Discuss The Extent To Which Supply Side Policies Are Effective In Reducing Inflation
Discuss the extent to which supply side policies are effective in reducing inflation.
Inflation is the consistent rise of price levels over a period of time. Inflation has two main causes: cost push and demand pull. Cost push inflation occurs when rising production costs cause the aggregate supply curve in the short run to shift outwards- see fig1, whereas demand pull inflation occurs due to an increase in demand when the economy is operating near full employment- see fig 2. Supply side factors affect the production of goods and services in an economy. Supply side policies aim to stimulate production and increase aggregate supply in by increasing the productive potential of the economy. Therefore supply side polices can be very effective in reducing inflation in the long term, and also allow the economy to expand without producing inflationary pressures. However some supply side policies, such as increasing investment in education, training or infrastructure for example may take time to have an impact. Supply side policies therefore impact the LRAS curve and work very much in the long term, rather than to act upon short term cost spikes.
Increasing productivity by implementation of supply side policies can reduce the inflationary pressures on the economy. If more production can be achieved at a lower unit cost, then the economy can expand without causing price levels to rise. Furthermore by increasing aggregate supply in the long run supply side policies increase the productive potential of the economy at the same price level. The benefits of increasing aggregate supply in the long run are demonstrated in Fig 3. Using a classical model, successful supply side policies leading to the outward shift of the long run aggregate supply curve from LRAS to LRAS1 curve allows the aggregate demand to rise from AD to AD1 while maintaining a similar price level PE. The equilibrium level in the economy, E shifts right to E1 meaning that the real GDP level
Inflation is the consistent rise of price levels over a period of time. Inflation has two main causes: cost push and demand pull. Cost push inflation occurs when rising production costs cause the aggregate supply curve in the short run to shift outwards- see fig1, whereas demand pull inflation occurs due to an increase in demand when the economy is operating near full employment- see fig 2. Supply side factors affect the production of goods and services in an economy. Supply side policies aim to stimulate production and increase aggregate supply in by increasing the productive potential of the economy. Therefore supply side polices can be very effective in reducing inflation in the long term, and also allow the economy to expand without producing inflationary pressures. However some supply side policies, such as increasing investment in education, training or infrastructure for example may take time to have an impact. Supply side policies therefore impact the LRAS curve and work very much in the long term, rather than to act upon short term cost spikes.
Increasing productivity by implementation of supply side policies can reduce the inflationary pressures on the economy. If more production can be achieved at a lower unit cost, then the economy can expand without causing price levels to rise. Furthermore by increasing aggregate supply in the long run supply side policies increase the productive potential of the economy at the same price level. The benefits of increasing aggregate supply in the long run are demonstrated in Fig 3. Using a classical model, successful supply side policies leading to the outward shift of the long run aggregate supply curve from LRAS to LRAS1 curve allows the aggregate demand to rise from AD to AD1 while maintaining a similar price level PE. The equilibrium level in the economy, E shifts right to E1 meaning that the real GDP level