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.