Supply and Demand Side Economics

Paper Summary:

One of the functions of the government is to maintain stability in the economy and create an environment conducive for economic growth. The paper discusses the differing roles of the government from supply side and demand side perspective. In supply side economics, the government may reduce tax rates to create incentives for households to save and for business to invest. In demand side economics, the government may increase its expenditure level. The paper shows how both have the effect of increasing national output. The writer states that government expenditure, however, depends on revenues, the level of which is determined by the tax policy in place.

From the Paper:

"Supply side economics adheres to the idea that cuts in tax rates will lead to increase in potential GNP (Taylor, 1995, p. 549) Supply side economists claim that tax cuts have incentive effects on savings, investment and labor supply. (Dornbusch & Fischer, 1990, p. 697) Lower tax rates mean less tax on capital gains or asset earnings and this encourages people to save. A rise in savings increases the supply of financial capital or credit leading to a decrease in interest rates, the price of capital. This stimulates investment thereby creating jobs. At the same time, lower tax rates mean higher after-tax income or disposable income for workers, so reductions in tax rates encourage them to work more. This results to an increase in labor supply. Together with the rise in investments, this leads to an increase in production activities in the country boosting the national output and eventually expanding the tax base. "

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