Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.
Aspect
Explanation
Definition
Supply-side Economics, often referred to as trickle-down economics, is an economic theory and policy approach that emphasizes the importance of stimulating the production and supply of goods and services to drive economic growth. It contends that by reducing taxes on businesses and high-income individuals, removing regulatory barriers, and promoting entrepreneurship and investment, the overall supply of goods and services will increase. The theory posits that this increase in supply will lead to economic expansion, job creation, and, ultimately, benefits that “trickle down” to all segments of society. Supply-side economics stands in contrast to demand-side economics, which focuses on managing aggregate demand through government intervention and spending to stimulate economic activity.
Key Concepts
– Supply-side Policies: The implementation of policies aimed at incentivizing production, investment, and entrepreneurship. – Tax Cuts: Reductions in income, corporate, and capital gains taxes to encourage investment and business growth. – Deregulation: Removing regulatory barriers and streamlining business-related regulations to reduce compliance costs. – Laffer Curve: A graphical representation showing the relationship between tax rates and tax revenue, often used to justify tax cuts as potentially increasing revenue through economic growth. – Trickle-down Effect: The belief that benefits from economic growth and increased supply will eventually reach all members of society.
Characteristics
– Pro-Production Policies: Supply-side economics promotes policies that favor production, investment, and entrepreneurship. – Tax Reductions: Reducing tax rates, especially for high-income individuals and businesses, is a central tenet. – Focus on Businesses: A strong focus on businesses as the drivers of economic growth and employment. – Market Efficiency: Belief in the efficiency of free markets in allocating resources. – Economic Growth: The ultimate goal is to achieve sustained economic growth.
Implications
– Economic Growth: Supply-side policies aim to spur economic growth through increased production and investment. – Job Creation: A stronger business environment is expected to lead to job creation. – Income Inequality: Critics argue that supply-side policies may exacerbate income inequality if benefits primarily flow to high-income individuals and corporations. – Fiscal Policy: Supply-side economics has implications for tax policy and government spending. – Laffer Curve: The concept of the Laffer Curve plays a role in shaping tax policies.
Advantages
– Economic Growth: Supply-side economics is associated with the potential for robust economic growth. – Job Creation: Businesses expanding and investing can lead to increased job opportunities. – Innovation: A favorable environment for entrepreneurship can stimulate innovation. – Tax Revenue: Proponents argue that lower tax rates can lead to increased tax revenue due to higher economic activity. – Efficiency: Advocates believe that market-driven resource allocation is more efficient.
Drawbacks
– Income Inequality: Critics contend that supply-side policies may exacerbate income inequality by benefiting high-income individuals and corporations more. – Budget Deficits: Tax cuts without corresponding spending cuts can lead to budget deficits. – Effectiveness: The effectiveness of supply-side policies can vary, and outcomes may not always align with expectations. – Deregulation Risks: Excessive deregulation can lead to market abuses and environmental concerns. – Social Safety Nets: Critics argue that reduced government revenues may strain social safety nets.
Applications
– Reaganomics: The economic policies of the Reagan administration in the 1980s, which included significant tax cuts and deregulation, are often cited as a prominent example of supply-side economics in practice. – Tax Reform: Various countries have implemented tax reforms aimed at reducing rates to stimulate economic growth. – Entrepreneurship Promotion: Many governments create programs and incentives to promote entrepreneurship and business development. – Deregulation Initiatives: Efforts to streamline regulations and reduce bureaucratic hurdles for businesses reflect supply-side thinking. – Investment Promotion: Attracting foreign and domestic investment is a common goal in supply-side economic policies.
Use Cases
– Reaganomics: The economic policies of U.S. President Ronald Reagan, which included substantial tax cuts and deregulation, are a well-known example of supply-side economics in action. – Tax Reforms: Various countries have enacted tax reforms aimed at reducing tax burdens on businesses and high-income individuals. – Start-up Ecosystems: Cities and regions worldwide seek to create favorable environments for start-ups and entrepreneurs. – Deregulation Initiatives: Governments often embark on deregulation efforts to reduce compliance costs for businesses. – Infrastructure Investment: Supply-side thinking can extend to infrastructure projects that facilitate business activities and economic growth.
Table of Contents
Understanding supply side economics
In essence, supply side economics is concerned with the determinants of productive capacity (output) over time.
The theory is based on the belief that increased production is the best way to drive economic growth.
Production can be stimulated by policies such as:
Deregulation – which removes certain restrictions and lowers the cost of compliance so that businesses are free to explore new opportunities.
Tax cuts – corporate tax cuts enable the company to invest more in hiring workers and capital infrastructure. Income tax cuts, on the other hand, increase the impetus for workers to remain employed and creates more labor output.
Supply side economics is otherwise known as Reaganomics because it formed part of U.S. President Ronald Reagan’s strategy to combat stagflation in the 1980s.
Reagan instituted deregulation, tax cuts, and decreased social spending with the belief that these benefits would “trickle down” from businesses and wealthy individuals to society in general.
In other words, as businesses expanded, they would employ more workers, increase their wages, and put more money in workers’ pockets.
The strategy remained popular in subsequent decades among U.S. Presidents. George W. Bush implemented broad tax cuts between 2001 and 2003 across income, dividends, and capital gains.
In 2017, President Trump cut income and corporate tax rates to stimulate growth and increased tariffs on foreign companies to encourage American manufacturers to produce more.
Is supply side economics effective?
Supply side economics rests on the central tenet that tax cuts for wealthier individuals produce more economic benefit than tax cuts for lower-income individuals.
However, there are two fundamental problems with this idea.
For one, tax cuts for wealthy individuals do not stimulate economic activity or create new jobs.
This is because the extra money tends to be saved, invested, or used to reduce debt. Instead, tax cuts aimed at lower and middle-class earners are a much better way to stimulate macroeconomic activity.
Proponents of supply side economics also believe that tax cuts incentivize workers to earn more money.
In reality, however, studies show that these cuts boost output by increasing discretionary income and thus stimulating demand.
Supply side economics and the Laffer Curve
The Laffer Curve was developed by economist Arthur Laffer in the 1970s. Laffer created the model to show the direct relationship between tax rates and government tax revenue, arguing that each substitutes the other on a 1:1 basis.
The curve showed that a reduction in tax revenue could be offset by the subsequent increase in economic growth which Laffer believed made tax cuts a more prudent policy choice.
Corporate tax cuts faired a little better, with 50% of the loss in tax revenue compensated by increased economic activity.
Key takeaways:
Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.
Supply side economics is otherwise known as Reaganomics because it formed part of U.S. President Ronald Reagan’s strategy to combat stagflation in the 1980s. The idea remained popular with successive U.S. presidents.
Supply side economics believes that tax cuts for wealthier individuals derive the most economic benefit, but in truth, tax cuts for low and middle-income earners are more effective. The ability of supply side economics to compensate for lower tax receipts with higher economic growth is also questionable.
Key Highlights
Supply Side Economics Definition: Supply side economics is a macroeconomic theory that emphasizes the role of production or supply as the primary driver of economic growth.
Focus on Production and Output: Supply side economics centers on the determinants of productive capacity (output) over time and believes that increased production is the key to stimulating economic growth.
Stimulating Production Through Policies:
Deregulation: Removing restrictions and reducing compliance costs to encourage businesses to explore new opportunities.
Tax Cuts: Corporate tax cuts encourage investment in hiring and capital infrastructure. Income tax cuts boost worker employment and labor output.
Origins and Popularization: Supply side economics is also known as Reaganomics due to its adoption in the 1980s by U.S. President Ronald Reagan. It involves strategies like deregulation, tax cuts, and reduced social spending, aiming to stimulate growth by benefiting businesses and wealthy individuals.
Effectiveness of Supply Side Economics:
Tax Cuts for Wealthier Individuals: The theory believes that tax cuts for wealthier individuals have greater economic benefits, but evidence suggests that tax cuts for lower and middle-income earners are more effective in stimulating macroeconomic activity.
Laffer Curve: This model, developed by Arthur Laffer, depicts the relationship between tax rates and government tax revenue. It suggests that lower tax rates can lead to higher economic growth and potentially offset revenue losses.
Critiques and Limitations: Studies show that the efficacy of supply side economics is limited. A substantial portion of income tax cuts may not lead to equivalent economic growth. Corporate tax cuts have a relatively better impact, but their ability to fully compensate for tax revenue losses is still questionable.
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.
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Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.
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The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
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The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”
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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
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Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
