Supply-Side Economics Definition

The concept emphasizes the factors of production—capital, land, labor, and entrepreneurship. Supply-side fiscal policies include the curtailment of borrowing rates, tax reduction, and deregulation of industries. The theory claims that Increased production results in excess supply over demand; consequently, goods prices plummet, and goods demand rises.

Key Takeaways

  • Supply-side economics is a macroeconomics concept that advocates the increase in supply or production to achieve long-term sustainable growth.The theory was introduced in the 1970s by Arthur Laffer—an American economist. He presented a relationship between tax rate and tax revenue using the Laffer Curve.This theory suggests that reduced taxes encourage producers, industries, businesses, and entrepreneurs to invest more and produce more.Keynesian economists criticize supply-side theory for lacking proven examples. Also, this approach does not visibly benefit the lower-and-middle-income group.

Supply-Side Economics Explained

In the 1970s, Arthur Laffer proposed the concept of supply-side economics to dispel the demand-side theory. Arthur is an American economist. He presented the Laffer curve to represent the relationship between the tax rates and the tax revenue.

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Laffer suggested that when governments reduce taxes, businesses are motivated to produce more goods and services. Consequently, when the market gets flooded with commodities, prices automatically go down—goods demand increases. When taxes are low, wealthy individuals invest more—the economy gets a boost—more jobs are created.

The supply-side fiscal policy boosts factors of production like land, capital, labor, and entrepreneurship. This is achieved by reducing taxes, industrial regulation, and borrowing rates. The supply-side theory claims that controlling inflation results in sustainable economic progress—in the long term. Further, higher production means increased labor requirements; thus, more jobs are created.

However, Keynesian economists have always criticized the supply-side theory for lacking proven examples. Also, this kind of growth does not show any positive impact on the lower-and middle-income group. On the one hand, this concept promises long-term outcomes, but at the same time, it is very expensive at present.

Fundamental Elements of Supply-Side Economics

The Supply-side approach aims to boost a nation’s production and economic activities for sustainable growth. The theory hinges on three fundamental pillars:

  • Monetary Policy: Governments increase the circulation of money by implementing expansionary measures—like reduced borrowing rates.Tax Policy: Governments curtail income tax and marginal taxes to motivate entrepreneurs, producers, investors, suppliers, and workers. Entrepreneurs, in turn, increase investment and economic activities.Regulatory Policy: The deregulation of industries is equally important to witness a free-market scenario. This way, governmental control or intervention in economic activities is minimal.

Example

Laffer’s supply-side theory is not entirely backed by real-world data. In 1981, to implement the tax cuts, President Ronald Reagan introduced the Economy Recovery Tax Act (SERTA). Reagan promised these policies in his campaigns.

This law curtailed marginal tax rates for individuals from 70% to 50%. Reagan believed that reducing the taxes would encourage people to produce more goods and services. This policy anticipated the speedy growth of the economy and business activities. Reagan’s policies are referred to as ‘Reaganomics.’

In hindsight, Reagan’s supply-side ideas failed because the tax savings offered to the rich did not lead to the anticipated amounts of job creation. Rather, tax savings were accumulated—the rich became richer.

Supply-Side Economics vs. Keynesian

Laffer’s supply-side theory is in stark contrast to the Keynesian demand-side theory. Let us understand the distinction in detail:

This has been a guide to Supply-Side Economics & definition. We discuss fundamental elements of supply-side economics vs. Keynesian theories along with Reagan policies and examples. You may learn more about economics from the following articles –

The supply-side theory assumes that an increased supply of goods leads to long-term economic growth. It focuses on factors of production—land, capital, labor, and entrepreneurship. It recommends the creation of favorable business environments by introducing supply-side fiscal policies—reduced taxes and reduced industrial regulation.

The fundamental elements of this theory are relaxation of industrial regulation, curtailed taxes, and borrowing rate discounts.

Supply-side theories are suitable in scenarios where the government wants to control inflation, generate job opportunities or ensure long-term sustainable growth. However, it fails to deal with adversities like a recession—when aggregate demand is already low, and supply is high. Also, these policies cannot be applied as a quick fix to solve economic problems.

In the 1970s, the American economist Arthur Laffer proposed the supply-side theory. The Laffer Curve illustrated a relationship between tax rates and tax revenue.

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