Supply Side Policies
• Supply side policies are economic policies that are used to increase
the productive capacity of an economy by increasing the level
competition and efficiency in the production of goods and services.
• Supply side policies help firms to be more efficient resulting in falling
costs of production, rising productivity and raising aggregate supply
Successful supply side policies increases aggregate
supply, increase real GDP, increase employment and
reduce the price level.
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Types of Supply Side Policies
• Improving the quality and access to education and training
increases the quality of human capital ( workers become better
skilled) resulting in increased labour productivity which increases
total productive capacity (aggregate supply)
• A reduction in indirect taxes reduces cost of production of firms
and incentivises them to increase production
• A reduction in corporate taxes increases firms’ profit after tax
which increases finance for investment. A rise in investment
increase productive capacity
Types of Supply Side Policies
• Reducing income taxes should boost the incentives to work because tax cuts
increase the reward from a job
• Abolition of the minimum wage reduces cost of production and makes firms
increase production
• Cutting unemployment benefits encourages increases the supply of labour, reduces
wage rate and cost of production since all those who are dependent on benefits are
forced to look for work
• Provision of subsidies to firm reduces cost of production and makes it easier for
firms to purchase modern and more efficient machinery which increase productivity
of labour and the productive capacity of firms
Types of Supply Side Policies
• Legal reforms that reduce the power and influence of trade unions makes
the labour market more competitive and reduces wages leading to lower cost
of production. It also limits the ability of unions to keep wages rates high.
• Privatisation is the sale of state owned business to the private sector.
Privatised firms now pursue the profit motive provides an incentive for them
to be more efficient.
• Promoting free trade and foreign competition compels domestic industry to
be efficient in order to survive. Trade creates competition and should be a
catalyst for improvements in cost.
Types of Supply Side Policies
• Regulations are rules and laws that restrict the activities of firms. Increased
regulation increase costs to firms. Regulation will be reduce in order reduce the
cost of production which increase AS
• Deregulation is the process of removing legal and operational restrictions on
the activities of firms. This reduces cost of production and increases production.
• Abolition of monopoly power encourages new firms to enter the industry and
compete. This increased competition helps to increase efficiency.
• Encouraging inward migration by relaxing visa and work permits helps
countries to attract migrant labour, increase the working population and
productive capacity.
Problems of Supply-side polices
• Successful supply side policies increases aggregate supply, increase
real GDP, increase employment and reduce the price level.
• They take a longer time to yield results unlike demand side policies
• Subsidies for example come at a huge opportunity costs, may encourage
inefficient firms to become dependent on government subsidies.
• Besides, there is no guarantee that they will be successful.
• They require effective demand
A policy conflict is a situation where one economic objective is
achieved at the cost of another objective, such as setting an objective of reducing
unemployment, which could lead to rising prices.
• The potential for policy conflicts is high, and represents a problem for
policy makers.
• The majority of macro-economic policy conflicts are associated with
policies which aim to regulate aggregate demand –
namely, fiscal and monetary policy.
• Macro-economic problems can be associated with excessive
aggregate demand – such as inflation, and a growing trade deficit –
and insufficient aggregate demand – such as rising unemployment,
deflation and recession.
Examples of conflicts
1 Policy Objective Conflict
Expansionary Reduce unemployment Higher inflation
demand side policy
Expansionary
Economic growth Trade deficit (import > export)
demand side policy
Expansionary Reduce unemployment Rising externalities
demand side policy
Reducing marginal
taxes (part Stimulate enterprise and economic Rising inequality
of supply side growth
policy)
Contractionary
demand side Reduce inflation Unemployment
policy
Policy Conflict
• The various objectives of governments might be difficult to
achieve all at once. In some cases policy aims might conflict.
• Healthy economic growth and high inflation
• Healthy economic growth and a balance of payments
disequilibrium
• Low unemployment (or full employment) and high inflation
• Healthy economic growth and the destruction of the
environment
• Healthy economic growth and inequality(inequitable
distribution of income and wealth)
Policy agreement
• High economic growth…………low unemployment
• High economic growth…………..trade surplus (export > import)
• High economic growth ……..long term redistribution of
income/reduction of poverty
• A possible way to resolve some of the problems associated with conflicting
1
objectives is to use a policy rule, – which advocates that for every single
policy objective there must be a separate policy instrument -for example,
using exchange rate manipulation specifically to ease a balance of
payments problem.
• However, given that most, if not all, economic variables impact on more
than one other variable, it must be concluded that policy conflicts cannot
be eliminated completely. This is one of the reasons why supply-side
policy is attractive in that it appears that there are far fewer conflicts
associated with supply-side policy.
• However, that is not to say that supply-side policy has no conflicts. For
example, in reducing marginal tax rates to provide incentives to individuals
and firms, there may be, at least in the short run, an increase in inequality.
