Civil Engineering Reference
In-Depth Information
SUPPLY-SIDE ECONOMICS
One of the main hallmarks of economic policy since 1979 has been concern over
the supply side of the economy. The focus has shifted from government spending
and aggregate demand to production and aggregate supply.
Aggregate supply
can
be regarded as total production, and clearly many factors influence its size such as
the level of profits, ease of movement into and out of markets, the level of wages,
the efficiency of capital and labour, the level of fixed costs, etc. As a result, policy
oriented to the supply side has given rise to measures to increase incentives within
the economy. Indeed, economists concerned with this perspective prefer market
forces to government intervention. The Statement of Intent on Environmental
Taxation (HM Treasury 1997) was an early example of this approach. This set out
the UK government's intention to use the tax system to promote sustainable growth,
by shifting the tax burden away from 'goods', such as employment, towards 'bads',
such as pollution. The policy sought to achieve a 'double-dividend' - of increasing
capacity and reducing environmental damage.
Supply-side policy, therefore, is geared to making markets work more
efficiently. This has been achieved by reducing the structural rigidities that clutter
many markets. For example,
wages councils
were stripped of many of their
powers in the 1980s and formally abolished in 1993; trade union activities have
been restricted and union membership significantly reduced as a result; and
market competition has been opened up through privatisation and deregulation.
Similarly, governments have made broad reductions in rates of income tax - from
33 per cent to 20 per cent at the basic rate and from 83 per cent to 50 per cent for
the top rate - to provide more incentives for people to work harder. Indeed, there
seems to be no market that has escaped from the plethora of supply-side measures.
Aggregate Supply
By devising supply-side methods to promote competition in as many markets
as possible, governments believe they can reduce the money they spend on direct
intervention and encourage the entrepreneurial spirit that drives production. In
technical terms, this policy is designed to shift the aggregate supply curve to the
right. This is demonstrated in
Figure 13.3
. An aggregate supply curve represents the
relationship between the output firms would be willing to supply and the general
price level.
It would be nice to simply conclude that the aggregate supply curve slopes up
because, the higher the price level, the greater the incentive for producers to produce
more. But it must be emphasised that we are not talking about changes to individual
specific prices - the vertical axis represents changes to the general price level; it is an
index of the weighted average of all prices. In order to understand the true purpose
of the aggregate supply curve, we examine four situations:
1 large amounts of unused capacity
2 full capacity
3
an intermediate range between the two
4
increasing capacity in the long run.
