O LevelEconomicsCambridge (CIE)Revision Notes4. Government & the Macroeconomy4.5 Supply-side PolicySupply-side Policy Measures

Supply-side Policy Measures (Cambridge (CIE) O Level Economics)

Revision Note

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Supply-side Policy Defined

  • Supply-side policies aim to increase the total supply (productive potential) of the economy

    • This is achieved by increasing the quality or quantity of the factors of production

    • It can be represented by an outward shift of the productive possibility curve

    • More consumer goods and more capital goods can now be produced using all of the available resources

Graph showing economic shifts. Y-axis: Capital Goods, X-axis: Consumer Goods. Curve shifting inward (A) signifies economic decline, outward (B) signifies economic growth.
Outward shifts of a PPC show an increase in the total supply of an economy 

  • The strategies used to increase total supply include education and training, labour market reforms, lower direct taxes, deregulation, improving incentives to work and invest, and privatisation

Supply-side Policy Measures

  • When successful, supply-side policies have the following effects on the government's macroeconomic objectives

  1. Economic growth: potential national output increases leading to higher real gross domestic product (rGDP)

  2. Inflation: a greater supply in the economy results in reductions in the prices of goods/services leading to disinflation

  3. Unemployment: this should fall as more workers are required to produce the higher levels of output

  4. Current Account Balance: due to the increased supply, the prices of goods/services often decrease which makes them relatively more attractive to foreigners - so exports increase and the current account balance improves

  5. Redistribution of income: this often worsens with the use of supply-side policies as wages fall and government tax revenue has fallen too
     

Specific Types of Supply-Side Policies

Supply-side Policy

Explanation

Education and training

  • Increasing government spending on education and retraining raises the quality of the workforce

  • Increasing government spending on healthcare so that worker productivity improves

Labour market reforms

  • Decreasing trade union power so wages can be decreased encourages firms to hire more workers as they are cheaper

  • Decreasing minimum wages to lower costs of production encourages firms to hire more workers as they are cheaper

  • Increased government spending on improving occupational mobility

Lower direct taxes

  • Reducing income/corporation tax rates incentivises workers to work harder (they keep more money for themselves) and provides firms with extra funds which they can use to invest in new machinery/technology

Deregulation

  • This is the process of removing government controls/laws from markets in order to increase competition

  • Any regulation increases costs of production for firms and deregulation decreases costs which may result in greater supply

Improving incentives to work and invest

  • Restructuring the unemployment benefits system to incentivise the unemployed to seek work

  • Increased government spending on innovation increases the supply of potential jobs in the economy

  • Direct support to firms (subsidies) increases output and promotes international competitiveness

Privatisation

  • Government firms are usually so big that private enterprise refrains from trying to compete with them. Privatisation encourages new firms to enter the market and compete, thus increasing the total supply in the economy

Strengths of supply-side policies

  • They increase the rate of growth of an economy

  • They reduce inflation

  • They often reduce unemployment 

  • They often increase the value of net exports as an increase in total supply usually results in lower prices leading to greater exports 

Weaknesses of supply-side policy

  • The distribution of income worsens as labour market reforms and wage policies lower worker's wages

  • They are expensive to implement

  • There are significant time lags between government expenditure and seeing the benefits e.g. education and training often take a long time

  • Due to the long-term nature, changes in government often result in changes to budgets and scope of projects

  • Vested interests can result in less effective outcomes e.g. There are many examples of privatisation occurring in such a way that the government's preferred bidders obtained an asset at a knock down price

Examiner Tip

There are some policy measures which may be a fiscal policy or a supply-side measure e.g. building new schools requires immediate government spending (fiscal policy), but results in greater supply of educational institutions in the economy (supply-side). In deciding which it is in any particular question, decide whether the government is using it with the intention of increasing total demand or total supply

When evaluating supply-side polices in essay responses, demonstrate critical thinking by acknowledging that privatisation has been used for so long that many economies have little left to privatise.

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.

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