2.6 – Supply-Side Policies

The Role of Supply-Side Policies

Supply-Side Policies and the Economy
Supply-side policies seek to affect the production of goods and services, that is to say, to
increase potential output from firms. There are two main methods:
1. Facilitating the institutional framework – this makes it easier to found and
administer firms.
2. Improving the Capacity to Produce – improving the quantity or quality of the factors
of production.
Interventionist policies are when the government
actively intervenes to improve factors of production.
Market-based policies will maximise the ability of
market force to operate freely without excessive
bureaucracy. The objective of both types of policy
remains the same: to shift the LRAS-curve to the right
to increase potential national output.

Interventionist Supply-Side Policies

Investment in Human Capital
This generally comes in the form of investment in education and training in order to
improve the quality of human capital. In modern society, governments generally provide
primary schooling for basic skills like reading, writing and basic mathematics. They will often
provide higher education like universities or technical colleges that allow students to
specialise in a particular profession.
There is a large time-lag in receiving the benefits of investment in education, since
individuals spend many years in school before they will enter the workforce. However, there
are clear gains in the form of an increased LRAS, making it an essential investment.

Investment in New Technology
Policies that encourage research and development have a short-term impact on aggregate
demand but will also result in new technology and increase the LRAS. It improves the capital
factor of production.
The investment may be in the form of research scholarships or government projects (such
as government organisations like NASA, CSIRO…)
Investment in Infrastructure
This improves the land factor of production by providing better access to land (e.g. railways
or roads, airports, internet connections) so that products can be transported to consumers.
Like the other policies, investment in infrastructure has a short term impact on aggregate
demand but increases LRAS.
Industrial Policies
Governments may wish to focus on specific industries for growth. For example, they may
subsidise certain areas of scientific or technological research. The government may also
influence locations of companies by lowering taxes or providing tax allowances in areas of
high unemployment. This, too, will increase LRAS.

Market-Based Supply-Side Policies
These aim to reduce contrains on the market.
Policies to Encourage Competition
Competition is essential to the free market. The idea behind these policies is that maximum
efficiency is achieved when businesses are motivated to make a profit. They often involve
deregulation and privatisation of state-owned firms, as well as trade liberalisation.
Nevertheless, reduced government intervention is not always the answer. Anti-trust laws or
competition laws make it illegal for companies to abuse market power and reduce
competition. Large companies may seek to temporarily lower their prices below costs in
order to eliminate the competition, then raise them again: this is against anti-monopoly
Labour Market Reforms
Several factors canmake up labour market reforms, such as reducing the power of labour
unions, reducing unemployment benefits and abolishing minimum wages. This makes the
market more flexible and responsive to supply and demand.
Labour unions and minimum wage regulations keep the pay levels high and often above
market equilibrium. They prevent wages from being completely left to market forces, which
leads to real-wage unemployment. Higher wages mean that costs of production are higher
than they need to be.
Reducing or abolishing the minimum wae is normally accompanied by reductions in
unemployment benefits in order make workers more flexible, as the opportunity cost of
being unemployed increases. However, these policies lower the influence of workers and
can have serious consequences for the protection of social, economic, civil and political

Incentive-Related Policies
Reductions in income tax aim to increase the incentive to work, productivity of workers and
the number of workers available. This goes hand in hand with reducing business tax and
capital gains tax to allow firms to make higher profits. The tax cuts may also increase the
incentive to invest.

Evaluation of Supply-Side Policies
Strengths Weaknesses
Ability to create employment
Reduce inflationary pressure
Impact on economic growth
Impact on the government budget
Effect on equity
Effect on the environment

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