Supply-side policies, the distinction between market-based and interventionist measures, their effects on AS and the macroeconomic objectives, and their limitations.

What this dot point is asking

AQA wants you to explain supply-side policies, distinguish market-based from interventionist measures, analyse their effects on aggregate supply and the macroeconomic objectives, and evaluate their limitations. The contrast with demand-side policy and the case for non-inflationary growth are the key marks.

What supply-side policies do

By raising capacity rather than demand, they can deliver non-inflationary growth, the rare combination that can improve several macroeconomic objectives at once. This is their central advantage over demand-side policy, which raises output only by also raising the price level once the economy nears capacity.

Market-based versus interventionist

The two approaches reflect different views of how markets work. Market-based reform assumes the state crowds out efficiency and that lower taxes and lighter regulation unleash enterprise. Interventionist policy assumes markets under-provide public goods such as education, infrastructure and research, so the state must invest to build capacity. In practice governments use a mix.

Effects on the objectives

A successful rightward shift of LRAS can:

• raise economic growth by expanding capacity,
• lower inflation because a higher level of output can be supplied at any given price level,
• reduce structural unemployment through better skills, mobility and incentives, and
• improve the balance of payments by raising productivity and international competitiveness.

This ability to improve growth, inflation, employment and the current account together is why supply-side policy is so prized, and why it is the long-run complement to demand management.

Limitations

Supply-side policies have important limits: they are often slow to take effect (education and infrastructure take years to raise capacity), many carry a high opportunity cost and worsen the budget in the short run, some (such as benefit cuts and weaker union power) can increase inequality, and there is no guarantee of success (a tax cut may be saved rather than used to work harder or invest). They also do little to fix a short-run shortfall in aggregate demand, so in a deep recession they need to be paired with demand-side stimulus.