Chapter 33- Supply Side Policies

 They are policies that help increase the aggregate supply in an economy
in order to help in achieving the macro economic objectives.
This can be done by:
1-Increasing Labour Productivity:
To increase productivity means that resources are used more effectively which
may cause an outward shift on the PPC. Below are ways to improve
productivity;
➢ Improving the flexibility in labour market:
-Less trade union legislations
-occupational mobility: training labour in order to increase skills and allow
them to change jobs within their field
➢ Restoring incentives:
-Monetary incentives
-Reduction in income tax, this positively affects production as it improves
labour productivity and increases potential output.
-When there are high taxes, people are discouraged to work and hence
unemployment increases as more people choose to remain unemployed.
➢ Increasing quantity and quality of labour;
-Quality is improved through education and training
-Quantity is improved by encouraging female participation or by increasing the
retirement age.

 When Labour productivity increases, this is represented as an outward

shift of the PPC from PPC1 to PPC2 as the economy can produce more
output.
 2-Increasing competition:
➢ Privatisation
-When privatisation is encouraged, firms become more efficient which
increases potential productivity.
-Breaking up state owned monopolies and selling them to the private sector as
the private sector has a profit incentive so they operate more efficiently and
increase output.
➢ Deregulation
-removing government regulations such as long paperwork
-promotes competition and allows new firms to enter easily
➢ Promoting small firms
-As more firms are set up the production potential increases
-To promote them; lower taxes, less bureaucracy, more advisory services

3-Increasing investment in capital market

➢ Investment in infrastructure
-facilitates transportation and communication which increases production
potential
➢ Investment in education & healthcare
-improves the quality of labour which increases the production potential as
labour is more skilled and can take less days off
➢ Investment in private sectors
-providing tax reliefs to new investors or tax reductions in the private sector
which also increases the production potential as more people are encouraged
to invest

 In the long run, supply side policies help in economic growth, reducing
unemployment and controlling inflation
 Chapter 34-Relationships between objectives and policies

The Monetary and Fiscal policies are used in the short term
1-Inflation and unemployment (inverse relationship)

➢ Contractionary Fiscal policy reduces inflation

-Contractionary is when there is a decrease in government spending (G)
and/ or an increase in tax (T)
-The decrease in G leads to a decrease in Aggregate demand (AD) since
AD=C+ I + G + (X-M)
-The increase in T also leads to a decrease in AD since Consumption (C)
and Investment (I) decrease which lead to a decrease in AD since AD=
C+I+G+(X-M)
-This average price level falls due to less Aggregate Demand which
reduces the inflationary pressure

➢ Tight Monetary Policy reduces inflation

- A tight monetary policy is when the central bank increases the
interest rate
- This leads to an increase in savings (more people want the higher
return so put their money in the bank)
- Borrowings also decrease because people do not want to pay back
loans with higher returns
- Consumption decreases and Investment decreases which leads to a
decrease in Aggregate Demand as AD=C+I+G+(X-M)
- The average price level decreases due to the decrease in Ad as there
is reduced inflationary pressure

 In both cases, in order to reduce inflationary pressure, the aggregate

demand in an economy decreases. This means that the level of output
decreases.
 This is known as an economic decline and hence firms do not need all
labour, lots of people are laid off as the less output requires less labour,
therefore the unemployment levels increase
 Therefore, there is a TRADE OFF between inflation and unemployment
2-Economic growth and Inflation

➢ Expansionary Fiscal Policy is used to stimulate economic growth

-Expansionary fiscal is when the taxes decrease and/or the government
spending increases
-The decrease in taxes leads to higher consumption and higher
investment and therefore aggregate demand increases since
AD=C+I+G+(X-M)
-As government spending increases this leads to an increase in AD
-Therefore, there is more output in an economy and there is economic
growth

➢ Expansionary Monetary Policy is also used to stimulate economic

growth
- This is when the interest rate decreases or there is quantitative
easing
- This leads to higher borrowing and more consumption and
investment
- Therefore there is increased AD which leads to economic growth

 In both cases AD increases in order to achieve economic growth, but as

AD increases there is more inflationary pressure due to the increased
demand which leads to higher inflation levels
 Therefore, there is a TRADE OFF between economic growth and inflation
 Supply side policies can be used to boost economic growth in the long
run while maintaining stable price levels as inflation can also be caused
by a decrease in Aggregate Supply when an economy is very close to its
capacity constraint
3-Economic Growth and Protection of the Environment

➢ Expansionary Fiscal Policy

- Increase in G and a decrease in T
- As T decreases, C and I Increase which leads to an increase in AD
- As G increases this leads to an increase in AD
- As AD=C+I+G+(X-M) and hence there is economic growth

➢ Expansionary Monetary Policy

- The interest rate decreases, there is quantitative easing
- Borrowing increases, C increases and I increases
- AD increases which leads to Economic growth

 However, as AD increases this leads to increase in pollution which

harms the environment and this reduces sustainable development
as the scarce resources are used up and there are fewer resources
left for the future
 4-Inflation and the Current Account Balance

➢ Tight Monetary Policy is used to reduce inflation

- The increase in interest rate leads to a decrease in borrowing, a
decrease in consumption, a decrease in investment and hence a
decrease in AD since AD=C+I+G+(X-M)
- Therefore, the price levels decrease
- The direct impact is that imports decrease as foreign goods are
viewed as more expensive
- (X-M) increases as there are fewer imports
- when the interest rate increases the demand for the currency
increases and hence the currency appreciates
- Local exports decrease as they become less price competitive so X
decreases
- Imports appear cheaper so M increases
- Therefore, the Current Account Balance worsens as X decreases and
M increases

➢ If a contractionary fiscal policy is used then the impact on the current

account balance will no longer exist as the interest rate is the
effective component

 Over the long run supply side policies can maintain stable price
levels while encouraging export opportunities.