Supply Side Policies Flashcards
(36 cards)
Supply side policies
Are government economic policies which aim to make markets more competitive and efficient, increase productive potential, and shift the LRAS curve outwards.
Supply side policies diagram
Benefits:
Examples of supply side policies
Limitations
Limitations
The Laffer Curve
The Laffer Curve is a relationship which suggests there is an optimum tax rate which maximises total tax revenue.
Laffer curve diagram - below optimum
Laffer Curve Diagram - optimum
Laffer curve - past optimum
Why might total tax revenues fall if the tax rate increases?
Evaluating Laffer curve
Evaluating Laffer curve
Evaluating Laffer curve
Crowding out
Why might crowding out be unlikely even if the fiscal deficit is high and national debt is rising
Privatisation
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.
Deregulation
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.
Reducing income tax rates
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.
Deregulate labour markets
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
Reduce the power of trade unions
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)
Reducing unemployment benefits
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.
Deregulate financial markets
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.
Increase free trade
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.
