2. Government and Aggregate Supply
The stagflation of the 1970s led to the
realization that all economic problems could
not be solved by focusing solely on
aggregate demand.
Supply-side economists focus their attention
on government policies such as high taxation
that impede the expansion of aggregate
supply.
3. Government and Aggregate Supply
Tax policies can improve the
unemployment/inflation trade-off
A reduction in taxes on capital gains (profit from
investment spending) and/or corporate income
will increase business profit expectations and
increase investment.
This increase in investment means greater
capital stock which leads to increased
productivity and an outward shift of both the
SRAS and the LRAS
4. Government and Aggregate Supply
A reduction in taxes on personal income leads
to higher levels of savings
More savings leads to lower interest rates = more
investment = more capital stock = SRAS and
LRAS shift out.
A reduction in taxes on personal income
creates an incentive to work and to work harder.
An increase in labor force participation = SRAS
and LRAS shift out.
An increase in productivity shifts SRAS and
LRAS outward
6. THE LAFFER CURVE
The Laffer Curve relates tax rate levels to
levels of tax revenue and suggests that,
under some circumstances, cuts in tax rates
will expand the tax base (output and income)
and increase tax revenues.
11. The Laffer Curve and Reaganomics
In the 1980s, as part of President Reagan’s
move to prove that less government is better,
Arthur Laffer’s ideas were put in play.
Taxes were cut with the expectation that tax
revenues would increase. The result was the
opposite – tax revenues fell.
Today most economists believe that we are in
the range of Laffer curve where tax rates and
tax revenues move in the same, not opposite,
direction.
