Test Your Knowledge Flash Cards 🔒Play Lemonaire 🔒Play Last Stand

Supply-Side Policy » Supply-Side Policy and the Macroeconomic Aims

What you'll learn this session

Study time: 30 minutes

Cambridge spec: 4.4.3

How supply-side policy may help a government reach each of its six macroeconomic aims
One short cause-and-effect chain for each aim
Which supply-side measure fits which aim best
How to write a clear chain of reasoning in an "Analyse" answer

🔒 Unlock Full Course Content

Unlock This Course

From measures to aims

In the last lesson you met the seven supply-side measures: education and training, infrastructure spending, labour market reforms, lower direct taxes, deregulation, improving incentives to work and invest, and privatisation. Each one tries to raise what the economy is able to produce.

This lesson asks a different question: so what? Why would a government bother? The answer is that a stronger, more productive economy can help it reach its macroeconomic aims. Remember, the six aims are economic growth, full employment, stable prices, balance of payments stability, redistribution of income and environmental sustainability.

The word may is important. A policy does not always work, and some work slowly. In this lesson you only show how a measure may help. Judging how well it works comes later, in the lessons on each aim.

How supply-side policy may help each aim

Below is one short chain for each aim. Notice that every chain starts with a measure and ends with the aim. The steps in the middle are where the marks are.

1. Economic growth

🎓 The chain

The government spends more on education and training. Workers gain skills, so output per worker rises. The economy's productive capacity grows, so it can produce more goods and services and real GDP may rise.

📈 In diagram terms

This is an outward shift of the PPC. The country can now reach combinations of goods that were unattainable before.

2. Full employment

The government cuts direct taxes or improves incentives to work, so a job pays more clearly than not working. More people look for jobs and accept them. At the same time, firms keep more of their profits, so they expand and need more workers. Labour market reforms that help workers retrain or move to where jobs are also help people to match with vacancies. Unemployment may fall.

3. Stable prices

The government builds better roads and ports, so firms spend less on transport and wasted time. Their costs per unit fall. Firms are then under less pressure to raise prices. As the economy can also produce more, supply keeps up with spending, so prices rise more slowly and inflation may be lower.

4. Balance of payments stability

The government deregulates and invests in training. Firms become more productive and face more competition, so their costs fall and the quality of their goods improves. Exports become cheaper and better for foreign buyers. Home buyers find home-made goods more attractive than imports. Export earnings may rise and spending on imports may fall, so a current account deficit may shrink.

5. Redistribution of income

The government pays for training for low-skilled workers. With new skills, they can move into better-paid jobs. Unemployed people who find work gain a wage. Low incomes rise faster, so the gap between low and high incomes may narrow.

6. Environmental sustainability

The government gives firms grants or tax relief when they buy new, cleaner machinery. Firms replace old, polluting equipment. New machines often use less energy and waste fewer materials for each unit produced. Pollution and resource use for each unit of output may fall, which supports sustainability.

Worked example: Dovrane

Dovrane is a made-up country where many young people have left school with few skills and unemployment is high. The government opens technical colleges and cuts the income tax paid by workers on low pay.

Employment: the tax cut means workers keep more of each extra dollar, so more people take jobs. The colleges give job-seekers skills that firms want, so firms can fill vacancies. Unemployment may fall.

Growth: more people in work, and each worker with more skills, means more output. Real GDP may rise.

One policy can help more than one aim. In an exam, choose the aim in the question and follow its chain.

Matching measures to aims

Almost any measure can be linked to an aim if you reason it through. These links come up most often:

Education and training: growth (productivity), employment (skills match jobs), redistribution (higher pay for low earners).
Infrastructure spending: growth and stable prices (lower costs for firms), balance of payments (cheaper exports).
Lower direct taxes and better incentives: employment (more people willing to work), growth (more work and investment).
Deregulation: stable prices and balance of payments (more competition, lower costs and better quality).
Grants for investment: sustainability (cleaner machines) and growth (more capital).

Common mistakes

Jumping straight from the measure to the aim, such as "training reduces inflation". Show the steps in between: lower costs, then less pressure to raise prices.
Writing that supply-side policy works by raising spending. Its chain runs through productivity, costs and productive capacity.
Saying a measure "will" achieve an aim. Use "may", because results are not certain and often take years.
Using the wrong direction for the balance of payments. Lower costs make exports cheaper and help to narrow a deficit. They do not make imports cheaper.

Exam-style question

Pennoria is a made-up country. Its economy is growing slowly and prices are rising quickly. Firms say that poor roads raise their costs and that many workers lack the skills they need. The government plans to spend more on roads and on training colleges.

(a) Identify two macroeconomic aims of a government. [2 marks]

(b) Explain how spending on roads may help economic growth in Pennoria. [3 marks]

Model answer

(a) Any two from: economic growth (1), full employment (1), stable prices (1), balance of payments stability (1), redistribution of income (1), environmental sustainability (1).

(b) Better roads let goods move faster and more cheaply (1). Firms waste less time and money, so they can produce more (1). The productive capacity of the economy rises, so real GDP may grow (1).

(c) Better roads cut firms' transport costs, and training makes workers more productive (1). Costs per unit of output fall (1). Firms then have less need to raise prices (1). The economy can also produce more, so supply keeps up with spending and prices may rise more slowly (1).

Exam tip

In "Analyse" questions, write each step as its own short sentence and join them with "so" or "which means". Start at the measure and finish at the aim named in the question.

Test Your Knowledge