means the quantity demanded for labour is less than the quantity supplied of labour. If a government reduces the minimum wage in the economy, the quantity demanded for labour rises and there is a decrease in unemployment. Reducing minimum wages is often seen as important to small businesses and this can encourage them to hire more workers.
Labour market regulations:
Governments can reduce the amount of labour market regulation that prevents firms from taking on new employees. If there are over-protective regulations, such as statutory redundancy payments, then firms are less likely to take on workers because of the high cost of making workers redundant.
