hw micro and macro economy

Macroeconomics Chapter 16 Supply Side Policy: Short Run Options Instructor: C. Speranzo

Chapter 16: Supply Side Policy

LO 1: Why the short-run AS curve sloped upward

LO 2: How an unemployment – inflation trade-off arises

LO 3: The tools of supply-side policy

Aggregate supply: the total quantity of output producers are willing and able to supply at alternative prices levels in a given time period, ceteris paribus

Stagflation: the simultaneous occurrence of substantial unemployment and inflation

Keynesian: concerned with unemployment; did not think risk of inflation in depths of recession

Monetarist: real output remains at natural state regardless of fiscal or monetary interventions; prices rise but do not entice producers to increase output; rather based decision on technology and market size

Hybrid: the closer to capacity, the greater risk that fiscal or monetary stimulus will spill over into price inflation.

The inflation-unemployment trade – off

Because both prices and output respond to demand side-shifts, the economy cannot reduce both unemployment and inflation at the same time – at least not with fiscal and monetary policies

Demand stimulus – fiscal and monetary efforts to reduce unemployment will also cause some inflation

Demand restraint – monetary and fiscal efforts to reduce inflation will also increase unemployment

The Phillips curve – a historical (inverse) relationship between the rate of unemployment and the rate of inflation, commonly expresses a trade-off between the two.

Developed by New Zealand economist, Alban Phillips

Inflationary flashpoint – the rate of output at which inflationary pressures intensity; the point on the AS curve where slope increases rapidly

Misery Index (Arthur Okum) a simple sum of the inflation and unemployment rates – measure of stagflation

Combines both problems into a single measure of macro performance

Policy Tools – how to shift AS – look at clues among forces that influence supply side response to changes in demand

· Tax incentives for saving, investment, work

· Human capital investment

· Deregulation

· Trade liberalization

· Infrastructure development

Supply – side theory Keynesian demand – side theory

Cut tax rates to boost incentives to work and invest cut tax rates to put more disposable income in people’s

Hands

Firms invest more and try new ventures; jobs are created; People use increased income to buy more goods and

AS increases services – AD increases

New investment and labor bring increased output To meet new demand, co’s expand output

both

Employment rises; new plants go up,

The whole economy expands

In Keynesian economics, tax cuts are used to increase AD

Taxes not only alter disposable income but also change incentives to work and produce.

The direct effects of taxes on supply of goods are the concern of supply-side economists.

Marginal tax rate – the tax rate imposed on the last (marginal) dollar of income

If marginal tax rate is high, there’s less incentive to work more – since most would go to US taxes

Discourages entrepreneurship since taxes as personal

Investment – expenditures on (production of) new plants, equipment, and structures (capital) in a given time period, plus changes in business inventories

If high tax rates discourage investment, AS will be constrained

Tax rebate- a lump sum refund of taxes paid

Tax elasticity of supply – the % change in quantity supplied divided by the % change in tax rates

Tax elasticity of supply = % change in quantity supplied/ % change in tax rate

Saving – that part of disposable income not spent on current consumption;; disposable income less consumption

Supply – side economists favor tax incentives that encourage saving as well as greater tax incentives for investment

Human Capital Investment

Human capital – the knowledge and skills possessed by the workforce

Structural unemployment – unemployment caused by a mismatch between the skills (or location) of job seekers and the requirements (or location) of available jobs

Investment in human capital reduces structural unemployment and shift the AS curve rightward.

Labor productivity – amount output produced by a worker in a given period of time; output per hour

Transfer payments – payments to individuals for which no current goods or services are exchanged, like Social Security, welfare, and unemployment benefits

Deregulation- raise production costs, est cost over $700B/yr

Factor markets – raise cost of production

Minimum wages – make more difficult to achieve full employment with stable prices

Mandatory benefits – FMLA – incur costs of absences and incur costs of replacements

Occupational Health and Safety - congress rescinded new ergonomics rules

Product Markets - regulation of factor markets raise production costs and inhibit supply

Transportation costs – increase shipping costs

Food and Drug Standards – cause fewer new drugs and increase costs of those reach market

The basic contention of supply-side economics is that regulatory costs are now too high.

Reducing Costs – balance safety and economic costs

Easing trade Barriers

Factor markets – restriction of foreign inputs make US AS expensive e.g. import sugar high, candy, cookies high

Product Markets – nontariff barriers constrain AS e.g. Mexican truckers and US

Immigration - skill shortages in US helped out by skilled visas

Infrastructure Development

Infrastructure – the transportation, communications, education, judicial, and other institutional systems that facilitate market exchanges; spending on infrastructure not only creates fiscal stimulus (AD) but also increases the capacity to produce (AS).

Because investment is always a bet on future economic conditions, expectations directly affect the shape of the AS curve.

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