Evaluate the use of supply side policies in raising the level of real output in an economy which is near to full employment

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Question: Evaluate the use of supply side policies in raising the level of real output in an economy which is near to full employment.

Answer

        A supply side policy is one which attempts to improve incentives and productivity in an economy (so increasing the productive potential of the economy) thereby shifting the LRAS to the right. An example of a supply side policy would be to lower certain taxes (for example high income tax leads to less people working and high corporation tax can reduce incentives of firms to make profits) to raise the LRAS. Improved education and training is another supply side policy as it raises the level of human capital, therefore resulting in a rise in LRAS. Privatisation gives firms a profit incentive, which increases efficiency, also shifting LRAS to the right.  

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All these policies will result in an increase of LRAS from LRAS1 to LRAS2. This will increase the real output from RO1 to RO2 and will decrease the price level from Pl1 to Pl2. The economy here is at Full Employment as the level of aggregate demand is at the level where the LRAS curve is vertical. The increase in LRAS has a favourable effect on inflation as price level decreases.

However, improved education and training involves an opportunity cost as the money could be spent elsewhere. Also, there is a time lag before the full effects are ...

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