Supply-Side Economics

“Supply creates its own demand”- Say’s Law

SUPPLY SIDE Economics

• 1980’s –Early 2000’s

• Producer Based

• Milton Freidman

• Government tries to influence GDP by influencing aggregate supply (the total quantity producers are willing and able to supply)

• Goal is to promote full employment while decreasing prices

Theory

• Production (supply) is the source that drives consumption and living standards. – In the long run, our income levels reflect our

ability to produce goods and services that people value.

Business organizations:

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25% 25%25%25%1. do not have profits as a goal.

2. have similar ownership structures.

3. do not include retail firms. 4. serve to link scarce

resources and consumer satisfaction.

START GOAL

How it changes Supply & Demand

Government Actions(Supply Side)

• Incentives for businesses

• Laissez-Faire Principles

• Decrease regulations

• Taxes Decrease (especially for Businesses)

• Can lead to Federal Deficits

Government Regulations

• Regulations strangle the growth of Aggregate Supply limiting the amount being produced

• Favor a laissez-faire government policy

Reduce Government Sector

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Taxes Decrease (especially for Businesses)

• “Supply-side economics” is also used to describe how changes in marginal tax rates influence economic activity. Supply-side economists believe that high marginal tax rates strongly discourage income, output, and the EFFICIENCY of resource use.

The Marginal Tax Rate

• The MARGINAL TAX RATE is crucial because it affects the incentive to earn. The marginal tax rate reveals how much of one’s additional income must be turned over to the tax collector as well as how much is retained by the individual. – For example, when the marginal rate is 40 percent, forty of every one

hundred dollars of additional earnings must be paid in taxes, and the individual is permitted to keep only sixty dollars of his or her additional income. As marginal tax rates increase, people get to keep less of what they earn.

An increase in marginal tax rates adversely affects the output of an economy in two ways:

• First, the higher marginal rates reduce the payoff people derive from work and from other taxable productive activities.

• Second, When people are prohibited from reaping much of what they sow, they will sow more sparingly. Thus, when marginal tax rates rise, some will opt out of the labor force. Others will decide to take more vacation time, retire earlier, or forgo overtime opportunities. Still others will decide to forgo promising but risky business opportunities. These adjustments and others like them will shrink the effective supply of resources, and therefore will shrink output.

The major incentive for taking risks to own a business is based on:

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1. managing others. 2. paying taxes. 3. making a profit. 4. having more leisure

time.

The Laffer Curve

• Economists Arthur Laffer argues:– after a point the

disincentive effect of higher tax rates will result in high rates reducing tax revenue

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– eliminate government debt, resolving any

apparent conflict between reducing revenue and fiscal responsibility.

Increasing Incentives

• Supply-side economists believe that the real problem was that high rates of taxation and heavy regulation had reduced the incentive to work, to save, and to invest.

• What was needed was not a demand stimulus but better incentives to stimulate supply.

Improve incentives by lowering taxes

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Make labor more responsive to supply and demand

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"Supply-side" economics was based primarily on:

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25% 25%25%25%1. stimulation of the business (supply) component.

2. government stimulation of consumer demands.

3. a repudiation of "trickle-down" theory.

4. increases in taxation.

• Will people have the incentive to work more if they pay less out in taxes?• Will the wealthy have the incentive

to produce more if they pay out less in taxes?

Supply-Side Tax Cuts—Workers • Problems: After-tax income is important to workers. But it is

only one -- a very important one, but nevertheless only one -- part of total job satisfaction. Job security, work environment, many other factors are also important, as numerous studies have shown. – Moreover, to enjoy the incentive of take home pay, you have to have

some pay to take home, and so these incentives mean nothing for the unemployed.

Supply-Side Tax Cuts—Firms

As far as businesses, It doesn't matter if taxes are smaller, if profitability expectations are dimmed because of a recession and unemployment, firms aren't going to be increasing productive capacity.

- They aren't able to sell all they can produce now. - A capital gains tax cut does nothing to guarantee

investment.- An investment tax credit may help a little more, at

least then there is some incentive to invest.

• Among the criticisms of supply-side economics is that it is unlikely a tax cut would substantially increase the supply of labor.

• When households receive a higher after-tax wage, they might have an incentive to work more, but they may also choose to work less.

Has it worked?

• Reagan’s deregulation of the banking system—led to – Savings &Loan crisis; $500 billion + taxpayer

bailout– 1990-91—Worst recession since WWII up to that

time.

Has it worked

• Clinton/Bush deregulation of banking system-led to – “Too Big to Fail” investment banks collapse; $900

billion bailout + $800 billion Stimulus Package

• Debt grows from $1 Trillion in 1980 to $10 trillion by 2008

Has it Worked?

• Created massive income inequality – Demand decreased as worker’s wages only

increased minimally• Thus, tax revenue decreased under a combination of

reduced taxes on the wealthy and less taxes from consumption.