Supply-Side Policies

Supply-Side Policies

Supply side policies are a range of measures intended to have a direct impact on aggregate supply, and specifically the potential capacity output of an economy.

The aggregate supply curve depends primarily on the quantity of factor inputs available in the economy, and on the efficiency of those factors. Therefore supply-side policies focus on affecting these determinants of AS in order to shift the AS curve to the right.

Investment is needed to shift the AS curve to the right in the long run. Demand-side policies that stabilise the macro-economy in the short run may also have long run effects on AS supply by encouraging investment.

Within supply side policies there are policies that can affect either the Labour Market or the Product market; these are distinguished below.

Labour Market Supply Side Policies

Education and Training

Investment is needed in human capital and one form of this is in education and training. An important supply-side policy takes the form of encouraging workers and potential workers to undertake education and training to improve their productivity.

This can take place in schools and colleges and it is important that the curriculum studied is designed to provide key skills that will be useful in the workplace. Adult education is also important. When the structure of an economy is changing, retraining must be easily available to enable workers to move between different sectors and occupations. This will prevent occupational immobility structural unemployment.

As we can see from the graph this causes a rightward (positive) shift of the LRAS curve which will cause an increase in employment and real output and at the same time cause price levels to fall easing inflation.

Flexibility of Markets

The reason that retraining increases supply is because it provides greater flexibility in labour markets, enabling workers to switch between economic activities.

Other ways to improve market flexibility include limiting the power of trade unions whose actions can sometimes lead to inflexibility in the labour market either through resistance to certain working practices or by pushing up wages so that the level of employment is reduced.

Unemployment Benefits

If unemployment benefits are too high then it may inhibit labour force participation, particularly for the low paid jobs. This may occur if some people decide to live on unemployment benefit rather than take low skilled and low-paid work. In some situations a reduction in unemployment benefit may cause an increase in the labour supply which would cause the aggregate supply curve to shift to the right in the long run. However, such a policy would need to be balanced against the need to provide protection for those who are unable to find employment. It is also important that unemployment benefits aren’t so low that workers are afraid to leave their jobs in search of another, for fear that they won’t be able to sustain their lifestyle; this would cause occupational labour immobility and might lead to structural unemployment in the long run.

Incentive Effects (Taxation)

There are also problems with setting taxes too high. Taxes are progressive meaning the more you earn the higher you are taxed. This is useful as a means of income distribution but there may come a point where the marginal tax rates are so high that a large portion of additional income is taxed away, reducing incentives to supply additional effort or labour. This could have a negative effect on the long run supply curve shifting it leftwards.

Product Market Supply Side Policies

Promotion of Competition

If there is a lack of competition in a market then monopolistic firms can keep the price high, which affects the price of other goods and may also keep them high (this could increase inflation). If competition is encouraged then prices will be kept down. Also productive efficiency is also relatively low in monopolistic firms as they become complacent. Therefore policies that encourage competition will lead to increases in productive efficiencies.

Deregulation

Deregulation involves removing rules that businesses have to follow. This should reduce the cost of products, increase profits and make the barriers for entry into industries a lot easier. This should therefore increase competition within markets and reduce the cost of goods.

Free Trade

Free trade policies such as that seen in Europe means there are no import or export taxes thus making goods cheaper. It will also increase foreign competition in a domestic market making goods cheaper for consumers and increasing the productive efficiencies of companies.

Government help for Firms

This could include reducing taxes in certain areas, introducing cheap loans or providing advice about setting up businesses. This will allow new businesses into markets and will help small businesses grow. This could create jobs and lead to an expansion in the PPF curve.

Page last updated on 20/10/13