AQA A-level Economics: Supply-side policies (7136) – Revision Notes

These notes condense supply-side policies for AQA A-level Economics (7136), from the AQA AS and A-level Economics specification, version 1.3. The AQA website numbers the sub-section 3.2.5.2; the combined PDF prints the A-level content as 4.2.5.2, with no AS-only or A-level-only labels. Read the study guide for full explanations, then test yourself with the practice questions. Use the AQA A-level Economics hub, the printable checklist and the free diagnostics to plan revision. All figures are invented and illustrative.

Key definitions

Term	Meaning
Supply-side improvement	Any rise in productive capacity or efficiency, from any source
Supply-side policy	Deliberate government action to bring such an improvement about
Potential output	Output when resources are fully employed
Trend rate of growth	Average rate at which potential output rises over time
Natural rate of unemployment	Unemployment at labour market equilibrium: frictional and structural, no cyclical
Unit labour cost	Wage per hour divided by output per hour
Short-termism	Bias towards quick returns at the expense of long-run investment
Free-market policy	Strengthens incentives and competition by removing obstacles
Interventionist policy	Government acts directly to correct market failure

The core distinction

• Improvements often originate in the private sector, independently of government: productivity gains, innovation, investment.
• Policies can help, either by improving incentives and the operation of markets, or by dealing with market failures such as short-termism.
• Exam test: if the question says the government did something, it is a policy. If a firm did it unprompted, it is an improvement.

Policy map

Type	Measure	Main mechanism	Typical weakness
Free market	Tax cuts	Higher reward for work, saving, investment	Revenue loss; uncertain response; inequality
Free market	Privatisation	Profit motive, possible competition	Private monopoly may replace public one
Free market	Deregulation	Easier entry, lower costs	Weaker protection; externalities
Free market	Some labour market reforms	Smaller disincentives, easier hiring	Lower job security; fairness concerns
Interventionist	Education and training	Higher human capital	Slow; costly; may not match jobs
Interventionist	Industrial policy	Support for key sectors or infrastructure	Government failure in picking winners
Interventionist	R&D subsidy	Captures spillovers	Deadweight if firms would have done it anyway

Chains of reasoning to know

1. Growth: policy raises labour supply, skills, capital or productivity, so LRAS shifts right, so potential output and the trend rate of growth rise. Actual growth also needs demand to rise to use the capacity.
2. Unemployment: training and better matching reduce structural unemployment, so the natural rate falls, so equilibrium unemployment is lower without inflationary pressure.
3. Inflation: higher productivity or lower input costs reduce unit labour costs, so SRAS shifts right, so the price level is lower than it would be. Lower natural unemployment also eases wage pressure.
4. Current account: lower unit costs and better quality improve price and non-price competitiveness, so exports rise and imports fall, so the current account balance improves. It also includes income and transfers.
5. Micro: a policy changes price, output, employment and incomes in particular markets, creating winners and losers.
6. Short-termism: firms undervalue long-run returns, so under-invest in R&D and training, so government subsidy or allowances can raise investment towards the social optimum.

Method boxes

Percentage change in a net reward after a tax change: (new net − old net)/old net × 100. Net = gross × (1 − marginal rate).

Unit labour cost: wage ÷ output per hour. Percentage change = (new ÷ old − 1) × 100.

Payback: cost ÷ annual return. Subsidy test: subsidy rate × cost; firm net = private benefit − (1 − rate) × cost; social net = private benefit + external benefit − cost.

Compounding: (1 + g)^n for n years at growth rate g. Compare two rates by dividing.

Worked reminders

Tax. Marginal rate falls from 35% to 30%. On an extra 800 cu, net pay rises from 520 to 560: 40/520 = 7.7%.

Natural rate. A labour force of 25 million with a natural rate of 5% means 1.25 million unemployed. At 4.4% it is 1.10 million, 0.15 million fewer.

Unit labour cost. Wage 45 cu an hour, output 36 units an hour: 45/36 = 1.25. Output rises 12.5% to 40.5 with the wage unchanged: 45/40.5 = 1.111, down 11.1%.

Trend growth. 2.5% against 2.9% for 8 years: 1.025^8 = 1.2184 and 1.029^8 = 1.2570. Potential output ends 3.2% higher.

R&D subsidy. Cost 6 million cu, private benefit 5, external benefit 3. Without help the firm loses 1. A 25% subsidy lowers its cost to 4.5, so its gain is 0.5. Social net gain is 5 + 3 − 6 = 2. Government cost: 1.5.

Short-termism. Spend 90 now, receive 25 a year. Payback is 90/25 = 3.6 years. A 3-year rule rejects the project even if the present value is positive at the firm’s discount rate.

Micro effect. In a local courier market demand is Qd = 150 − 5P and supply is Qs = 30 + 5P, so P = 12 and Q = 90. Deregulation lets new firms in, and supply becomes Qs = 50 + 5P, so P = 10 and Q = 100. Price falls 16.7% and quantity rises 11.1%. Spending changes from 1,080 to 1,000, so the policy lowers consumer outlay here. Existing licence holders lose, and consumers gain, which is why micro effects belong in the answer as well as macro ones.

Must-know distinctions

• Improvement versus policy.
• Supply-side policy versus demand-side policy: supply-side shifts LRAS; demand-side shifts AD.
• Potential growth versus actual growth.
• Free-market versus interventionist: the first removes barriers, the second spends or directs.
• Natural rate versus cyclical unemployment.
• Short run versus long run: most supply-side effects take time.

Evaluation toolkit

• Time lags: training and R&D pay back slowly.
• Opportunity cost: spending on one policy means less for another.
• Uncertainty: responses depend on elasticities that are hard to predict.
• Equity: tax cuts and deregulation can widen inequality; training can narrow it.
• Magnitude: a small change to a large economy may be small in total.
• Government failure: poor targeting, capture by lobbying, deadweight loss.
• Judgement: say which policy is likely to matter most for the economy in the question, and why.

Quick self-test

1. Distinguish a supply-side improvement from a supply-side policy.
2. Marginal tax falls from 35% to 30%. Calculate the percentage rise in net pay from an extra 800 cu.
3. Explain how training can reduce the natural rate of unemployment.
4. Wages are 45 cu an hour and output per hour rises from 36 to 40.5. Calculate the percentage change in unit labour cost.
5. Classify: deregulation, an R&D subsidy, privatisation, spending on apprenticeships.
6. A project costs 6 million, brings the firm 5 million and spillovers of 3 million. Calculate the firm’s net gain with a 25% subsidy.
7. Why can supply-side policies reduce inflation?
8. Explain how supply-side policies can improve the current account.
9. A project costs 90 and returns 25 a year. Find the payback.
10. Give two reasons why a tax cut may not raise potential output.

Answers

1. An improvement is any rise in capacity or efficiency, often privately driven. A policy is a deliberate government action to promote one.
2. 520 to 560, so +7.7%.
3. It matches skills to vacancies, so structural unemployment falls and equilibrium unemployment is lower.
4. 1.25 to 1.111, a fall of 11.1%.
5. Deregulation and privatisation: free market. R&D subsidy and apprenticeship spending: interventionist.
6. Firm pays 4.5 and gains 5, so net +0.5 million.
7. Productivity gains and lower costs shift SRAS right and cut unit labour costs. Lower natural unemployment eases wage pressure.
8. Lower costs and better quality raise export competitiveness and cut import demand. The current account also includes income and transfers.
9. 90/25 = 3.6 years.
10. The response of hours may be small or negative because of the income effect, and weak demand may leave the extra capacity unused.

Where marks are usually lost

• Describing policy without explaining the mechanism to LRAS or SRAS.
• Writing “unemployment falls” without saying that it is the natural rate that changes.
• Treating a rise in LRAS as a rise in actual output without saying demand must use the capacity.
• Calling a firm’s own investment a government policy.
• Quoting a tax cut as raising incentives with no mention of the income effect or lost revenue.
• Listing evaluation points without applying them to the policy in the question.
• Using the term “interventionist” for tax cuts, or “free market” for subsidies.
• Giving one-sided answers that ignore time lags and cost.
• Forgetting that the current account includes more than trade in goods and services.

Official syllabus

AQA, AS and A-level Economics specification, version 1.3 (29 June 2022), A-level content section 4.2.5.2 in the combined PDF (3.2.5.2 on the AQA website): Supply-side policies. Published by AQA.