4 Key Supply-Side Policies: How to Analyse and Evaluate

Supply-side policies are policies that increase the productive potential of the economy. 

Such policies aim to increase an economy’s long-run aggregate supply. 

We can split supply-side policies into two types: 

  • Interventionist. Those that involve more government intervention.
  • Market-based. Those that involve less government intervention or the government “getting out of the way”.

Contents

For more A-level Economics resources, including papers, notes and model answers, check out the link below:

A-level Economics Resources

Market-based 

This includes policies such as:

  • Privatisation, for example Royal Mail or the proposed Channel 4 privatisation.
  • Deregulation.
  • Reducing trade union power or workers’ rights. For example the Trade Union Act 2016 required strike ballots to have 50% turnout minimum, in order to legally support a strike.
  • Reducing or eliminating the minimum wage. To read more on the minimum wage, check out the link here.
  • Cutting welfare benefits or 
  • Cutting income or corporation taxes.

Privatisation means selling a state-owned firm to private owners. This gives the firm a motive to make profit or to survive in the face of competition. This gives an incentive for managers/workers to work harder and for managers to cut wasteful spending within the firm, decreasing costs and increasing productivity. This means the LRAS shifts right.

Supply-side policies are often about increasing productivity. Productivity is the output per unit of input.

Reducing trade union power in theory means firms and workers lose less time to strikes. This includes both the workers striking and those who are inconvenienced by strikes (for example somebody who cannot make it to work because of train strikes). As a result we can say either workers can then work more working hours or that workers are more productive in the hours they do work, so the LRAS shifts right.

Interventionist 

This includes increasing government spending on :

  • Education. For example the Lifetime Skills Guarantee, a UK Government programme where adults without A-level training can take A-level equivalent courses for free (subsidised by government).
  • Infrastructure projects. For example the HS2 high speed railway being built in the UK. 
  • Research and development. 

For example more education spending allows workers improve their knowledge, skills, “human capital”, so there is an increase in productivity. This shifts the LRAS right. Note with workers seeing a rise in their marginal revenue product, wages also rise.

Consider an infrastructure project such as HS2. Faster transport links mean more people can get to work more quickly, reducing time lost to travel time. Also this means workers have access to more jobs, meaning labour supply increases and also workers can find jobs that better suit their skills. This again leads to higher productivity and hence LRAS shifts right.

A-Level Economics Practice Papers in style of AQA and Edexcel

Key graph for supply-side policies

Supply-side policies shift the LRAS to the right from LRAS to LRAS1. This leads to a fall in price level from PL to PL1 while increasing real GDP from Y to Y1. Thus supply-side policies do not cause a trade off between inflation and economic growth (unlike with monetary policy where higher growth can lead to higher inflation, for example).

LRAS shifts right diagram for supply side policies
Effect of supply-side policies on the economy: LRAS shifts right

Other AS-AD effects of supply-side policies

For interventionist policies that involve more government spending, an increase in government spending shifts AD to the right, with AD=C+I+G+X-M. This could lead to multiplier effects, where the increase in AD leads to an increase in real incomes, increasing consumption further so AD shifts right.

For privatisation, AD could increase because of higher firm investment. Or AD could decrease because of reduced government spending. 

Higher future productivity and hence wages can also lead to higher future consumption.

For A-level Economics model answers, check out the link below:

Model Answers for A-level Economics

Evaluation points

General

Time lag – it can take a long time for supply side policies to increase the productive potential of the economy. 

Consider the example of government funding for education. It takes time to provide and set up courses, learn the skills, and for workers to find jobs where workers can implement the acquired skills. Particularly if the education programme is to help children in their early years, then it could be 15-20 years before there are economic returns to the policy. Infrastructure projects are also known to face delays and extensions.

Inequality with market based policies. For example privatisation could lead to higher profits for the CEO and any shareholders at the expense of firing workers. 

Increased government spending with interventionist policies. Government spending usually comes with an immediate opportunity cost. Alternatively it increases the budget deficit, leading to higher debt interest payments. This is particularly the case for infrastructure projects, whose projected costs often seem to increase well beyond the original cost estimate.

Policy specific evaluation points

Education 

  • The success of education schemes depend on who can access this training. If this training is not widely publicised or maybe it’s hard to retrain all workers, especially those who have worked in same industry for a long time.

Infrastructure projects 

  • Unintended consequences. For HS2 for example, what if accelerates the growth of London and does not help Birmingham (what if it doesn’t reach other places).

Privatisation 

  • The risk of a loss of taxpayer money if the government undervalues the worth of company. For example shares in Royal Mail were initially sold at too low a price. The extra money couldhave been used on public services.
  • If the privatised firm needs to cut costs to compete with competition, it may cut costs by firing workers or by reducing the quality of their output which would harm consumer welfare.

Legislation to weaken trade unions 

  • Workers benefit from having trade unions in terms of protecting working conditions and supporting workers through pay disputes. Trade unions have helped in bringing worker protections into law, for example*. This will help improve workers’ living standards and reduce poverty and inequality. 
  • In the UK trade union membership is low, with only 24% of workers being in trade unions in 2019. One could argue that unions are quite weak already in the UK (Source: here).

Other Questions

Why are supply side policies important?

Why are supply side policies important?

In theory, supply-side policies can lead to economic growth without increasing inflation. They are important to long-run economic growth.

However supply-side policies can be very controversial. For example, infrastructure projects can lead to environmental concerns and ballooning costs. While market based supply side policies can increase inequality in some instances.

Why do supply side policies improve the current account?

Supply side policies can reduce the rate of domestic inflation. This renders domestic exports more price competitive, so export demand increases and import demand decreases. So net exports are likely to improve, reducing the size of any current account deficit.

For more A-level Economics notes, click the link below:

A-level Economics Notes

Comparative advantage notes are here:

Comparative Advantage Notes

For notes on the balance of payments, click this button below:

Balance of Payments Notes

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Tom Furber

Helping economics students online since 2015. Previously an economist and economics tutor, I now focus on providing economics resources on tfurber.com. Read more about me here.