Question 1

Is cutting income tax a demand-side or supply-side policy?

Accepted Answer

It can be both, and it is crucial to distinguish the two effects. As a demand-side (fiscal) policy, lower income tax increases households' disposable income, boosting consumption and aggregate demand. As a supply-side policy, the aim is to increase the incentive to work. It may encourage the unemployed to take a job or existing workers to work more hours, thus increasing the size of the labour force and shifting LRAS to the right.

Question 2

Are supply-side policies only useful for achieving long-run growth?

Accepted Answer

While their primary objective is to increase long-run aggregate supply, they can have short-run effects. For instance, announcing a major infrastructure project can boost business confidence and investment (an AD component) in the short run. However, their main purpose and the criteria by which they are judged relate to their long-term impact on the economy's productive potential and the LRAS curve.

Question 3

Do supply-side policies always work as intended?

Accepted Answer

No, their success is not guaranteed and they are subject to government failure. Interventionist policies can be inefficiently managed, leading to wasted resources (e.g., building infrastructure that is not needed). Market-based policies can have unintended consequences; for example, deregulation might lead to a decline in safety standards or environmental quality, and tax cuts may be used to fund higher dividends for shareholders rather than for new investment.

Supply-side policy

What you need to know

Supply-side policy