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Monetary and Supply-Side Policy: Question 3

Syllabus 4.4

Structured 9 marks

Brindale's government has identified low labour productivity as the main obstacle to raising its long-run rate of economic growth. Over the next five years, it plans to introduce three measures:

  1. increased government spending on technical and vocational education for school leavers;
  2. removing licensing rules that currently restrict how many firms may operate in the road-haulage (freight transport) industry;
  3. selling its majority shareholding in the state-owned national airline to private investors.

(a) Define supply-side policy. [2]

(b) Identify which of Brindale's three planned measures is an example of deregulation, and explain how this measure is expected to help raise Brindale's long-run economic growth. [4]

(c) Explain one reason why supply-side policy measures such as these often take longer to improve an economy's performance than a change in monetary policy. [3]

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Worked solution

Part (a): Defining supply-side policy

Supply-side policy is government action aimed at raising the economy’s productive capacity, or potential output, and strengthening incentives to work, save and invest, rather than managing the level of demand in the economy, which is what fiscal and monetary policy do.

Part (b): Identifying and explaining the deregulation measure

Of Brindale’s three planned measures, removing the licensing rules restricting entry into road haulage is the example of deregulation. It removes a legal barrier that was limiting the number of firms allowed to compete in that industry.

Once this barrier is removed:

  • More firms are free to enter the road-haulage industry, increasing competition.
  • Facing more competition, existing firms have a stronger incentive to cut costs, improve efficiency and innovate, or risk losing business to new entrants.
  • The industry ends up with greater capacity and lower costs for moving freight around Brindale, which supports other industries that rely on transport and raises the economy’s overall productive potential, contributing to higher long-run economic growth.

Part (c): Why supply-side policy takes longer to work

Supply-side measures generally change the underlying capacity of the economy rather than the amount people spend right away, and building that capacity takes time. New road-haulage firms need time to register, buy vehicles and hire staff before they add meaningfully to industry capacity; more generally, workers need to complete training before their skills improve, and new infrastructure takes years to plan and build. A change in the interest rate, by contrast, can alter household and firm borrowing decisions, and therefore spending, within a matter of months, so its effect on demand is felt much sooner than the effect of supply-side measures on the economy’s capacity.

Final answers

  • (a) Supply-side policy raises the economy’s productive capacity and incentives to work, save and invest, rather than managing demand.
  • (b) Removing the road-haulage licensing rules is deregulation; it increases competition, pushing down costs and raising transport capacity, supporting long-run growth.
  • (c) Supply-side measures take years to build capacity (training, new firms setting up), while interest-rate changes affect spending within months.