Question: Assess the use of supply-side policies as a means to increase economic growth.
Supply-side policies are designed to increase productivity/efficiency and shift LRAS right. The productive capacity of the economy increases because more can be produced. As LRAS shifts right, the price level falls and real GDP rises.
Many different types of supply-side policies could be used to increase economic growth.
Firstly, the government could invest in education and training to improve workers’ human capital. Labour becomes more skilled and efficient, the marginal productivity of labour rises so workers produce more and LRAS shifts right and GDP rises. Also, better trained labour means less structural unemployment as workers can adapt more easily to different jobs, and more employment means more can be produced.
Additionally, the government could reduce corporation tax. If corporation tax falls, firms’ after-tax profits rise, investment is incentivized because firms keep more of their profits, investment rises, better technology and more efficient machinery is developed, so more output can be produced, LRAS shifts right and GDP rises.
Furthermore, the government could boost economic growth by investing in the infrastructure. An increase in government spending on the infrastructure means better roads, railways, ports, utility networks and telecommunications, the economy becomes more efficient and firms can produce more so LRAS shifts right and GDP rises.
But, the effectiveness of supply-side policies to boost economic growth depend on many factors.
For example, the magnitude of a cut in income tax is important. A small cut in income tax or a small increase in government spending on the infrastructure will not increase efficiency that much so LRAS only shifts a little bit.
Also, there may be time-lags involved. Most supply-side policies exert their effect in the long-run because it takes time to educate and train workers, build roads and telecommunication networks and to develop new and more efficient technology.
Finally, supply-side policies may be very expensive so there is an opportunity cost involved. For example, an increase in government spending on the infrastructure may mean less spending on education or healthcare.