Questions to Lecture 10 – Supply-side policies

Marina Haurylchyk, Anuar Turegeldiyev.

  1. What is stagflation and why it cannot be explained by the shift of aggregate demand curve?

Stagflation is simultaneous occurrence of substantial unemployment and inflation. It occurs only because of shifts of AS curve to left. It cannot be explained by shifts in Ad because when AD curve shifts, it causes either unemployment or inflation, not both at the same time.

  1. How can producers respond to the change in AD? What will this response depend on?

Producers can respond by shift in position and slope of AS curve. Respond depends on the shift of AD curve.

Producers can respond either by change in prices or change in the supplied output. Respond depend on the slope and position of AS curve

  1. Draw and explain the AS curve according to Keynesian theory. Which time horizon does it refer to? As is horizontal up to full employment, and becomes vertical at full employment. Refers to short term.
  1. Draw and explain the AS curve according to Monetarist theory. Which time horizon does it refer to? Producers make output decisions based on technology, market size and capital. Refers to long term. AS is vertical and located at full employment.
  1. Draw and explain the hybrid AS curve.

At low rates of unemployment AS curve is horizontal and at high levels AS is almost vertical.

  1. What is Philips curve?

Phillips curve shows trade off between the rates of unemployment and inflation.

  1. Explain on the picture what are the effects of a rightward shift of AS curve. How does this shift affect Phillips curve (and what does this imply for the observations of inflation-unemployment trade-off that we have from the real world)?

The rightward shift of AS curve causes an increase in total output and simultaneously decrease in price levels. The rates of unemployment and inflation go down, this causes the Phillips curve shift to left.

  1. On the picture explain what are the effects of a leftward shift of AS curve. What can cause a leftward shift of AS curve?

Leftward shift in AS curve causes lower rates of total production and higher prices. The unemployment rate and inflation go up, which causes the Phillips curve shift rightwards.

  1. Compare the Keynesian and Supply-side theories’ opinion on the tax cuts.

For both parties tax cut is a good thing, the difference is in what taxes to cut. For Keynesians it does not matter, they will agree for every tax cut. The supply side theorists concerned more on marginal taxes or taxes that create incentives for work, such as progressive income taxes.

  1. In the supply-side policies the emphasis is on the marginal tax rate (as opposed to total amount of tax) and their effect on the labor supply. Explain why.

The marginal tax rates create incentives for work. If government cuts these taxes, people get more money from their additional income, which causes them to work and earn more.

  1. Compare progressive and flat tax rate systems with respect to their effect on the labor supply of individuals. Give an example of country with progressive and flat tax rate.

Progressive tax means higher tax on every level of higher income, while flat tax is only a certain amount of money that workers have to pay to government on any rate of income.

You mix flat and lump sum tax (which is what you have described). Flat tax = one tax rate that you have to pay, regardless of the level of income – good work incentives.

  1. Explain the effect of tax incentives on the labor supply, entrepreneurship decision and investment decision of firms.

Labor supply:

Marginal tax rate influences one’s incentive to work. If it is too high, people don’t want to work more.

Entrepreneurship:

If progressive tax rate is high, there is less incentive to enter markets.

Investment:

If marginal tax rates are too high, investors will not put their money into businesses.

  1. What is the tax elasticity of supply? If this elasticity is smaller than 1, will the tax cut result in the lower or higher tax revenues than before?

Elasticity of supply shows percentage change in quantity supplied divided by percentage change in tax rates. If elasticity is smaller than 1, it will result in lower tax revenues.

  1. What is the relationship between the structural unemployment and AS curve?

If structural unemployment is too high, there are not enough skilled people to produce what people want, so it lowers total output, which means leftward shift in AS.

  1. State and explain 4 directions on the development of human capital in the economy. Choose one and explain in more details.

a)worker training

Businesses that spend money on worker trainings are helping to shift As curve to right. In the long run, this policy will result in higher poructivity.

b)education spending

c)reducing discriminating barriers

d)transfer payments

  1. What is the opinion of supply-side economists concerning regulation of factor and production markets. What categories of regulation are they concerned with?

Supply-side economists favor deregulation. They think that regulatory costs are too high. In order to shift AS curve to right, businesses should be able to put their products on markets at lower costs of regulations.

  1. What is the difference between tariff and quota?

Tariff is the tax put on import, and quota is the quantity of import that can be imported.

  1. What policies help to ease trade barriers? How does this affect AS curve?

Such policies as free trades and green cards for skilled workers help to ease trade barriers. If more goods & services are imported, AS curve shifts to right.

  1. Explain the role of immigration in the shift of AS curve. What are the positive aspects of immigration? What are the problems connected with immigration?

Immigration of skilled people helps to shift AS curve to right, increasing total output. Brain drain and unskilled second and third generation of immigrants is the problem.

  1. How does infrastructure affect the AS in the country? What are the components of the infrastructure?

Improving infrastructure decreases the costs of supplying goods, causing shift in AS to right. The components are:

Transportation, communications, education, judicial and other institutional systems that facilitate market exchanges.

  1. Supply-side policies usually concern today’s expenditures for future growth and well-being, without striking immediate results. Why do you think this might be a problem for their implementation?

People may demand immediate results, while supply side economists offer positive results only on long run. Some may not believe them and prefer other policies that they think will give results faster.+ these policies might be expensive in the short run (e.g. education)