1. 3.4.2 Managing the National Economy Supply-side policies AQA ECON4: T HE NATIONAL AND INTERNATIONAL ECONOMY What is supply-side policy? How would you describe the current government’s attitude to supply-side policy?

2. S UPPLY - SIDE POLICIES  You should develop a more sophisticated understanding of supply-side policies using A2 concepts such as progressive taxation and the natural rate of unemployment  You should understand the contribution of supply-side policies to the management of the economy and to achieving particular macroeconomic policy objectives  You should also appreciate that supply-side policies, such as tax changes, privatisation and labour market reforms, can have microeconomic as well as macroeconomic effects

3. S UPPLY - SIDE POLICIES Key points and terms to remember, from ECON2, are:  Definition  “Policies that seek to improve the long run productive potential of the economy”  Expansionary supply side policy will:  Increase productivity  Improve incentives  Improve the allocation of resources and their efficiency  Boost output without creating inflationary pressure  Policy options  Improve efficiency of labour markets  Improve efficiency of product markets Test yourself! Can you draw a diagram to show the impact of a successful expansionary supply-side policy on an economy?

4. S UPPLY - SIDE POLICIES – L ABOUR M ARKET Policies that aim to improve the overall skills and productivity of the workforce, as well as improving labour mobility. Policy options include:  Income tax cuts  Enhance the incentive to work  They need to be carefully planned to maximise revenue and create genuine incentives  Lower welfare benefits  Enhance incentives to work by making welfare less attractive  This is often viewed as a simplistic measure on its own, and may need to be implemented in conjunction with income tax cuts  Education and training  Boost labour productivity and reduce unit labour costs, thus enhancing efficiency and output as well as promoting occupational mobility  Removal of national minimum wage  It is argued that the NMW creates disequilibrium in the labour market, so its removal might enhance labour market efficiency  Trade union reforms  TU action e.g. bidding up wages and strike action, can reduce labour market flexibility and increase costs of production Recap your knowledge of the natural rate of unemployment in section 3.4.1 To what extent do you think these policies might be effective in reducing the frictional and structural issues associated with the natural rate of unemployment?

5. S UPPLY - SIDE POLICIES – P RODUCT M ARKET Policies that aim to improve overall competition and efficiency. Policy options include:  Privatisation  The sale of state owned enterprises to private corporations removes state controlled monopolies and theoretically opens markets to private competition, whilst reducing the pressure on government finances  Deregulation  An effective competition policy will encourage more competition, reduce the incidence of monopoly and encourage new firms to enter markets  As markets become increasingly contestable, firms will become incentivised to improve efficiency, lower prices and boost output  Investment incentives  The government can effect policies to encourage firms to invest in capital projects  For example, the provision of tax relief on capital investment projects or the reduction of corporation tax for small businesses  Entrepreneurship incentives  The government may also encourage more enterprise by for example, reducing regulation for small businesses, providing cheap loans or grants for new business start-ups How effective has deregulation been in the bus industry?

6. S UPPLY - SIDE POLICIES – T HE L ABOUR M ARKET AND I NCOME T AX C UTS  Labour market incentives can be enhanced through the creation of incentives to work via the tax system  In the UK, income tax is a progressive tax system, meaning that as incomes rise, the greater the proportion of their income in tax an individual pays  The table below shows income tax bands in the UK for 2014-15, and the previous tax year of 2013-14 SalaryTax Rate 2013-4SalaryTax Rate 2014-15 £0 - £32,01020£0 - £31,86520 £32,011 - £150,000 40£31,866 - £150,000 40 £150,001 +45£150,001 +45 Personal Tax Allowance £9,440Personal Tax Allowance £10,000 Class Discussion: What impact do you think the increase in the personal tax allowance and the reduction in salary band on the 40% rate will have on the labour market? Would you make the system more or less progressive? If so, how? What impact might your decisions have?

7. T HE L AFFER C URVE The current UK government believe point X to be around 45% (reduced from 50% in April 2013) and that if tax rates were increased beyond this, then tax revenue would fall. To what extent do you agree with this? Tax Revenue Tax Rate (%) X 0 100 Supply-side economist, Arthur Laffer sought to identify the relationship between tax rates and tax revenue. Laffer identified that a tax rate of 0% would yield £0 in tax revenue, but so would a tax rate of 100% as there would be no incentive to work for individuals. Therefore, the government should seek to find point X, where there is enough incentive to work and tax revenue is maximised.

8. S UPPLY - SIDE POLICIES & M ACROECONOMIC POLICY OBJECTIVES Price Level Real National Output LRAS P FE FE 1 LRAS 1 AD AD1 P1 Y Y1 The successful application of a supply side policy has the impact of shifting LRAS to LRAS1 and boosting productive potential to FE1. If the expansionary demand side policies were also implemented, inflationary pressure would be minimised, as prices remain at P1. Lower inflation can improve international competitiveness and help to control the balance payments.

9. C LASS D ISCUSSION :  What impact do you think the increase in the personal tax allowance and the reduction in salary band on the 40% rate will have on the labour market?  Would you make the system more or less progressive?  If so, how?  What impact might your decisions have? “Lib Dems pledge further tax-free allowance rise.” Economic sense or a vote winner?