Definition of supply-side policy

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Government and the Macro‑economy – Supply‑side Policy

4.4.1 Definition (Cambridge IGCSE 0455)

Supply‑side policy is a set of government measures that increase the productive capacity of the economy, thereby shifting the long‑run aggregate‑supply (LRAS) curve to the right.

4.4.2 Main Objectives

  • Raise the quantity and quality of the factors of production – labour, capital, land and entrepreneurship.
  • Improve the efficiency with which resources are allocated.
  • Boost productivity and the country’s international competitiveness.
  • Reduce structural (long‑term) unemployment.
  • Support sustainable, long‑run economic growth while keeping inflation under control.

4.4.3 Supply‑side Measures Required by the Syllabus

The syllabus expects nine categories. For each, a brief description and an illustrative example are given.

  1. Education, training and skills development – free vocational courses, apprenticeships, university scholarships.
  2. Research, development and innovation incentives – R&D tax credits, grants for university‑industry collaboration, subsidies for start‑up incubators.
  3. Lower direct taxes on labour and capital – reduced income‑tax rates, lower corporation‑tax rates, reduced National Insurance contributions.
  4. Incentives to work and to invest – wage subsidies for the long‑term unemployed, tax relief for new plant‑and‑machinery investment, capital‑allowance incentives.
  5. Deregulation and removal of barriers to entry – simplifying licensing procedures, cutting compliance costs, eliminating unnecessary regulations.
  6. Privatisation of state‑owned enterprises – selling utilities, transport firms or telecoms to private owners.
  7. Infrastructure investment – building motorways, expanding broadband networks, upgrading energy grids and public transport.
  8. Labour‑market reforms – flexible wage‑setting, reducing trade‑union power, introducing flexible working hours, encouraging part‑time or self‑employment.
  9. Environmental sustainability measures (cross‑cutting) – subsidies for renewable‑energy technologies, green‑technology tax breaks, carbon‑pricing schemes that also encourage productivity gains.

4.4.4 How Supply‑side Policies Affect the Economy

Policy Action Immediate (short‑run) Effect Long‑run Effect on LRAS
Improved education & training Higher skill levels; modest rise in wages and employment Right‑ward shift of LRAS – more productive labour force
R&D & innovation incentives Increased private sector research; new products & processes Right‑ward shift of LRAS – higher total factor productivity
Lower direct taxes on firms Higher after‑tax profit; greater investment spending Right‑ward shift of LRAS – larger capital stock
Tax credits for work or investment More people seek employment; firms expand capacity Right‑ward shift of LRAS – greater output potential
Deregulation / reduced entry barriers Lower compliance costs; new firms enter market Right‑ward shift of LRAS – more efficient allocation of resources
Privatisation of state‑owned enterprises Improved management incentives; possible short‑run restructuring costs Right‑ward shift of LRAS – higher efficiency and output
Infrastructure projects (roads, broadband, energy) Reduced transport and communication costs; lower business‑operation costs Right‑ward shift of LRAS – lower production costs, higher productivity
Labour‑market reforms Greater flexibility in hiring/firing; reduced wage rigidity Right‑ward shift of LRAS – better utilisation of labour resources
Environmental sustainability measures Adoption of cleaner technologies; possible short‑run cost increase Right‑ward shift of LRAS – sustainable growth and lower long‑run energy costs

4.4.5 Quick‑review Diagram (Suggested)

Draw the LRAS curve before and after a supply‑side policy:

  • Horizontal axis: Real GDP (output)
  • Vertical axis: Price level
  • Show the original LRAS (vertical) and a second LRAS shifted to the right.
  • Label the shift “Increase in productive capacity – result of supply‑side policy”.
  • Optionally add a short‑run AD/AS diagram to illustrate that the shift raises potential output without moving the price level in the long run.

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