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Question
Evaluate the effectiveness of market-based supply-side policies such as privatisation and deregulation (25 marks).
Possible Answer
KAA 1 – Deregulation
A market-based supply-side policy is deregulation. Deregulation reduces costs for firms in terms of the costs paid to lawyers or to hire staff to comply with the regulations. Firms may also face lower costs because of the reduced risk of being fined for overstepping the regulations. This decrease in costs shifts short-run aggregate supply (SRAS) to the right from SRAS to SRAS1. Also deregulation may remove barriers to entry, allowing more firms to enter markets and further increasing short-run aggregate supply. With more entrepreneurs in the market, the increase in the quantity of factors of production shifts LRAS to the right from LRAS to LRAS1. Lower business costs from deregulation increase profits for firms, leading to higher investment in new capital, which increases the quality and quantity of capital, which further increases the productive potential (LRAS) of the economy. This leads to real GDP increasing from Y to Y1. This will also increase employment, as labour demand is derived from demand for goods and services. Increasing real GDP and profits are likely to increase government revenue from taxes too. So the government can reduce the budget deficit and achieve budget balance. For an example of deregulation, consider the Deregulation Bill in the UK, which altered 182 different parts of regulation. For example, eliminating health and safety rules for self-employed workers in low-risk jobs. 800,000 self-employed workers would see lower costs and hence higher productive potential.
Evaluation 1
However this depends on the type of regulation – some regulations are beneficial for businesses and increase productive potential. For example the Companies Act 2006 legally requires large companies to pay for independent audits of financial statements. This makes company financial statements more trustworthy, so investors are more willing to invest in UK companies, boosting investment in UK companies which increases the number and size of companies, increasing aggregate supply. Removing such regulations would reduce investor confidence and reduce aggregate supply.
KAA 2 – Privatisation
Privatisation is the transfer of ownership of a firm from government to private owners. In the case of Royal Mail, privatisation means a private firm has taken over the service of mail delivery. A private firm has the incentive to maximise profits to satisfy shareholders and to survive in the face of competition, whereas government owned firms will likely survive if they sustain heavy losses due to government subsidies. So to increase profits, the privatised firm may cut average costs, reduce X-inefficiency as it now has an incentive to cut costs and in doing so, increase productivity. In the case of Royal Mail, this has meant lower delivery times for mail. This means the LRAS shifts right from LRAS to LRAS1. In addition, firms, after being privatised, can list their company on the stock exchange where shareholders can buy their company’s shares. The revenue from selling shares brings an increase in investment, both from domestic sources and from abroad, into UK companies. This shifts AD to the right from AD to AD1, as I is a component of AD (AD = C + I + G + X -M). This increase in investment increases incomes for UK workers, which increases workers’ disposable incomes, leading to higher consumption and AD shifting further right to AD2. This increases the rate of economic growth, with real GDP rising from Y to Y1. This will also increase employment, as labour demand is derived demand from demand for goods and services.
Evaluation 2
However the success of privatisation depends on how the firms try to increase their profits. The firms may choose to fire workers to cut costs and increase profits, increasing the rate of unemployment. Royal Mail cut 1600 jobs after the privatisation. Higher unemployment could force some people into poverty, while increasing inequality as shareholders earn higher dividends. Higher unemployment could also mean lower spending in local shops, causing a negative multiplier effect, reducing AD and slowing economic growth.
Conclusion
Overall market-based supply-side policies such as deregulation and privatisation can be effective in achieving economic growth, as they lower costs, encourage competition and boost productive capacity. However these policies may come with tradeoffs, for instance increasing inequality and reducing worker protections. Following Thatcher’s market-based supply side reforms, the UK closed its productivity gap with Germany and the US, but the UK’s income inequality Gini coefficient increased from 0.25 to 0.34. The success of privatisation and deregulation depends on how firms allocate their extra profits. Some water companies have been accused of allocating profits towards shareholder dividend payouts, rather than investment, in which case LRAS may not increase.
Tutor’s Commentary
Overall this answer should score in the top bands for A-level Economics Edexcel A. It should score close to full marks or full marks.
Note the structure of each KAA point:
- Explain the point.
- Include a diagram. For 25 markers for Edexcel, level up the complexity of the diagram. For macro, this can involve showing two curves shifting on the same diagram. For micro or tariff macro diagrams, showing areas can also help.
- Extend the worded analysis, for instance by linking to macroeconomic objectives
- Make sure to feature a real world example within your KAA paragraph.
The use of examples in this answer helps to support the analysis.
Note the conclusion is not a summary of arguments. A conclusion should do the following:
- Make a decision about whether the policies are effective and then tries to justify it.
- Add what the final judgement may depend on and refers to real world context.
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