Download Supply-Side Economics

Supply-Side
Economics
Economics at Klein Oak High School
Fall 2003
Review Keynesian Economics

focus on demand side


aggregate demand (AS) management
C+I+G+(Ex-Im)=GDP
Keynesian Recession Strategy

increase AD

increase G (government spending)


government spends more
increase C (consumption)


decrease taxes (fiscal policy)
increase money supply (monetary policy)
Keynesian Inflation Strategy

decrease AD

decrease G (government spending)


government spends less
decrease C (consumption)


increase taxes (fiscal policy)
decrease money supply (monetary policy)
Supply Side Perspective

stagflation is different

caused by decrease in AS (aggregate supply)

because lower supply  lower output (GDP) and
higher prices (inflation)
Cause of Decrease in AS

government policy (unintended
consequences)

high taxes

discourage business investment
 “tax wedge” decreases after tax rate of return

decrease savings
 same reason
 causes higher interest rate  decreases business
investment
Note on “Tax Wedge”

difference between what is paid and what is
received

ex: to pay $5.50 to an employee costs a
business $7.00, due to taxes


after taxes, the employee receives $4.50
difference between $7.00 cost to business and
$4.50 incentive to employee is the “tax wedge”
Cause of Decrease in AS (2)

government policy (unintended
consequences)

high taxes

discourage work
 “tax wedge” increases after tax cost to business
 “tax wedge” decreases after tax return to employee
 therefore, employment decreases and so does
production
Cause of Decrease in AS (3)

government policy (unintended
consequences)

excessive regulation


increases cost of production  decreases supply
supply shock

little can be done about this but it isn’t a long run
problem
Supply Side Goal
Supply Side Policy

increase AS



reduce taxes on business
reduce regulation on business
reduce taxes on savers

people with a high “marginal propensity to save”
 i.e. people who save additional dollars
 primarily high income people
The Laffer Curve


after a point the
disincentive effect of
higher tax rates will
result in high rates
reducing tax revenue
more
Implications of Laffer Curve

it’s possible to raise rates and get less
revenue


the higher rates cause a “recession”
it’s possible to lower rates and get more
revenue

if the lower rates stimulate the economy enough
Tax Fairness

tax cuts will give more $ to wealthy than to
others because


wealthiest 50% pay 96% of income taxes
wealthiest 5% pay 53% of income taxes
Short-run vs. Long-run

Keynes: “In the long run we are all dead.”

Keynes ignored the long run complications of the
policies he advocated.


Of course, it was the great depression.
Supply-side policies focus on the long run

emphasis on incentives

requires that people and businesses can depend
on policies remaining in force for years
Effect of Supply–Side Ideas



Most economists still primarily Keynesian.
However, most now acknowledge that we
must consider the supply-side effects of our
policies.
Recommendations are now more long-run
in perspective.