Supply-side policies practice questions.

A government cuts the top rate of personal income tax with the stated aim of strengthening incentives to work and enterprise. This measure is best classified as:

• an interventionist supply-side policy
• a market-based supply-side policy
• a purely demand-side fiscal policy with no supply-side effects
• a contractionary monetary policy

Answer: a market-based supply-side policy

Tax cuts designed to improve incentives work through market forces rather than direct government provision, so they are market-based supply-side policies (though they also affect AD).

Assume a package of supply-side policies is fully successful. In the monetarist/new classical AD/AS model, the most likely long-run outcome is:

• LRAS shifts right, raising output and lowering the price level
• the AD curve shifts left, lowering both output and the price level
• the SRAS curve shifts left, causing stagflation
• the LRAS curve shifts left, reducing potential output

Answer: LRAS shifts right, raising output and lowering the price level

Successful supply-side policies increase the economy's productive capacity, shifting LRAS right: real output rises while downward pressure is placed on the price level.

Which of the following measures is an interventionist supply-side policy?

• Privatizing the state-owned airline
• Abolishing the national minimum wage
• Subsidised apprenticeship programmes
• Cutting the rate of corporate income tax

Answer: Subsidised apprenticeship programmes

Interventionist policies rely on direct government involvement, such as spending on education and training; the other options rely on freeing up market forces.

A government reduces the level and duration of unemployment benefits. The primary supply-side intention of this reform is to:

• increase aggregate demand through higher transfer payments
• reduce the size of the labour force
• raise frictional unemployment by encouraging longer job searches
• raise work incentives, cutting the natural rate of unemployment

Answer: raise work incentives, cutting the natural rate of unemployment

Cutting benefits raises the opportunity cost of remaining unemployed, encouraging faster job acceptance and reducing the natural rate of unemployment.

A frequently made criticism of market-based supply-side policies, such as weakening employment protection laws, is that they:

• tend to worsen income inequality and reduce worker security
• always cause a rapid rise in the price level
• directly increase the national debt through higher spending
• shift the LRAS curve to the left

Answer: tend to worsen income inequality and reduce worker security

Market-based reforms often redistribute bargaining power away from workers, so equity concerns (greater inequality, less job security) are a standard evaluation point.

Which supply-side measure is likely to involve the longest time lag before it raises potential output?

• Removing licensing rules in a service industry
• Cutting personal income tax rates
• Spending on primary and secondary schooling
• Reducing the legal power of trade unions

Answer: Spending on primary and secondary schooling

Education spending improves the skills of the future workforce, so its effect on productivity and potential output may take many years, or even decades, to appear.