2015 May TZ2 SL P1 Q4

(a)Explain how business spending on research and development and government expenditure
on infrastructure might shift the long-run aggregate supply curve.

Infrastructures are the large scale public systems, services, and facilities of a country that are
necessary for economic activity. They are accumulated through investment, usually by the
government. Added to Capital Stock. Research and development are aimed at refining the
production methods and improving the productivity of resources.

Research and development in new technology will improve the quality of physical and natural
capital, hence increasing productive capacity. For example Brazil enterprise of agricultural and
livestock research developed some new technologies in the 1990s’. A variety of cattle breeds and
soybeans have been developed suited for the local climate. This in turn attracted firm investing in
agricultural industry, for example putting in place the farm machinery, building and other forms
of physical capital needed to exploit the land. As a result the land productivity had been
improved significantly.

Government expenditure in infrastructure will increase productive capacity by accumulating

physical capital. For example, in China a $300 billion expenditure is spending on building a 25,000
km high speed rails network by 2020. This infrastructure reduces the costs of business and build
connection between cities, it is estimated that, since 2009, 59% of the growth in market potential
for second-tier cities in China is contributed by the establishment of the high speed rails.

The increase in productivity and quality and quantity of factors of production due to R&D and
infrastructure can be shown on the following diagram. Increased productivity in the factors of
production increases the total output for the macro-economy, when all the resources are fully
employed. The long-run aggregate supply is therefore, shift to the right, given a higher level of
full employment level of output Yfe2.

APL LRAS1 LRAS2

Real GDP
Yfe1 Yfe2
(b)Evaluate the effectiveness of interventionist supply-side policies to achieve economic growth.

Interventionist Supply-side policies are macroeconomic policies that government directly

participated in improving the quality and quantity of factors of production, promoting an
increase in productivity and a shift of LRAS. Interventionist supply-side policies includes
educational spending, infrastructure spending and government funded research and
development and an industrial reform include tax allowance that rewards innovation and
subsidies to key industries, for example telecommunication and export-oriented industries that
promote long-run economic growth. Economic growth is defined as increase in per capita real
income over time.

Interventionist supply-side policies aim at increase the quality and quantity of factors of
production and promote long-run production a possibility (potential growth) the possible effect
of the interventionist polices on growth is explained in part A already. In my opinion,
interventionist supply-side policies are often very effective in promoting growth in the short
period of time but the long-run effect may not be as good as its alternative policy: The market
based supply-side policy.

To begin with, since interventionist supply-side policies always have a specific target, the short
run effect on increasing the real output and real income is often very significant. For example
the Brazilian government in the 2010s’ targets energy sectors of the businesses and meanwhile
lunched an industrial reform: tax allowance and subsides are provided to the firms doing export.
The short-run aggregate supply increases due to cost reduction and the Brazilian economy enjoys
quite a few years of high-speed economic growth.

However, when a government constantly running budget deficit to spend on infrastructure and
education or give key industries tax credit or subsidies, a large proportion of the tax revenue
will be spent on debt-servicing and repayments; this in turn may weaken the ability of
government intervention in promoting long-run growth. In the case of Brazil, from the year
2016 to year 2017, the economic growth rate gets close to zero, when government stopped using
interventionist policies to support the export and energy sectors, the firms having a long-time
dependence on the subsidies and tax allowance will not be able to remain competitive and
productively efficient. The higher costs of production forced many firms to shut down.

By contrast, market-based supply-side polices may be more effective in promoting economic

growth in the long-run. For example in recent years, government of China takes a series of
supply-side reforms such as tax incentives (replace the sales tax by value added tax so that the
intermediate sectors of the macro-economy may enjoy a reduction in tax payment) and energy
sector trade-liberalization. It opened the market for coal and other mineral to foreign firms and
the increased level of trade competition forces that state-level governments to take reforms to
remove the regulation and taxation levied on mining industries, this in turn significantly reduces
the costs of the firms and make the local industries more productive and more competitive. In
this case, market-based supply-side policies are designed for long-run consideration as it
increases the productivity of the businesses and make them more competitive.
It should be pointed out that interventionist supply-side policies are at governments’ discretion,
so that the implementation of the interventionist supply-side policies will less likely to cause
problems in promoting other objectives. In addition, for interventionist supply-side policies,
government may provide infrastructure, education and training to people living in the remote
areas, these may narrow the gap between the rich and poor and at the same time promote
growth by accumulating human capital. Recently, the British government subsidies the
telecommunication firms to provide fast-speed internet service to the remote areas. When larger
markets are penetrated by the low-cost and fast-speed services, government can promote
growth by increasing productivity and at the same time, as agreed on the early stage, reimburse
some of the spending paid to the service providers. By contrast, market based supply-side
policies, as alternatives, may be harmful to achieve other macroeconomic objectives at the
time when it is aimed at promoting growth. Continue with the example discussed in last
paragraph, trade-liberalization and mining industry deregulation may lead to pollution and being
harmful to the environment. Some radical market-based policies, such as decrease in
unemployment benefit and reduce the power of union, may be able to promote growth by
increasing the opportunity costs of being unemployed and prompting labor participation.
Nevertheless, the direct consequence is that they may exacerbate the problem of inequality in
income distribution.

In conclusion, interventionist supply-side policies are often very effective in promoting growth in
the short period of time but the long-run effect may not be as good as its alternative policy: The
market based supply-side policy. The key reason is that market-based policies are always
centralized on competition and therefore, will improve the productivity of resources. In addition,
when take into account the side-effect of a policy in promoting growth, interventionist is
considered to be superior over other macro policies.