Definition of supply-side policy

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 ActionImmediate (short‑run) EffectLong‑run Effect on LRAS
Improved education & trainingHigher skill levels; modest rise in wages and employmentRight‑ward shift of LRAS – more productive labour force
R&D & innovation incentivesIncreased private sector research; new products & processesRight‑ward shift of LRAS – higher total factor productivity
Lower direct taxes on firmsHigher after‑tax profit; greater investment spendingRight‑ward shift of LRAS – larger capital stock
Tax credits for work or investmentMore people seek employment; firms expand capacityRight‑ward shift of LRAS – greater output potential
Deregulation / reduced entry barriersLower compliance costs; new firms enter marketRight‑ward shift of LRAS – more efficient allocation of resources
Privatisation of state‑owned enterprisesImproved management incentives; possible short‑run restructuring costsRight‑ward shift of LRAS – higher efficiency and output
Infrastructure projects (roads, broadband, energy)Reduced transport and communication costs; lower business‑operation costsRight‑ward shift of LRAS – lower production costs, higher productivity
Labour‑market reformsGreater flexibility in hiring/firing; reduced wage rigidityRight‑ward shift of LRAS – better utilisation of labour resources
Environmental sustainability measuresAdoption of cleaner technologies; possible short‑run cost increaseRight‑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.