UNIT 5: Supply side economics and the Laffer curve

  Supply side Economics Reaganomics

    

Makes changes in AS but not AD and it determines the level of inflation, unemployment  and economic growth

-          Lower marginal tax rate induce more work this AS increases. It also makes leisure more expensive and work more attractive.

-           Supply side economist support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transferred payment such as unemployment compensation and welfare programs provide disincentives to work, invest, innovate and undertake entrepreneur inventions

           Incentive to save and invest

        1.      High marginal tax rate can reduce the rewards for savings and investments.
        2.      Consumption might increase,but investment depend upon savings.
        3.      Lower marginal tax rates encourage saving and investment.

L    Laffer Curve

       It depicts a theoretical relationship between tax rate and government revenue. As tax rate increase from zero, government revenues increase from zero to some maximum level and then decline.

Criticisms of the Laffer curve.

        1.     research suggests that the impact of tax rates on incentives to work, save and invest are small.
        2.      Tax cuts also increase demand which can fuel inflation, which causes demand to exceed supply.
        3.      Where the economy is actually located on the curve is difficult to determine