Supply Side Policies

Question 1

Supply side policies

Answer 1

Are government economic policies which aim to make markets more competitive and efficient, increase productive potential, and shift the LRAS curve outwards.

Question 2

Supply side policies diagram

Answer 2

Question 3

Benefits:

Answer 3

Question 4

Examples of supply side policies

Answer 4

Question 5

Limitations

Answer 5

Question 6

Limitations

Answer 6

Question 7

The Laffer Curve

Answer 7

The Laffer Curve is a relationship which suggests there is an optimum tax rate which maximises total tax revenue.

Question 8

Laffer curve diagram - below optimum

Answer 8

Question 9

Laffer Curve Diagram - optimum

Answer 9

Question 10

Laffer curve - past optimum

Answer 10

Question 11

Why might total tax revenues fall if the tax rate increases?

Answer 11

Question 12

Evaluating Laffer curve

Answer 12

Question 13

Evaluating Laffer curve

Answer 13

Question 14

Evaluating Laffer curve

Answer 14

Question 15

Crowding out

Answer 15

Question 16

Why might crowding out be unlikely even if the fiscal deficit is high and national debt is rising

Answer 16

Question 17

Privatisation

Answer 17

This involves selling state-owned assets to the private sector. It is argued that the private sector is more efficient in running businesses because they have a profit motive to reduce costs and develop better services. See more on Privatisation.

Question 18

Deregulation

Answer 18

This involves reducing barriers to entry to allow new firms to enter the market. This will make the market more competitive. For example, BT used to be a monopoly in telecommunications, but now several firms compete for our business. Competition tends to lead to lower prices and better quality of goods/service.

• The difficulty is that not all industries are amenable to competition. For example, power generation and water supply is a natural monopoly. Privatising and deregulating these industries tends to create a private monopoly who can charge higher prices.

Question 19

Reducing income tax rates

Answer 19

It is argued that lower income tax rates increase the incentives for people to work harder, leading to an increase in labour supply and more output. Similarly, a cut in corporation tax gives firms more retained profit they can use for investment.

However this is not necessarily true, lower taxes do not always increase work incentives (e.g. if income effect outweighs substitution effect). Firms may not invest the increased profit but give to shareholders or save. See: Cutting corporation tax.

Question 20

Deregulate labour markets

Answer 20

Labour markets can be deregulated through policies such as

• Make it easier to hire and fire workers. Abolish redundancy pay or right of appeal
• Reduce maximum working weeks and minimum holiday pay.
• Enable zero-hour contracts which allow firms to employ workers when demand is greater.

If it is cheaper to hire and fire workers, the argument is that it encourages firms to take on workers in the first place, creating more employment opportunities.

However, more flexible labour markets can cause increased uncertainty and lower productivity. See also: Flexible labour markets

Question 21

Reduce the power of trade unions

Answer 21

This can involve legislation which reduces the ability of trade unions to go on strike. This should:

Increase efficiency of firms e.g. less time lost to strikes.

Reduce real wage unemployment. (if labour markets are competitive)

Question 22

Reducing unemployment benefits

Answer 22

Lower benefits may encourage the unemployed to take jobs. Lower means-tested benefits for those in work may increase the incentive to work longer hours.

Question 23

Deregulate financial markets

Answer 23

For example, building societies were allowed to become for profit-making banks. Deregulation should allow more competition and, in theory, lead to lower borrowing costs for consumers and firms.

Question 24

Increase free trade

Answer 24

Lower tariff barriers will increase trade and provide an incentive for export firms to invest. Increasingly important are non-tariff barriers. For example, the EU Single Market has harmonisation over regulations, which enables more frictionless trade. Negotiating frictionless trade-deals can lead to lower cost for business and improve productivity.

Question 25

Removing unnecessary red tape

Answer 25

Planning restrictions can make it difficult for firms to expand and invest in new capacity. Reducing red tape and levels of bureaucracy reduce firms’ costs and encourage an environment conducive to encouraging investment.

Question 26

Encourage immigration

Answer 26

Free-movement of labour (means that workers are entitled to look for work in another country, without requiring any visa) can enable firms to fill labour shortages – whether they are skilled jobs, in construction and engineering or low-skilled jobs such as fruit picking. Liberal immigration policies make labour markets more flexible and in economic booms – help firms keep up with growing demand. This can prevent wage inflation and enable firms to increase productive capacity.

Question 27

Two main types of supply side policies:

Answer 27

1. Free Market supply side policies
2. Interventionist supply side policies

Question 28

Free market supply side policies

Answer 28

Involve policies to increase competitiveness and free-market efficiency.

For example, privatisation, deregulation, lower income tax rates, and reduced power of trade unions.

Question 29

Interventionist supply side polices

Answer 29

Involve government intervention to overcome market failure.

For example, higher government spending on transport, education and communication.

Question 30

Interventionist supply side policies

Answer 30

1. Increased education and training
2. Improving transport and infrastructure
3. Build more affordable homes
4. Improved healthcare

Question 31

Increased education and training

Answer 31

Better education can improve labour productivity and increase AS. Often there is under-provision of education in a free market, leading to market failure. Therefore the government may need to subsidise suitable education and training schemes to fill vacancies in the labour market.

However govt intervention will cost money and require higher taxes, It will take time to have an effect and the government may subsidise the wrong types of training.

Question 32

Improving transport and infrastructure

Answer 32

With transport, there is usually a degree of market failure – congestion and pollution. Government spending on improved transport links can help reduce congestion and overcome this market failure. Improved transport provision helps reduce the cost of transport and will encourage firms to invest. Transport bottlenecks on the road, rail and air – are often cited as a major stumbling block for the UK economy.

However, in a crowded country like the UK, it can be difficult to increase transport capacity, especially in London.

Question 33

Build more affordable homes

Answer 33

Building affordable council homes in expensive areas can make it easier for workers to move and find jobs in expensive areas reducing geographical immobility. Firms can suffer from labour shortages in areas that have become very expensive to live in.

Question 34

Improved healthcare

Answer 34

Business can face substantial costs from time lost to ill-health. Health care spending which improves a nation’s health can improve labour productivity. Improved health can also come from discouraging unhealthy habits. For example, tax on cigarettes, alcohol and sugar can reduce health care costs associated with drunkenness, obesity and polluted environments.

Question 35

Crowding out

Answer 35

Crowding out suggests that when the government increases its spending, it will increase the demand for goods and services, which can lead to higher interest rates and inflation. This, in turn, can make borrowing more expensive for private investors, reducing their ability to invest in new projects and businesses. As a result, private investment may decrease or “crowd out” as the government spending increases.

Question 36

Supply side improvements

Answer 36

Are reforms undertaken by the private sector to increase productivity so as to reduce costs and to become more efficient and competitive