3.7.1 An Overview of Supply-Side Policies

• Supply-side policies aim to shift the long-run aggregate supply (LRAS)
• There are two categories of supply-side policies
  • Interventionist and market-based
    
    
• Interventionist supply-side policies require government intervention in order to increase the full employment level of output
  
  • These are mainly used to correct market failure
    
    
• Market-based supply-side policies aim to remove obstructions in the free market that are holding back improvements to the long-run potential
  • E.g. Setting up a regulator to prevent monopolies from forming

• Supply-side policies can be extremely useful in generating long term growth, lowering average price levels, and creating new jobs in an economy

The five goals of Supply-side policy
  

• When successful, supply-side policies have the following effects on the government's macroeconomic objectives

1. Economic growth: potential national output increases leading to higher real gross domestic product (rGDP)
2. Inflation: a greater supply in the economy results in reductions in the prices of goods/services leading to disinflation and making the exports of the nation more competitive
3. Unemployment: this should fall as lower wage bills allow firms to recruit more workers
4. Net external demand: due to the increased supply, the prices of goods/services often decrease which makes them relatively more attractive to foreigners - so exports increase
5. Redistribution of income: this often worsens with the use of supply-side policies as wages fall and government tax revenue has fallen too
    

• Market based supply-side policies aim to free up markets and improve market incentives so as to increase the long-run aggregate supply
   

An Explanation of Market Based Supply-side Policies

The possible impact of abolishing minimum wages

• A national minimum wage (NMW) is a legally imposed wage level that employers must pay their workers
  • It is set above the market rate
  • Removing it will allow wage levels to fall, thus reducing the costs of production for firms

Removing the national minimum wage (NMW₁) may cause wage rates to fall from W₁ to W_e

Diagram Analysis

• The demand for labour (D_L) represents the demand for workers by firms
• The supply of labour (S_L) represents the supply of labour by workers
• The national minimum wage and quantity for truck drivers in the UK is seen at W₁Q_d
• The UK government removes the national minimum wage (NMW) at W₁
• Incentivised by lower wages, the demand for labour by firms increases from Q_d → Q_e
• Facing lower wages, the supply of labour by workers decreases from Q_d → Q_e
• The labour market is now in equilibrium at W_eQ_e - a lower wage rate and higher quantity of workers employed

• Interventionist supply-side policies require government intervention in order to increase the full employment level of output
   

An Explanation of Interventionist Supply-side Policies

• Successful supply-side policies will increase the long-run aggregate supply (LRAS)
  • This equates to an increase in the production possibilities of an economy
    
    
• The successful implementation can be illustrated on either a Classical or Keynesian diagram
  
  

A Classical diagram that illustrates the implementation of a successful supply-side policy

A Keynesian diagram that illustrates the implementation of a successful supply-side policy

Diagram Analysis

• Efforts to reduce trade union power have been successful
  • There is now less protection on wage levels and wage levels fall
    
• Firms may hire more workers and the quantity of productive labour in the economy has increased
  • This causes LRAS₁ to increase to LRAS₂  
    • Output increases from Y_FE to Y_FE1
    • Average price levels fall from AP₁→AP₂