SUPPLY-SIDE POLICY

Supply Side Policy What are supply side policies? How effective have they been in the UK? ET Sept 2004 Handout- ‘Supply side policy worksheet’

SUPPLY-SIDE POLICY Increasing the productive capacity of the economy through supply-side measures can be very effective in enabling the government to meet the key macroeconomic objectives. If an economy becomes capable of producing more products at lower cost, in comparison to its main competitors, the balance of payments on current account position should improve. Sustained increases in the quality and/or quantity of resources available should increase the trend growth rate. Increasing the productive capacity of the economy should reduce the risk of inflation. Improved education, training and health, combined with increased labour market flexibility, should reduce unemployment. Increasing Long run aggregate supply (LRAS) in an economy can be very effective when AD is at, or very near to, the full employment level (can show using LRAS/AD analysis).

Market based supply side policies Policies to encourage competition (deregulation, privatisation, trade liberalisation, anti- monopoly regulation) Labour Market reform (benefits, TUS, min wage) Incentive- related policies (tax cuts)

Interventionist Supply Side Policies Investment in human capital Investment in new technology Investment in infrastructure Industrial policies (s/t impact on AD, long term impact on LRAS)

SUPPLY-SIDE POLICY Limitations to the effectiveness Increasing LRAS in an economy will not be very effective when AD is below the full employment level (can show using LRAS/AD analysis). Supply-side policies can take a long time to take effect. For example, improvements in quality of primary education could take a long time to improve the quality of the labour force. They can be very expensive to implement, supply side policy can be significantly influenced by the government’s budgetary position. There is no guarantee that they will bring about the desired improvements in the quantity and/or quality of resources available. Policies may have some undesired effects, consumers and producers may respond to them in unintended ways. Use examples for each. For example, Reducing corporate tax rates may not lead to firms increasing investment as intended.

Illustrate Using the Keynesian LRAS The position of AD when supply side policy is Effective Most Effective Not effective

SS Policy is effective when the AD curve is positioned on the ‘curved’ part of the LRAS Price Level LRAS LRAS1 AD Real GDP

SS Policy is most effective when the AD curve is on the perfectly inelastic portion of the LRAS (i.e. when the economy is operating at full employment) LRAS LRAS1 Price Level AD Real GDP

SS Policy is least effective when AD curve is on the perfectly elastic portion of the LRAS curve (when there is a lot of spare capacity in the economy) LRAS LRAS1 Price Level AD Real GDP