Supply Side Policies

Definition of Supply Side Economics

Supply Side economics is the branch of economics that considers how to improve the productive capacity of the economy. It tends to be associated with Monetarist, free market economics. These economists tend to emphasise the benefits of making markets, such as labour markets more flexible. However, some supply side policies can involve government intervention to overcome market failure

Supply Side Policies are government attempts to increase productivity and shift Aggregate Supply (AS) to the right.

Benefits of Supply Side Policies

1. Lower Inflation.

Shifting AS to the right will cause a lower price level. By making the economy more efficient supply side policies will help reduce cost push inflation.

2. Lower Unemployment

Supply side policies can help reduce structural, frictional and real wage unemployment and therefore help reduce the natural rate of unemployment.

See: Supply side policies for reducing unemployment

3. Improved economic growth

Supply side policies will increase the sustainable rate of economic growth by increasing AS.

4. Improved trade and Balance of Payments.

By making firms more productive and competitive they will be able to export more. This is important in light of the increased competition from S.E. Asia.

see also: Economic Importance of Supply Side Policies

Diagram Showing effect of Supply Side Policies



Classical view of LRAS shifting to the right.


Keynesian view of LRAS shifting to the righ.


Supply Side Policies

Most supply side policies aim to enable the free market to work more efficiently by reducing govt interference.

1. Privatisation.

This involves selling state owned assets to the private sector. It is argued that the private sector is more efficient in running business because they have a profit motive to reduce costs and develop better services.

See more on Privatisation

2. Deregulation

This involves reducing barriers to entry in order to make the market more competitive. For example BT used to be a Monopoly but now telecommunications is quite competitive. Competition tends to lead to lower prices and better quality of goods / service.

3. Reducing Income Taxes.

It is argued that lower taxes (income and corporation) increase the incentives for people to work harder, leading to more output.
However this is not necessarily true, lower taxes do not always increase work incentives (e.g. if income effect outweighs substitution effect)

4. Increased education and training

Better education can improve labour productivity and increase AS.
Often there is under-provision of education in a free market, leading to market failure. Therefore the govt may need to subsidise suitable education and training schemes.
However govt intervention will cost money, requiring higher taxes, It will take time to have effect and govt may subsidise the wrong types of training

5. Reducing the power of Trades Unions

This should

a) increase efficiency of firms e.g. less time lost to strikes
b) reduce unemployment ( if labour markets are competitive)

6. Reducing State Welfare Benefits

may encourage unemployed to take jobs.

7. Providing better information about jobs
This may also help reduce frictional unemployment

8. Deregulate financial markets to allow more competition and lower
borrowing costs for consumers and firms.

9. Lower Tariff barriers this will increase trade

10. Removing unnecessary red tape and bureaucracy which add to a firms costs

11. Improving Transport and infrastructure.
Due to market failure this is likely to need govt intervention to improve transport and reduce congestion. This will help reduce firms costs.

12 Deregulate Labour Markets

This is said to be an important objective for the EU to increase competitiveness. E.g. Make it easier to hire and fire workers.