Macro 13: Supply Side Policy

Question 1

Natural Rate of Unemployment - info

Answer 1

> Data can suggest that there’s no correlation between inflation and unemployment. One explanation for this is that the Phillips Curve can move depending on the ‘natural rate of unemployment’.
This is unemployment caused by structural and frictional issues rather than cyclical - it is the unemployment rate that can be maintained in a stable economy.
The NRU is closely related to the NAIRU (non-accelerating inflation rate of unemployment), which includes voluntary unemployment.

Question 2

Natural Rate of Unemployment - definition

Answer 2

> The level of unemployment that persists in a stable economy.
Includes frictional and structural unemployment.

Question 3

NAIRU - definition

Answer 3

> Non-Accelerating Inflation Rate of Unemployment.
The rate of unemployment at which the rate of inflation is stable.
Increasing the rate of employment higher than the NAIRU will lead to the rate of inflation in the economy increasing.

Question 4

Voluntary Unemployment - definition

Answer 4

> Unemployment due to members of the workforce who are able to work but not willing at the market wage rate.

Question 5

What happens when the economy is at the NAIRU and there are injections into the economy to increase demand and decrease unemployment?

Answer 5

> The impact will be that while there may be a temporary increase in employment rate, the scarcity of resources (especially labour) will lead to a rise in costs of production, including the cost of convincing those who are voluntarily unemployed to work.
Increase in costs = rise in inflation = all workers demand increased wages to cover their cost of living = further increase in costs and the supply in the economy returning to the NAIRU, only now at a higher price level.

Question 6

The Long-Run Phillips Curve

Answer 6

> Introduced as an alternative to S-R Phillips Curve.
If the theory surrounding the L-R PC applies, then the trade-off between unemployment and inflation doesn’t necessarily stand in the long-run.
If polices can be implemented to shift the L-R PC then it is possible to have lower unemployment rates without causing increasing rates of inflation.
The model was adapted by monetarists to show that in the long-run output will always return to the full employment level.

Question 7

Disadvantage of the short-run Phillips curve

Answer 7

> The short-run Phillips Curve is limited as it doesn’t say how the economy will adjust.
So monetarists cemented this idea into the L-R PC. (see diagram in book),

Question 8

What does the L-R PC argue?

Answer 8

> Model argues that increasing AD doesn’t increase long-run growth or increase employment.
What we need is supply side.
If SRAS shifts left, SRPC shifts right.
If LRAS shifts right, LRPC shifts left.

Question 9

How can the NRU fall?

Answer 9

> Shifting the Long-Run Phillips Curve left is the only way the NRU can fall.
It’s the only way to grow sustainably in the long-term
Supply-side policies shift the LRPC.

Question 10

Types of supply-side polices

Answer 10

1. Interventionist

2. Market-based

Question 11

Interventionist Supply-Side Policies - definition

Answer 11

> Measures to increase AS in an economy that involve increasing the role of the government.
E.g. tax incentives, reduce min. wage.

Question 12

Market-based Supply-Side Policies - definition

Answer 12

> Measures to increase AS in an economy that involve reducing the role of the government in the economy in order to promote the free market.
E.g. relax immigration controls.

Question 13

Supply-side improvements - extra

Answer 13

> Some supply-side improvements can occur without the implementation of policies, simply through natural progression of the economy in the free market.
Demand-side polciies, e,g, increased gov. spending on infrastructure or reductions in interest rates may lead to supply-side improvements as a secondary consequence.
Those that target SRAS will affect LRAS in the long run.

Question 14

Aim of supply-side policies

Answer 14

> Supply-side policies aim to increase the productive potential of the economy by increasing the quality/quantity of the FoPs or by improving the efficiency of markets.
All 4 macro objectives should improve.

Question 15

Targets and aim of supply-side policies

Answer 15

>Targets:
-labour markets
-industries
-free-markets
-efficiency (all of them).
>Aim = EPIC = Efficiency, Productivity, Incentives, Competition.

Question 16

Labour market example supply-side policies

Answer 16

> Improve education/training = increase in productivity = increase in quality of labour.
Reduction in income tax provides an incentive for potential workers to enter the labour force = increases quantity of labour.
Abolishing minimum wage or reducing trade union power = reduction in costs of production as it’s argued that TUs and min. wage fixes wage rates in labour market above equilibrium wage rate, which causes an excess supply, which causes inefficiencies = so brings wages back down to equilibrium wage rates = E increases.
Reduce unemployment benefits incentivises employment.

Question 17

Industry example supply-side policies

Answer 17

> Reduce corporation tax = decrease costs of production = gives them more retained profits, which they may be able to use for investment = increase in quality and quantity of capital = incentivises them to invest.
Subsidise R&D = incentive to innovate and advance technology = decreases costs of production and increase increases quality and quantity of capital.

Question 18

Free market example supply-side policies

Answer 18

> Privatisation = profit motive + incentivises competition in the market, which causes a strive for greater for greater efficiency = increase in AS as now more firms and profit motive brings down costs by increase in efficiency.
Deregulation incentivises new firms to enter market (competition) = greater strive for efficiency as cut costs to get ahead of competitions = increased investment.

Question 19

Pros - supply-side policies

Answer 19

1. All macro-objectives improved (they promote higher growth (both actual + potential), reduce unemployment, reduces inflation + improve trade position.
2. Stimulate AD and AS (increase in gov. spending, decrease in tax = increase in consumption both of which boost short-run economic growth = increased AD).
3. Sustainable as they are non-inflationary. Main drawback with demand side policy is that they are unsustainable.

Question 20

Cons - supply-side policies

Answer 20

1. Very expensive so carry opportunity cost (where’s the money from? could have been best used elsewhere?).
2. Take a long time to work (e.g. education).
3. No guarantee they will work. Will firms use subsidies or money from tax cuts in right way?
4. Will be ineffective with a large amount of spare capacity in the economy (as what’s needed is an increase in AD not AS).

Question 21

What is main ‘depends on’ of supply-side policy?

Answer 21

> Initial level of economic activity - only effective if nearing full capacity.