Supply-side policies

Aims

Supply-side policies try to raise productivity (output per worker), competition (so firms become more efficient) and incentives (to work, invest and take risks). If they work, LRAS shifts right: more output at a lower price level, lower natural unemployment and better competitiveness.

Free market supply-side policies

• Deregulation of product markets (removing barriers to entry) and labour markets (fewer restrictions on hiring and firing, weaker union power, flexible contracts).
• Privatisation: selling state-owned firms to the private sector, to add the profit incentive.
• Tax reductions: cutting income tax to raise incentives to work; cutting corporation tax to raise investment and attract FDI.
• Changing welfare payment levels: reducing benefits relative to wages to increase the incentive to take a job.
• Cutting bureaucratic costs for firms: reducing red tape and compliance costs.

Interventionist supply-side policies

• Education, training and skills: raises human capital and occupational mobility.
• Tax incentives or subsidies for investment: to raise the capital stock.
• Infrastructure investment: transport, energy, broadband, lowering firms' costs.
• Finance for start-ups: loans and grants to new firms, raising competition and innovation.
• Regional policy: incentives for firms to locate in depressed areas, tackling structural unemployment.

Strengths and weaknesses

Strengths: can raise growth without inflation; reduce structural and frictional unemployment; improve competitiveness and the current account.

Weaknesses: time lags (education takes years); costly to the government (opportunity cost; budget deficit); uncertain effectiveness (tax cuts may not raise work effort much); inequality (tax cuts for high earners, lower benefits and weaker job security hurt the poor); privatised monopolies may need regulation; deregulation may cause environmental or safety problems. They do little to fix a sudden fall in AD.

Worked example

Evaluate spending on infrastructure as a supply-side policy.

1. Better transport and energy networks cut firms' costs and journey times, raising productivity and attracting FDI, so LRAS shifts right.
2. It also raises AD in the short run through the multiplier.
3. But it is costly, may increase the budget deficit, and takes years to plan and build; projects may run over budget or be poorly chosen.

Answer: Likely to raise capacity in the long run, but with time lags, opportunity costs and project risks.

Check yourself

1. Which is a free market supply-side policy?
   • Privatisation of a state-owned airline
   • Government spending on apprenticeships
   • Subsidies for firms locating in deprived regions
   • Building a new high-speed railway
   Show answer

   Privatisation of a state-owned airline. Privatisation reduces the role of the state.

2. Which is an interventionist supply-side policy?
   • Reducing employment protection laws
   • Cutting the top rate of income tax
   • Government funding for vocational training
   • Deregulating the taxi market
   Show answer

   Government funding for vocational training. The state actively provides or funds training to raise skills.

3. A key weakness of spending more on education as a supply-side policy is
   • a long time lag before productivity rises
   • it reduces AD
   • it reduces the labour force
   • it always causes inflation
   Show answer

   a long time lag before productivity rises. Students take years to enter the workforce.

4. Which supply-side policy is most likely to increase income inequality?
   • Free training for unemployed workers
   • Grants for start-ups in poor regions
   • Investing in public transport
   • Reducing unemployment benefits relative to wages
   Show answer

   Reducing unemployment benefits relative to wages. Lower benefits reduce the income of the poorest.

5. If successful, supply-side policies are shown on an AD/AS diagram by
   • a leftward shift of AD
   • a rightward shift of LRAS
   • a leftward shift of LRAS
   • a movement along LRAS
   Show answer

   a rightward shift of LRAS. They increase productive capacity.

6. Which type of unemployment are training and regional policies most directly aimed at?
   • Seasonal
   • Demand deficient
   • Frictional only
   • Structural
   Show answer

   Structural. They tackle occupational and geographical immobility.

7. Explain how a cut in corporation tax could shift LRAS to the right.
   Show answer

   Firms keep more of their post-tax profit, so the return on investment rises and they invest more in capital, which raises productivity and productive capacity; it may also attract FDI.. Lower tax, higher post-tax returns, more investment, more capacity.

8. Why are supply-side policies less useful in a sudden recession caused by a collapse in AD?
   • They act slowly and do not directly raise spending
   • They always reduce output
   • They raise interest rates
   • They make AD curves vertical
   Show answer

   They act slowly and do not directly raise spending. Recessions caused by falling demand need demand-side responses; supply-side effects take years.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.