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The role of supply side policies

Introduction

 This page explains what economists mean by supply side policies and considers the role that they play in any successful economy.

Enquiry question

What are supply side policies and how do they play a role in maintaining a modern successful economy?

Lesson time: 45 minutes

Lesson objectives:

Explain that supply-side policies aim at positively affecting the production side of an economy by improving the institutional framework and the capacity to produce (that is, by changing the quantity and/or quality of factors of production).

State that supply-side policies may be market-based or interventionist, and that in either case they aim to shift the LRAS curve to the right, achieving growth in potential output.

Teacher notes:

1. Beginning activity - begin with the opening video which takes 10 minutes to watch and then discuss the opening activity  (Allow 15 minutes in total)

2. Processes - technical vocabulary - the students can learn the background information from the opening video, the first two activities on this page and the list of key terms.  Allow 20 minutes for the both activities. 

3. Final reflection - activity 3 contains a short video from the popular UK series Dragons Den.  Discuss the importance of entrepreneurship and capital in a modern economy.  (15 minutes)

Key terms:

Supply side policies - policies aimed at increasing aggregate supply (AS), a shift from left to right. They enhance the productive capacities of an economy while improving the quality and quantity of the four factors of production.  Successful policies can lower the natural rate of unemployment and can contribute to long-term economic growth without increasing the rate of inflation.

Pillars of supply side policy - tax policy, regulatory policy, and monetary policy.

Privatisation - the transfer of assets from the public (government) sector to the private sector.

The activities on this page are available as a PDF at:  Role of supply side policies

Beginning activity

What are the secrets to a successful economy?  Why are some nations more successful than others?

As the next video will highlight the secret of success is not difficult to quantify.  With the exception of a small number of resource wealth nations, successful economies are based on good institutions; an independent media, central bank and judiciary; a well educated workforce and a society largely free from corruption.  As the video also highlights geographical luck is also a significant factor.

Activity 1

Start by watching the following video which explains how to make a country richer.  After the video rank your own nation according to the criteria described in the video.  What additional measures could your home country, or the country where you study, take to help the country develop?

Land - suggestions might include the discovery of new commodities or resources, improvements to infrastructure or farming techniques.  For example an improvement to the road or railway network may reduce travel times (and prices) for farmers to get their produce to market.

Labour - this is the most difficult factor to improve in the short term as the improvements take around than 10 or 15 years to observe.  However long term governments that invest substantial resources towards improvements in training and education are likely to benefit (in the future) from a workforce that is equipped to produce better quality products.

Capital - governments can of course provide incentives for businesses to improve their capital base, investing in new machinery as well as high value added industries such as bio-tech or IT services.

Entrepreneurship - the number of small businesses can be increased through a series of subsidies and government incentives for new businesses.  Some countries, such as Luxembourg and Ireland have also adopted a policy of low corporation tax rates which has increased the number of companies locating into their countries.

Institutions - the most successful nations have the best institutions and are largely free of corruption.  One successful policy adopted in India is a corruption hotline where patriotic citizens are encouraged to telephone a confidential hotline if they are asked to pay a bribe for a service.

Activity 2

The diagram to the right illustrates the long run average supply curve, represents the productive capacity of the country, at any given time, given the factors of production available in the economy. 

(a) Illustrate on this diagram, the impact of a government diverting extensive resources towards infrastructure and human capital.

(b) Explain why this policy might be more popular with many economists than demand side policies?

One obvious advantage of supply side policies is that unlike demand side policies, the higher GDP comes without a rise in inflation.  There is also more potential with supply side policies because demand side policies can only expand an economy up to its current potential and not beyond it.

They can also help create real jobs and sustainable growth through their positive effect on labour productivity and competitiveness. Increases in competitiveness will also help improve the balance of payments.

(c) Illustrate the effect of successful supply side policies on a PPF diagram?

Note that unlike a rise in AD, a rise in LRAS, shifts the PPF to the right because at the new level of AS the economy has a higher output capacity.

(d) Describe some of the weaknesses of supply side policies?

Supply-side policy can take a long time to work their way through the economy. For example, improving the quality of human capital, through education and training, is unlikely to yield quick results. The benefits of deregulation can only be seen after new firms have entered the market, and this may also take a long time.

In addition, supply-side policy is very costly to implement.  For example, the provision of education and training is highly labour intensive and extremely costly, certainly in comparison with changes in interest rates.

Furthermore, some specific types of supply-side policy may be strongly resisted as they may reduce the power of various interest groups. For example, in product markets, profits may suffer as a result of competition policy, and in labour markets the interests of trade unions may be threatened by labour market reforms.

Finally, there is the issue of equity. Many supply-side measures have a negative effect on the distribution of income, at least in the short-term. For example, lower taxes rates, reduced union power, and privatisation have all contributed to a widening of the gap between rich and poor.

Activity 3

Finish the lesson by enjoying this short video illustrating the productivity of labour over time.