Supply-side policy
Key terms
Define each term.
Multiple choice
Circle the correct answer.
Which of the following is a supply-side policy?
An economy is producing at a point inside its production possibility curve. Which statement is correct?
Against a vertical LRAS curve, an increase in aggregate demand will:
Worked problems
Show your working.
Measuring the effect of a training programme. A factory employs 8 workers who together produce 240 units a week. After a government-funded training scheme, the same 8 workers produce 300 units a week. Calculate labour productivity before and after, and the percentage change.
Chains of reasoning
The steps are in the wrong order. Write the letters in the order that makes a linked chain.
How training delivers non-inflationary growth
- A Real output and employment rise while the price level falls, since capacity has grown rather than demand.
- B Growth achieved this way is non-inflationary, which no demand-side policy can deliver.
- C The government funds vocational training, raising the skill level of the workforce.
- D Lower unit costs mean firms are willing to supply more at every price level, so LRAS shifts right.
- E Higher productivity lowers the cost of producing each unit of output for firms.
- F With aggregate demand unchanged, the equilibrium moves along AD to the new LRAS.
- G Better-skilled workers produce more per hour, so labour productivity rises.
Diagrams
Draw a production possibility curve for an economy producing capital goods and consumer goods. Show the effect of a successful supply-side policy. Then, on the same diagram, mark a point inside the curve and show what a successful demand-side policy would do from there.
Draw an AD/AS diagram with a vertical LRAS. Show a successful supply-side policy shifting LRAS right, and mark the change in real output and the price level. On a second diagram, show an equivalent rightward shift of AD against the same vertical LRAS.
Answers
Supply-side policy: Government measures intended to increase the productive capacity of the economy by improving the quantity or quality of the factors of production, or the efficiency with which they are used.
C. Apprenticeships raise the skill of the workforce, so output per worker rises and productive capacity increases. The interest rate cut and the welfare increase both work by raising demand, and a higher unemployment benefit is generally argued to weaken the incentive to take work, so if anything it acts against the supply side.
B. A point inside the curve means resources are unemployed, so raising demand can bring them into use and increase output with no change in capacity. Supply-side policy still shifts the curve outwards, but it does not address the immediate problem, which is that existing capacity is going unused.
B. A vertical LRAS means capacity is fixed in the long run, so extra demand meets a supply that cannot expand and is absorbed entirely by prices. This is the analytical core of the case for supply-side policy: without shifting LRAS, demand management cannot raise long-run output.
Step 1. Calculate productivity before the training. Labour productivity = total output / number of workers = 240 / 8 = 30 units per worker per week.
Step 2. Calculate productivity after the training. 300 / 8 = 37.5 units per worker per week.
Step 3. Calculate the percentage change. Change = 37.5 - 30 = 7.5. Percentage change = (7.5 / 30) x 100 = 25%.
Step 4. Explain why this is a supply-side effect. The workforce has not grown and no extra spending is required to sustain the gain. The same eight workers now produce more, so the firm's costs per unit fall and the economy's productive capacity has risen. That is a change in what can be produced, not in how much is being demanded.
Always divide by the input. Candidates who compare 240 with 300 and report a 25% rise in output have answered a different question, and the fact that the answer happens to be 25% here will not save them when the workforce also changes.
C, G, E, D, F, A, B
- The government funds vocational training, raising the skill level of the workforce.
- Better-skilled workers produce more per hour, so labour productivity rises.
- Higher productivity lowers the cost of producing each unit of output for firms.
- Lower unit costs mean firms are willing to supply more at every price level, so LRAS shifts right.
- With aggregate demand unchanged, the equilibrium moves along AD to the new LRAS.
- Real output and employment rise while the price level falls, since capacity has grown rather than demand.
- Growth achieved this way is non-inflationary, which no demand-side policy can deliver.
The final step is the one worth stating explicitly. Fiscal or monetary expansion raises output at the cost of a higher price level; supply-side expansion raises output and eases the price level. AO2 is 40% of the written papers, and this contrast is where those marks sit.
This is the cleanest way to see the difference. Supply-side policy shifts the whole curve outwards, raising what is possible. Demand-side policy moves the economy from a point inside the curve towards it, using capacity that already exists. An economy already on its curve can only grow by shifting it.
Drawing both is the argument. Against a vertical LRAS, a rightward AD shift raises the price level and leaves real output unchanged, which is the purest statement of why demand policy cannot deliver long-run growth. The LRAS shift raises output and lowers the price level. Examiners reward candidates who use the comparison rather than describing one diagram.