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Supply-Side Policy » Supply-Side Policy Measures

What you'll learn this session

Study time: 30 minutes

Cambridge spec: 4.4.1, 4.4.2

What supply-side policy is and how it differs from fiscal and monetary policy
The seven supply-side measures in the syllabus
How each measure works to make the economy able to produce more
How to explain a measure step by step in an exam answer

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What is supply-side policy?

The last two lessons were about fiscal policy and monetary policy. Both mainly try to change how much people spend. Supply-side policy is different. It is about how much the economy is able to produce.

Key terms:

Supply-side policy: government policies that aim to increase the productive capacity of the economy, so that it can produce more goods and services, usually by making markets and firms work better.

Think of a country as a factory. Fiscal and monetary policy try to bring more customers through the door. Supply-side policy tries to build a bigger, better factory. If it works, the PPC from earlier in the course shifts outwards.

Supply-side policies often take years to work. A new college or a new railway line does not change output overnight. That is a key difference from a change in the interest rate, which can change spending quickly.

The seven supply-side measures

Cambridge lists seven measures. Each one works by improving the quantity or quality of resources, or by giving people and firms a stronger reason to produce.

1. Education and training

The government pays for schools, colleges and training programmes. Workers gain skills, so they can produce more in each hour. Remember, output per worker is called productivity. Better-skilled workers are also easier to move into new jobs when industries change.

2. Infrastructure spending

The government spends on roads, railways, ports, power and internet networks. Goods reach markets faster and cheaper, and firms waste less time and fuel. Good infrastructure also makes a country more attractive to firms that want to set up there.

3. Labour market reforms

These are changes that make the labour market work better, so that workers and jobs are matched more easily. Examples include:

Helping workers retrain or move to where jobs are, which improves mobility of labour.
Making it easier for firms to hire and lay off workers.
Reducing the power of trade unions to hold up wages.

Supporters say firms then hire more readily and labour is used more efficiently. Critics say workers may lose job security and pay.

4. Lower direct taxes

Direct taxes are taken from incomes and profits. Cutting income tax means workers keep more of each extra dollar they earn, so more people look for work and some work longer hours. Cutting the tax on firms' profits leaves them more to invest in machinery.

5. Deregulation

Deregulation means removing or reducing rules and restrictions on firms. It makes it easier for new firms to enter a market and compete. Lower costs of following rules and more competition push firms to improve and to produce more.

6. Improving incentives to work and invest

An incentive is a reward that encourages an action. A government may:

Reduce the benefits a person loses when they take a job, so that work clearly pays more than not working.
Give firms grants or tax relief when they buy new machinery or train workers, so that investing becomes more worthwhile.

If a person or firm gains more from working or investing, more of it is likely to happen.

7. Privatisation

Remember, privatisation is the sale of government-owned firms to the private sector. As a supply-side measure, the idea is that private owners want profit, so they cut waste and improve quality. Once the firm is free of government control, it may also face more competition, which adds to the pressure to improve. Critics worry that essential services may become more expensive or that private firms may ignore less profitable users.

🎓 Improves quality

Education and training raise the skills of workers, so each worker can make more.

💪 Improves incentives

Lower direct taxes and incentives to work and invest give people and firms a stronger reason to produce.

Worked example: Keldara

Keldara is a made-up country with poor roads. Lorries take two days to bring crops from farms to the port. The government builds a new road and the journey takes one day. Farmers lose fewer crops on the way and can send more each week. This is infrastructure spending: it makes it cheaper and quicker to produce and sell goods, so the economy can produce more.

Common mistakes

Writing that supply-side policy "raises demand". Its main aim is to raise what the economy can produce. Interest-rate changes, and tax cuts aimed at boosting spending, are mainly about demand. A cut in direct taxes is supply-side when the aim is to improve incentives to work and invest.
Writing "the government spends money" with no link to output. Say how the spending helps: workers become more productive, or goods move more cheaply.
Saying a measure works quickly. Most supply-side measures take years.
Mixing up deregulation and privatisation. Deregulation removes rules. Privatisation changes who owns the firm.

Exam-style question

Ostmark is a made-up country. Its firms find it hard to hire skilled workers, and its roads are in poor condition. The government plans to cut income tax and to spend more on training courses.

(a) Define supply-side policy. [2 marks]

(b) State two supply-side policy measures other than those in the paragraph. [2 marks]

(d) Analyse how a cut in income tax may increase the amount that Ostmark can produce. [3 marks]

Model answer

(a) Government policies (1) that aim to increase the productive capacity of the economy, so it can produce more (1).

(b) Any two from: infrastructure spending (1), labour market reforms (1), deregulation (1), improving incentives to work and invest (1), privatisation (1). Note that income tax and training are already in the paragraph, so they do not score. A general "lower direct taxes" would repeat the income tax cut.

(c) Training gives workers more skills (1). Skilled workers can produce more in each hour, so productivity rises (1). Firms can then fill vacancies and produce more at lower cost per unit (1).

(d) A cut in income tax means workers keep more of what they earn (1). This gives people a stronger incentive to take a job or work longer hours (1), so the number of workers and hours worked rise, and the economy can produce more (1).

Exam tip

In part (b), check which measures the question has already named. Repeating them earns no marks, so pick two different ones from the list of seven.

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