An Overview of Supply-Side Policies (DP IB Economics)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
Introduction to Supply-side Policy
Supply-side policies aim to shift the long-run aggregate supply (LRAS)
There are two categories of supply-side policies
Interventionist and market-based
Interventionist supply-side policies require government intervention in order to increase the full employment level of output
These are mainly used to correct market failure
Market-based supply-side policies aim to remove obstructions in the free market that are holding back improvements to the long-run potential
E.g. Setting up a regulator to prevent monopolies from forming
The Goals of Supply-side Policy
Supply-side policies can be extremely useful in generating long term growth, lowering average price levels, and creating new jobs in an economy
The five goals of Supply-side policy
When successful, supply-side policies have the following effects on the government's macroeconomic objectives
Economic growth: potential national output increases leading to higher real gross domestic product (rGDP)
Inflation: a greater supply in the economy results in reductions in the prices of goods/services leading to disinflation and making the exports of the nation more competitive
Unemployment: this should fall as lower wage bills allow firms to recruit more workers
Net external demand: due to the increased supply, the prices of goods/services often decrease which makes them relatively more attractive to foreigners - so exports increase
Redistribution of income: this often worsens with the use of supply-side policies as wages fall and government tax revenue has fallen too
Market Based Supply-side Policies
Market based supply-side policies aim to free up markets and improve market incentives so as to increase the long-run aggregate supply
An Explanation of Market Based Supply-side Policies
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To increase incentives |
| Taxes decrease → firms and individuals retain more money for themselves → incentives increase → productivity improves → long term growth increases |
To improve competition and efficiency |
| Regulation on firms decreases → the cost of production for firms falls → firms lower selling prices → international competitiveness improves State owned firms are privatised → more firms enter the market to compete → competition and efficiency improves |
To reduce labour costs and create labour market flexibility |
| Wages decrease → the cost of production for firms falls → firms lower selling prices → international competitiveness improves |
The possible impact of abolishing minimum wages
A national minimum wage (NMW) is a legally imposed wage level that employers must pay their workers
It is set above the market rate
Removing it will allow wage levels to fall, thus reducing the costs of production for firms
Removing the national minimum wage (NMW1) may cause wage rates to fall from W1 to We
Diagram Analysis
The demand for labour (DL) represents the demand for workers by firms
The supply of labour (SL) represents the supply of labour by workers
The national minimum wage and quantity for truck drivers in the UK is seen at W1Qd
The UK government removes the national minimum wage (NMW) at W1
Incentivised by lower wages, the demand for labour by firms increases from Qd → Qe
Facing lower wages, the supply of labour by workers decreases from Qd → Qe
The labour market is now in equilibrium at WeQe - a lower wage rate and higher quantity of workers employed
Interventionist Supply-side Policies
Interventionist supply-side policies require government intervention in order to increase the full employment level of output
An Explanation of Interventionist Supply-side Policies
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Education and training |
| Skill level increases → productivity improve → the cost of production for firms falls → firms lower selling prices → international competitiveness improves |
Improving quality, quantity and access to health care |
| Human capital improves → productivity improves → the cost of production for firms falls → firms lower selling prices → international competitiveness improves |
Research and development |
| A new industry emerges → new infrastructure is developed → more jobs are created → r.GDP increases → increase in long term economic growth |
Provision of infrastructure |
| New infrastructure is developed → costs of production decrease → supply increases → firms lower selling prices → international competitiveness improves |
Industrial policies |
| Industries receive subsidies → costs of production decrease → supply increases → firms lower selling prices → international competitiveness improves |
Examiner Tips and Tricks
Essay questions will test your ability to differentiate between market-based and interventionist supply-side policies.
When evaluating supply-side polices in essay responses, demonstrate critical thinking by acknowledging that privatisation has been used for so long that there is often relatively few assets left to privatise and perhaps a better way forward is to improve competition policy and regulation.
Remember, the private sector will also be increasing supply in an economy (it is not only up to the government) as they are incentivised to increase their profits.
Diagrams to Illustrate Supply-side Policies
Successful supply-side policies will increase the long-run aggregate supply (LRAS)
This equates to an increase in the production possibilities of an economy
The successful implementation can be illustrated on either a Classical or Keynesian diagram
A Classical diagram that illustrates the implementation of a successful supply-side policy
A Keynesian diagram that illustrates the implementation of a successful supply-side policy
Diagram Analysis
Efforts to reduce trade union power have been successful
There is now less protection on wage levels and wage levels fall
Firms may hire more workers and the quantity of productive labour in the economy has increased
This causes LRAS1 to increase to LRAS2
Output increases from YFE to YFE1
Average price levels fall from AP1→AP2
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