Demand-Side Effects of Supply-Side Policies

Introduction

• Economists argue that supply-side policies alone cannot lead to economic growth.
  In order for true efficiency or full capacity to occur, there must be a corresponding increase in AD.
• Luckily, some supply-side policies typically have short-term effects on AD.
  

Supply side policies that have demand-side effects:

• Industrial policies
• Cutting household income tax
• Reducing unemployment benefits (negative)
• Abolishing the minimum wage (negative)
  

Positive Demand-Side Effects

• These shift the LRAS and AD curve to the right, meaning there is economic growth without inflation.
  

Industrial Policies

• When the government chooses to support certain industries, those industries and their linked industries must hire workers leading to an increase in income and therefore consumption.
  

Reducing Personal Income Tax

• Cutting taxes increases disposable income for workers leading to a higher consumption.
  

Negative Demand-Side Effects

• No effect on aggregate demand in the long run.
• AD curve might even shift left in the short-run.
  

Reducing Unemployment Benefits

• Individuals that were relying on unemployment benefits now must cut back on excess or additional spending.
  

Minimum Wage Reduction

• Reducing the minimum wage results in workers receiving lower incomes and leading to a decrease in consumption.
  

Fiscal Policy Effects on the Supply Side

• The use of taxes and government spending are designed to affect AD but the use of fiscal policy can have unintended consequences on the supply-side.
  

How Fiscal Policies Affect the Demand Side

Increase in Spending

• Typically government spending on things like infrastructure, investment in human capital, education and healthcare leads to an increase in AD but also, in the long run, an increase in the potential output of an economy.
  

Expansionary Fiscal Policy

• Expansionary fiscal policy, like lower household income taxes, might increase the incentive to work harder and become more productive.
• Expansionary fiscal policy, like lower corporate taxes, might lead to increased investments and increased R&D.