What Is Meant By Supply Side Economics – Supply-side economics is a theory that states that the engine of economic growth is an increase in the supply of goods and services. He advocates for tax cuts to encourage job creation, business expansion and entrepreneurship.
Supply-side economics can be thought of as the polar opposite of Keynesian or demand-side economics, which posits that increasing demand for goods and services is the primary driver of economic growth.
What Is Meant By Supply Side Economics
Supply-side economics is sometimes known as Reaganomics because of its association with President Ronald Reagan. He and his Republican contemporaries popularized the controversial idea that tax cuts for wealthy investors and businesses gave them incentives to save and invest, spilling over into the overall economy.
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Reagan often cited the aphorism “a high tide lifts all boats” to explain his view of the theory.
Like most economic theories, supply-side economics attempts both to explain macroeconomic phenomena and, based on these explanations, to offer policy prescriptions for sustainable economic growth.
In general, supply-side theory has three pillars: tax policy, regulatory policy, and monetary policy. However, the same idea behind all three pillars is that production (ie the “supply” of goods and services) is most important in determining economic growth.
Supply-side theory contrasts sharply with Keynesian theory, which usually includes, among other aspects, the idea that demand can fluctuate, so that if lagging consumer demand pushes the economy into recession, the government must intervene with fiscal and monetary stimulus.
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The only major difference is this: a pure Keynesian believes that consumers and their demand for goods and services are the main economic drivers, while a consumerist believes that the rate of economic growth is determined by producers and their willingness to create goods and services.
In economics, we study supply and demand curves. The graph below illustrates a simplified macroeconomic equilibrium: aggregate demand and aggregate supply interact to determine aggregate output and price levels. (In this example, output could be gross domestic product and the price level could be the consumer price index.)
The graph below illustrates the supply-side hypothesis: an increase in supply (that is, the production of goods and services) will increase output and lower prices.
In fact, the supply side goes further and claims that demand is largely irrelevant. He says that overproduction and underproduction are not continuous phenomena.
What Is Demand?
Supply siders argue that when companies temporarily “overproduce,” excess inventories build up, prices subsequently fall, and consumers increase their purchases to compensate for the excess supply.
This corresponds to the belief in a vertical (or near-vertical) supply curve, as shown in the diagram below.
In the graph below, we show the effect of an increase in demand: prices rise, but output does not change much.
Under such dynamics—when supply is vertical—the only thing that increases output (and thus economic growth) is an increase in production in the supply of goods and services, as shown below:
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Three supply-side pillars follow from this assumption. From a tax policy perspective, proponents of the proposal advocate lower marginal tax rates. Given the lower marginal income tax, suppliers believe that lower rates will encourage workers to prioritize work over leisure (at the margin).
As for lower capital gains tax rates, they argue that lower rates force investors to use capital productively. At certain rates, the supply side would even argue that the government would not lose total tax revenue because the lower rates would be more than offset by a higher tax revenue base—due to higher employment and productivity.
On the issue of regulatory policy, supply sides tend to align with traditional political conservatives—those who favor smaller government and less interference with the free market.
This makes sense because supply-siders—while they may accept that government can temporarily help purchases—don’t think that the demand created in this way can save a recession or have a lasting impact on growth.
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The third pillar, monetary policy, is particularly controversial. By monetary policy, we mean the Federal Reserve’s ability to increase or decrease the amount of dollars in circulation (ie, where more dollars means more purchases by consumers, creating liquidity).
A Keynesian tends to think that monetary policy is an important tool for regulating the economy and dealing with business cycles, while the supply side does not think that monetary policy can create economic value.
While both agreed that the government should have a printing press, the Keynesian believed that the printing press could help solve economic problems. But the contractor believes that the government (or the Fed) can cause problems with his printing press in the following ways:
Because supply-siders see monetary policy more as a controllable variable than as an instrument that can create economic value, they propose a stable monetary policy or a mild inflationary policy tied to economic growth—for example, 3% per year and 4% monetary growth.
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This principle is the key to understanding why supply-siders often advocate a return to the gold standard, which may seem strange at first (and which most economists probably find questionable).
The idea is not that gold is particularly special, but that gold is the most obvious candidate for a stable “store of value”. Supply sides argue that if the US dollar were pegged to gold, the currency would be more stable and currency fluctuations would have less disruptive consequences.
As an investment topic, supply-side theorists say that the price of gold – because it is a relatively stable store of value – provides investors with a “leading indicator” or signal for the direction of the dollar. In fact, gold is usually seen as a hedge against inflation. Although the historical record is hardly perfect, gold often provides the first signals against the dollar.
The theory is called supply-side economics because production (the “supply” of goods and services) is the most important macroeconomic component in achieving economic growth.
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The opposite of supply-side economics is Keynesian economics, which believes that the demand for goods (spending) is the main driver of economic growth.
Reaganomics is the term for President Ronald Reagan’s economic policies that focused on tax cuts for the rich, believing that this would lead to savings and higher investment, leading to economic benefits that would trickle down to the entire economy. Reaganomics also focused on increasing military spending and deregulating domestic markets.
Keynesian economics is demand-side economics, which believes that demand in the economy is the main driver of growth. An increase or decrease in demand for goods and services affects how much supply producers bring into the economy.
Keynesian economics believes that if consumer demand falls, it is the government’s responsibility to increase spending and intervene with fiscal and monetary stimulus.
Fiscal Fraud: Why Supply Side Economics Refuses To Die
Supply-side economics believes that producers and their willingness to create goods and services determine the rate of economic growth, while demand-side economics believes that consumers and their demand for goods and services are the main economic drivers.
The supply economy has a checkered history. Some economists consider the supply side a useful theory. Other economists disagree with the theory so strongly that they dismiss it as an updated approach to classical economics because it offers nothing particularly new or controversial.
Based on the three pillars above, you can see how the supply side cannot be separated from policy areas, as this means a limited role for government and less progressive tax policies.
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Supply Side Economics
In 2011, I entered the international MBA program. Coming from a legal background, the MBA was a way for me to quickly change direction.
I wanted a career in business (as an entrepreneur rather than a manager). I wanted to quickly find a career and move to the US (I’m originally from Italy).
Fast forward to 2013, after finishing my MBA I got a job in California as an analyst focusing on corporate finance and business strategy.
However, rather than becoming an entrepreneur, I was anchored in a stable career where, like in the military, I had to take a few linear steps and wait a few years to move up the ladder.
Pdf) Supply Side Economics And Supply Side Fiscal Policy
Fast forward four years since starting my MBA and three years into my new life in California. My career path in MBA was not satisfactory for me.
That’s why I didn’t apply for MBA. So I quit my job, moved back to Italy and started my own digital business (a lot of things happened in the meantime, like moving to NYC for a few months, but let’s skip that part for now for brevity).
I found most of the things I learned in business school to be very useful for a linear career path