SUPPLY SIDE ECONOMICS Government and Aggregate Supply The stagflation of the 1970s led to the...
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Transcript of SUPPLY SIDE ECONOMICS Government and Aggregate Supply The stagflation of the 1970s led to the...
SUPPLY SIDE ECONOMICS
Government and Aggregate Supply The stagflation of the 1970s led to the
realization that all economic problems could not be solved by focusing solely on aggregate demand.
Supply-side economists focus their attention on government policies such as high taxation that impede the expansion of aggregate supply.
Government and Aggregate Supply Tax policies can improve the
unemployment/inflation trade-off A reduction in taxes on capital gains (profit from
investment spending) and/or corporate income will increase business profit expectations and increase investment. This increase in investment means greater capital
stock which leads to increased productivity and an outward shift of both the SRAS and the LRAS
Government and Aggregate Supply A reduction in taxes on personal income leads
to higher levels of savings More savings leads to lower interest rates = more
investment = more capital stock = SRAS and LRAS shift out.
A reduction in taxes on personal income creates an incentive to work and to work harder. An increase in labor force participation = SRAS
and LRAS shift out. An increase in productivity shifts SRAS and
LRAS outward
Government and Aggregate SupplyPL
RGDP
LRAS2AS2
PL2 PL1
LRAS1
AS1
AD2
AD1
Q1 Q2
THE LAFFER CURVE
The Laffer Curve relates tax rate levels to levels of tax revenue and suggests that, under some circumstances, cuts in tax rates will expand the tax base (output and income) and increase tax revenues.
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The Laffer Curve and Reaganomics In the 1980s, as part of President Reagan’s
move to prove that less government is better, Arthur Laffer’s ideas were put in play.
Taxes were cut with the expectation that tax revenues would increase. The result was the opposite – tax revenues fell.
Today most economists believe that we are in the range of Laffer curve where tax rates and tax revenues move in the same, not opposite, direction.