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Supply Side Policies (LRAS & capacity)
Supply side policies are policies with the primary aim of shifting LRAS to the
right.
A supply side policy is an action taken by the govt to increase the productive
capacity of the economy or cut costs for all firms. They focus on increasing
incentives, promoting competition and improving productivity. They increase the
capacity of the economy and allow long run economic growth to take place.
diagram
Increasing LRAS
1. leads to economic growth
2. reduces inflationary pressure
3. increases employment
4. leads to higher exports and lower imports
Note!!!!!!!!!!!!!!!!!!!!
Improve AD curve, achieve 2 in 4, econ growth and decrease unemployment
But then have inflation and increase consumption on imports
A supply side policy is any policy whose PRIMARY aim is to increase AS. [ but will
also affect AD]
ie it fulfils all 4 macroeconomic aims
It avoids the conflict of objectives It also pushes out the ppf.
Market based and interventionist approaches.
A) Market based policies are designed to remove barriers to the efficient working of
free markets. In labour markets they might be policies to allow workers to move jobs,
or they might be policies to reduce inefficient production. Free market economists
argue the state should be as small as possible and taxes as low as possible.
, (cut tax & benefits and also increase R&D)
B) Interventionist policies involve the government stepping in to correct a market
failure. This could be the provision of education, or increasing investment by firms.
These economists argue that the market fails frequently and the govt will need to
step in to push out LRAS and create growth.
Categories of supply side policies.
a. Incentives
b. Competition
c. Labour market reform
d improve quality of labour force
e. Improving infrastructure
WITHIN EACH CATEGORY THERE ARE SEVERAL POLICIES [explain how the
policy increases LRAS]
LRAS = PPF
Increase capacity/ productivity
a. Incentives
MARKET BASED
Policy 1.
Reducing taxes on income
High marginal rates of tax discourage people from working. The basic rate of tax in
the UK has been cut from 33% to20% since 1979
Supply side economists believe cuts in taxes will encourage more people to work
which will increase the labour supply and increase LRAS
Effects of a tax cut.
1) substitution effect
cuts in taxes makes working more attractive so people will substitute leisure for work
and work more. This can happen as people enter the labour force now that their take
home pay is sufficient to cover childcare costs or as they choose to work instead of
claiming benefits.
This can get people out of the unemployment trap. The additional labour will
increase the supply of workers and reduce the wage rate
However
Income effect
The cut in taxes increases people's post tax income so people could work less and
take home the same amount. The overall effect for the economy would have to be
that the substitution effect is bigger than the income effect for this policy to work.
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