SUPPLY SIDE ECONOMICS

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SUPPLY SIDE ECONOMICS
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Government and Aggregate Supply

• The stagflation of the 1970s led to the
  realization that all economic problems could not
  be solved by focusing solely on aggregate demand.
• Supply-side economists focus their attention on
  government policies such as high taxation that
  impede the expansion of aggregate supply.

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Government and Aggregate Supply

• Tax policies can improve the unemployment/inflatio
  n trade-off
• A reduction in taxes on capital gains (profit
  from investment spending) and/or corporate income
  will increase business profit expectations and
  increase investment.
• This increase in investment means greater capital
  stock which leads to increased productivity and
  an outward shift of both the SRAS and the LRAS

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Government and Aggregate Supply

• A reduction in taxes on personal income leads to
  higher levels of savings
• More savings leads to lower interest rates more
  investment more capital stock SRAS and LRAS
  shift out.
• A reduction in taxes on personal income creates
  an incentive to work and to work harder.
• An increase in labor force participation SRAS
  and LRAS shift out.
• An increase in productivity shifts SRAS and LRAS
  outward

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Government and Aggregate Supply

• PL
• RGDP

AS2
LRAS1
LRAS2
AS1
PL2
PL1
AD2
AD1
Q1
Q2
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THE LAFFER CURVE

• The Laffer Curve relates tax rate levels to
  levels of tax revenue and suggests that, under
  some circumstances, cuts in tax rates will expand
  the tax base (output and income) and increase tax
  revenues.

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THE LAFFER CURVE
100
Tax rate (percent)
l
0
Tax revenue (dollars)
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THE LAFFER CURVE
100
Tax rate (percent)
m
l
0
Tax revenue (dollars)
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THE LAFFER CURVE
100
n
Tax rate (percent)
m
l
0
Tax revenue (dollars)
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THE LAFFER CURVE
100
n
Tax rate (percent)
m
m
Maximum Tax Revenue
l
0
Tax revenue (dollars)
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The Laffer Curve and Reaganomics

• In the 1980s, as part of President Reagans move
  to prove that less government is better, Arthur
  Laffers ideas were put in play.
• Taxes were cut with the expectation that tax
  revenues would increase. The result was the
  opposite tax revenues fell.
• Today most economists believe that we are in the
  range of Laffer curve where tax rates and tax
  revenues move in the same, not opposite,
  direction.