Supply-Side Economics

Earlier in this chapter, we talked about how productivity increases aggregate supply. This is because, increasing productivity means you can achieve higher output with a given input, hence increasing supply within the economy.

Effect of Productivity Growth

The effect of productivity growth is shown in the above model, where increasing productivity increases aggregate supply from AS1 to AS2. This causes an increase in real GDP from Y1 to Y2 meeting the objective of economic growth. Increases in economic growth will also increase the employment of resources, including labour, meeting the objective of full employment. In addition, price levels will decrease from P1 to P2 as there is more output, competition for goods and services decreases, hence meeting the objective of price stability. Governments aim to promote productivity growth as it best meets all three main economic policy objectives and ensures the international competitiveness of the Australian economy. If there is more output of our exports, we can lower the prices of our exports and increase our international competitiveness.

Effect of a Decline in Productivity

Worsening productivity represents an unideal position in the economy as cost push inflation takes place. Lower productivity increases the unit cost of production, decreasing aggregate supply from AS1 to AS2 hence, causing an increase in price levels from P1 to P2 while simultaneously decreasing economic growth from Y1 to Y2 and higher unemployment. This represents a situation that does not meet any of the economic policy objectives of government.

Useful Topics

Elucidate:

• Economic Policy Objectives - Sustainable Economic Growth

• Economic Policy Objectives - Full Employment

• Economic Policy Objectives - Price Stability