Transcript Supply-Side Economics

Supply-Side
Economics
Economics at Klein Oak High School
Fall 2003
Review Keynesian Economics

focus on demand side
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aggregate demand (AS) management
C+I+G+(Ex-Im)=GDP
Keynesian Recession Strategy
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increase AD
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increase G (government spending)
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government spends more
increase C (consumption)
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decrease taxes (fiscal policy)
increase money supply (monetary policy)
Keynesian Inflation Strategy
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decrease AD
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decrease G (government spending)
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government spends less
decrease C (consumption)
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
increase taxes (fiscal policy)
decrease money supply (monetary policy)
Supply Side Perspective
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stagflation is different
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caused by decrease in AS (aggregate supply)
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because lower supply  lower output (GDP) and
higher prices (inflation)
Cause of Decrease in AS

government policy (unintended
consequences)
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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”
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difference between what is paid and what is
received
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ex: to pay $5.50 to an employee costs a
business $7.00, due to taxes

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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)
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government policy (unintended
consequences)
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excessive regulation

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increases cost of production  decreases supply
supply shock
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little can be done about this but it isn’t a long run
problem
Supply Side Goal
Supply Side Policy
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increase AS
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reduce taxes on business
reduce regulation on business
reduce taxes on savers
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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
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it’s possible to raise rates and get less
revenue

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the higher rates cause a “recession”
it’s possible to lower rates and get more
revenue
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if the lower rates stimulate the economy enough
Tax Fairness
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tax cuts will give more $ to wealthy than to
others because
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wealthiest 50% pay 96% of income taxes
wealthiest 5% pay 53% of income taxes
Short-run vs. Long-run
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Keynes: “In the long run we are all dead.”
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Keynes ignored the long run complications of the
policies he advocated.
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Of course, it was the great depression.
Supply-side policies focus on the long run
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emphasis on incentives
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requires that people and businesses can depend
on policies remaining in force for years
Effect of Supply–Side Ideas
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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.