3.7 Supply Side Policy.pdf

3.7 Supply-Side Policies YEAR 11 ECONOMICS 2021-22 Starter 1: Read through the Economist article Read the first two sides of the article (up to the charts) 1. What is the key issue for the UK economy that is highlighted in this article? 2. Using the charts in Figure 1, describe what has happened to...

3.7 Supply-Side Policies YEAR 11 ECONOMICS 2021-22 Starter 1: Read through the Economist article Read the first two sides of the article (up to the charts) 1. What is the key issue for the UK economy that is highlighted in this article? 2. Using the charts in Figure 1, describe what has happened to the UK’s GDP per hour worked. How does this compare with the US economy? Read the rest of the article 3. What does the article attribute as the key factors contributing to the issue (you have identified in Q1) faced by the UK economy. State and explain at least 2 different causes. Starter 2: Draw a diagram showing the effect of a shortage of lorry drivers on the market for groceries. Introduction Fiscal and monetary policy are aimed at influencing the level of aggregate demand (AD) and creating short term economic stability. Supply side policies are aimed at increasing the ability of the economy to supply more goods and services, through increasing its long run productive capacity (aggregate supply). These are policies are therefore aimed at increasing long run economic growth. Supply-side policies are usually one of three types: 1. Increase the quantity of factors of production 2. Improve the quality (productivity) of factors of production 3. Improve the efficiency of product and factor markets Can you think of policies that would increase the quantity and quality of Labour: Capital: Enterprise: Land: Examples of supply-side policies 1. Education and Training We know that the four factors of production are land, labour, capital and enterprise. However, labour varies by skill level and experience. Human capital is the knowledge and skills embodied in a worker. An increase in education and training of workers will lead to higher levels of human capital, thereby improving the quality of the labour force and the productive capacity of the economy. This will lead to higher output and long run economic growth. How would the immigration of skilled workers affect the productive capacity of the economy? Why might there be a shortage of skilled and educated workers in developing economies? Case Study on p197 of textbook (EMA in England was replaced by the 16-19 bursary) £180m bursary scheme replaces EMA - BBC News 2. Reducing direct taxes on workers and firms A reduction in direct taxes on workers and firms increases the productive capacity of the economy. Reducing income tax rates or raising the personal allowance means that there will be an increased incentive to work longer hours, because workers will lose less of their income in taxes. This means that there is an increase in the quantity of labour; as a result there will be an increase in the productive capacity of the economy, leading to higher output and long run economic growth. Reducing corporation tax means that firms will retain more of their profits which they can use to invest in a higher quantity and quality of capital. This means that there will be an increase in the productive capacity of the economy, leading to higher output and long run economic growth. 3. Reducing benefits Reducing benefits may lead to a decrease in the unemployment trap where workers are better off on benefits than in work. This means that more workers enter the workforce which means that the quantity of labour will increase, thereby increasing output and long run economic growth. Unemployment Trap Explained I A Level and IB Economics – YouTube Some people would argue that raising the minimum wage would reduce the problem of an unemployment trap because it would ‘make work pay’. What harm do minimum wages do? | The Economist 4. Infrastructure and R&D Infrastructure refers to the basic physical and organisational facilities that are needed for the operation of an economy, in terms of both production and distribution. Better road and rail links, airports and docks will lead to a better movement of goods (both raw materials and finished products). It will also increase the geographical mobility of labour and give consumers greater access to markets (can you think of some examples?) Better telecoms and electricity are also fundamental to the operation of firms. Overall, better infrastructure increases the productive capacity of the economy, leading to an increase in output and long run economic growth. Subsidies for R&D and technological progress will improve the quantity and quality of capital. When Will London Heathrow's 3rd Runway Be Built? - Simple Flying Progress Update (August 2021) – YouTube (Crossrail) HS2 in 2021: a year of major moments for Britain’s biggest infrastructure project - YouTube 5. Increasing market efficiency a) Reducing trade union power is likely to increase the flexibility of labour markets and reduce the cost of production as there would be less pressure on wages to rise. There will be fewer strikes, which would increase productivity and make labour markets more efficient. This means that there will be an increase in output and long run economic growth. Source: Trades Unions - Economics Help 5. Increasing market efficiency b) Controlling private sector monopoly power is likely to mean lower prices for consumers and greater efficiency. Governments breaking up monopolies or refusing to allow mergers will reduce monopoly power and increase efficiency in product markets. This means that there will be an increase in output and long run economic growth. Many countries have laws to protect consumers and ensure fair competition. Avoid and report anti-competitive activity: Types of anti-competitive activity - GOV.UK (www.gov.uk) Understanding Antitrust Laws (investopedia.com) 5. Increasing market efficiency c) Reducing business regulations is likely to reduce barriers to entry. This will lead to more firms entering the market which means that there is an increase in competition and market efficiency. This means that there will be an increase in output and long run economic growth. d) Privatisation This is when the government sells off part or all of a business / industry to the private sector. State-owned enterprises typically lack the profit motive and have less incentive to be efficient. In the UK, many industries were privatised in the 1980s and 1990s (British Telecom, British Gas, British Airways, British Rail, and so on). Why did we sell off the railways? | FT Feature - YouTube Case study – p200 1. The opportunity cost is the next best alternative that is given up when making a choice. In this case, the government of directing spending towards paying PIP benefits means that it may have to give up spending on other projects or areas of the economy, such as infrastructure or education. 2. Benefits could include: fall in budget deficit,possibly lower taxation to stimulate the economy,use of the money for health/education etc.,encourage more disabled peopleinto work. Costs could include: loss of spending power leading to fall in consumption and lower growth, discouragement of disabled people to find employment, increase spending on care by local authorities. Case study – p201 The measures mentioned in the article are likely to lead to increased competition within the banking industry, for example by introducing measures that make it easier for customers to switch between different providers. Increased competition in the banking sector is likely to lead to increased productivity within the sector, as firms need to reduce their costs in order to offer competitive prices (rates of interest) to customers. This is turn may also lead to a greater number of households and firms being able to take out loans, some of which may be used for investment, in, for example, new technology. The likely effect of higher levels of competition in the banking sector is an improvement in the quantity and quality of capital in the economy. This will lead to an increase in the productive capacity of the economy, leading to long-run economic growth and also reduced inflationary pressure. Higher levels of investment and output is also likely to lead to increased levels of employment. Overall, a supply-side policy such as increasing levels of competition therefore has the potential to help the government to achieve all of it’s key macroeconomic objectives. Evaluating Supply-side policies Potential benefits of supply-side policies 1. Targets specific markets: supply-side policies can target particular markets in order to improve efficiency; for example, addressing a specific skill shortage or a specific geographical area or industry. This is different from say, using monetary policy, where the change in the interest rate would affect the entire economy. 2. Helps the government achieve its macroeconomic objectives of economic growth, low unemployment, low and stable inflation and a stable balance of payments. Analysis When asked to analyse the effect of a supply-side policy, ask yourself if it affects the quantity or quality of a particular factor of production or is it more focused on improve the efficiency of markets. Explain carefully how this links to the stated objective. Write a clear chain of reasoning linking one supply-side policy to one macro objective. Examples: analyse the effect of lowering benefits on employment analyse the effect of reducing trade union power on inflation Analyse the effect of lowering benefits on employment Reducing benefits may lead to a decrease in the unemployment trap where workers are better off on benefits than in work. This means that more workers are incentised enter the workforce which means that the quantity of labour will increase. If there is a sufficient level of aggregate demand in the economy, then it is likely that at least of a proportion of the new members of the workforce will subsequently find jobs, leading to an increase in the level of employment. Note: while the ‘level’ of employment is likely to increase, the employment ‘rate’ may not increase if a high proportion of new members of the workforce are unable to find work, despite becoming willing and able to work as a result of the reduction in benefit payments. Analyse the effect reducing trade union power on inflation Reducing trade union power is likely to reduce the ability of trade union members to demand higher wages. This therefore helps firms avoid significant increases in the cost of production, and therefore they are not required to pass on large price increases onto consumers. Reducing trade union power therefore helps to avoid or reduce inflation. Potential costs of supply-side policies 1. Time lags: can take a long time to implement. Infrastructure projects (HS2, Crossrail) can take years to construct, improving human capital through education can take many years, and the effects of deregulation or privatisation can take a while to become apparent. 2. Can be very expensive to introduce. Many large infrastructure projects typically overspend and expanding education is also expensive. There is always an opportunity cost involved. 3. Unintended effects: that the policies will bring about the intended improvements in the quantity and/or quality of resources available. For example, reducing corporation tax rates may not lead to firms increasing investment. They may increase payments to shareholders instead. Cutting income tax rates might lead to workers working less because they can have higher disposable income with the same number of hours. Potential costs of supply-side policies 4. Possible inflation: Aggregate demand could grow too quickly because of increased government spending on supply-side policies; this may lead to (demand-pull) inflation if the productive capacity is not growing as fast. 5. Opposition and resistance from certain groups in the economy. Unions will oppose policies to reduce their powers; people affected by infrastructure projects will protest (HS2 or a third runway at Heathrow); there might be socio-economic problems associated with increased immigration. 6. Inequality: supply-side polices could have a negative effect on the distribution of income, especially in the short term (for example, reducing benefits). Evaluating the sustainability of supply-side policies (make sure you can explain what is meant by the three types of sustainability; see Section 1.2 of spec) SUSTAINABILITY Environmental sustainability Social Sustainability Economic Sustainability LOSSES GAINS SUSTAINABILITY LOSSES GAINS Environmental sustainability New road building and other infrastructure projects may increase air and noise pollution. Congestion might move from one area to another. Some projects are designed to reduce congestion Subsidies for e.g. renewable energy; incentives to industries to reduce carbon emissions; R&D for ‘greener’ production methods. Social Sustainability Cuts in benefits may increase the number of households living in poverty. Expansion of skills and spending on health may reduce inequality of opportunity. Economic Sustainability Large-scale long term projects e.g. HS2 may increase government borrowing and debt. Policies that improve productivity may lead to higher incomes and higher tax revenues in future Supply-side policy evaluation case study In 2016, the UK Government decided to approve the building of a new runway at Heathrow Airport Evaluate whether building an additional runway at Heathrow Airport would increase economic growth.