SupplySide Economics at Klein Oak High School Fall

Supply-Side Economics at Klein Oak High School Fall 2003

Review Keynesian Economics n focus on demand side n n aggregate demand (AS) management C+I+G+(Ex-Im)=GDP

Keynesian Recession Strategy n increase AD n increase G (government spending) n n government spends more increase C (consumption) n n decrease taxes (fiscal policy) increase money supply (monetary policy)

Keynesian Inflation Strategy n decrease AD n decrease G (government spending) n n government spends less decrease C (consumption) n n increase taxes (fiscal policy) decrease money supply (monetary policy)

Supply Side Perspective n stagflation is different n caused by decrease in AS (aggregate supply) n because lower supply lower output (GDP) and higher prices (inflation)

Cause of Decrease in AS n government policy (unintended consequences) n high taxes n discourage business investment § “tax wedge” decreases after tax rate of return n decrease savings § same reason § causes higher interest rate decreases business investment

Note on “Tax Wedge” n difference between what is paid and what is received n ex: to pay $5. 50 to an employee costs a business $7. 00, due to taxes n n after taxes, the employee receives $4. 50 difference between $7. 00 cost to business and $4. 50 incentive to employee is the “tax wedge”

Cause of Decrease in AS (2) n government policy (unintended consequences) n high taxes n discourage work § “tax wedge” increases after tax cost to business § “tax wedge” decreases after tax return to employee § therefore, employment decreases and so does production

Cause of Decrease in AS (3) n government policy (unintended consequences) n excessive regulation n n increases cost of production decreases supply shock n little can be done about this but it isn’t a long run problem

Supply Side Goal

Supply Side Policy n increase AS n n n reduce taxes on business reduce regulation on business reduce taxes on savers n people with a high “marginal propensity to save” § i. e. people who save additional dollars § primarily high income people

The Laffer Curve n n after a point the disincentive effect of higher tax rates will result in high rates reducing tax revenue more

Implications of Laffer Curve n it’s possible to raise rates and get less revenue n n the higher rates cause a “recession” it’s possible to lower rates and get more revenue n if the lower rates stimulate the economy enough

Tax Fairness n tax cuts will give more $ to wealthy than to others because n n wealthiest 50% pay 96% of income taxes wealthiest 5% pay 53% of income taxes

Short-run vs. Long-run n Keynes: “In the long run we are all dead. ” n Keynes ignored the long run complications of the policies he advocated. n n Of course, it was the great depression. Supply-side policies focus on the long run n emphasis on incentives n requires that people and businesses can depend on policies remaining in force for years

Effect of Supply–Side Ideas Most economists still primarily Keynesian. n However, most now acknowledge that we must consider the supply-side effects of our policies. n Recommendations are now more long-run in perspective. n