Explain how fiscal policy can be used to try to improve the supply side of an economy

AQA A-Level Economics Paper 2 June 2018

Explain how fiscal policy can be used to try to improve the supply side of an economy. (15 marks)

1. Fiscal policy is the manipulation of government spending and taxation.
2. Usually, this is done to influence the level of aggregate demand in the economy.
3. These changes can also improve the supply-side of an economy.

1. For example, the government could reduce income taxes.
2. The first effect of lower income taxes is that people keep more disposable income.
3. This allows for more consumer spending which leads to an increase in aggregate demand.
4. Additionally, lower income taxes increase the incentive to work.
5. This can lead to a decrease in early retirements or an increase in migration.
6. If higher rate income taxes are reduced, then this influences workers earning between £50,000 and £125,000.
7. Therefore, it is likely to attract skilled workers in particular to move to the UK.
8. This would therefore lead to an increase in both the quality and quantity of labour in the economy.
9. This means that there is an increase in the productive potential in the economy.

1. Another example of how fiscal policy can influence the supply side of an economy is through spending on infrastructure.
2. The UK government has spent around £40 billion so far on HS2. 
3. So far, this has led to an increase in government spending, so aggregate demand has shifted to the right.
4. Furthermore, the project leads to a creation of jobs which can also lead to higher incomes and more aggregate demand. Therefore, there is a multiplier effect. 
5. When the project is finally completed, the project allows faster travel between the rest of the UK.
6. This means that businesses that rely on transport can increase their productivity.
7. It also increases geographical mobility of labour which increases the size of the workforce.
8. Overall, as there is an increase in the quality and quantity of factors of production, the economy would see an improvement of its productive potential. 
9. This can be seen by a right shift in LRAS, as shown in the diagram below.

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