IB DP Economics: Supply-side policies – Revision Notes

These notes follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. They cover sub-topic 3.7, Supply-side policies, for SL and HL; the guide marks no part of 3.7 as HL only. For full explanations and worked examples, read the study guide first. Then use the practice questions, the Economics hub, the printable checklist and the free diagnostics.

All figures in this page are invented.

Core idea

Supply-side policies target productive capacity and market efficiency. In the AD/AS model with a long-run aggregate supply (LRAS) curve, a successful policy shifts LRAS to the right.

Goals (five)

Goal	One-line link
Long-term growth	Higher productive capacity
Competition and efficiency	Firms cut costs under pressure
Labour market flexibility	Lower labour costs and unemployment
Lower inflation	Better international competitiveness
Innovation	Lower costs raise incentives to invest

Policy map

Family	Group	Policies in the guide
Market-based	Competition	Deregulation; privatization; trade liberalization; anti-monopoly regulation
Market-based	Labour market	Reducing union power; reducing unemployment benefits; abolishing minimum wages
Market-based	Incentive-related	Personal income tax cuts; cuts in business tax and capital gains tax
Interventionist	Government provides or funds	Education and training; health care (quality, quantity, access); research and development; infrastructure; industrial policies

Definitions to know

• Deregulation: scrapping rules that block entry or restrict behaviour.
• Privatization: moving ownership from the state to private owners.
• Trade liberalization: lowering barriers to imports.
• Anti-monopoly regulation: limiting market power and anti-competitive mergers.
• Industrial policy: government support for chosen sectors.
• Capital gains tax: a tax on the profit made when an asset is sold.

Diagram 1: LRAS shift

Method in steps:

1. Draw axes: price level (vertical), real output (horizontal).
2. Draw a vertical LRAS1 and a downward-sloping AD.
3. Mark the equilibrium at Y1 and P1.
4. Draw LRAS2 to the right. Mark Y2 and P2, with P2 below P1 if AD is unchanged.
5. Label every curve and axis, and write one sentence on what caused the shift.

If the policy also lifts AD, for example through a tax cut, draw AD shifting right too. The price-level fall is then smaller, or the price level may rise.

Diagram 2: minimum wage

Method in steps:

1. Draw wage (vertical) against quantity of labour (horizontal), with demand sloping down and supply sloping up.
2. Mark We and Qe where they cross.
3. Draw a horizontal line at Wmin above We.
4. Mark Qd where the line meets demand and Qs where it meets supply.
5. Label the gap Qs − Qd as unemployment.

Abolishing the minimum wage moves the market back to We and Qe.

Worked reminder (fictional town): Qd = 400 − 10W and Qs = 100 + 20W.

1. Equilibrium: 400 − 10W = 100 + 20W, so 300 = 30W and W = 10. Employment = 400 − 100 = 300.
2. Minimum wage of 14: Qd = 400 − 140 = 260 and Qs = 100 + 280 = 380.
3. Unemployment = 380 − 260 = 120. Jobs lost = 300 − 260 = 40, a fall of 13.3%.

Demand-side effects (must-know)

Policy	Effect on AD
Income tax cut	Higher disposable income, so consumption rises
Business tax cut	Higher investment
Spending on infrastructure, education, health	Government spending rises first, capacity later
Lower costs	Greater competitiveness, so net exports may rise
Lower unemployment benefits	Less spending by those who lose income

Supply-side effects of fiscal policy

• Tax cuts change incentives to work, save and invest.
• Spending on education, health, research and infrastructure raises capacity over time.
• A tax cut can reduce revenue if the base grows too little to compensate.

Effectiveness table

	Constraints	Strengths
Market-based	Equity issues; time lags; vested interests; environmental impact	Better resource allocation; no burden on the government budget
Interventionist	Costs; time lags	Direct support of sectors important for growth

Policies and objectives

Objective	How supply-side policy can help	Main limit
Long-term growth	Raises quantity or quality of factors, or efficiency (LRAS right)	Lags; costs of funding
Low unemployment	Flexible labour markets; training for structural unemployment	Little effect on cyclical (demand deficient) unemployment
Low and stable inflation	Lower costs and higher output push prices down	Tax cuts and spending can lift AD
International competitiveness	Lower costs and better productivity	Gains depend on what other countries do

Building a supply-side essay

A reliable plan for a 25-mark extended answer is:

1. Define supply-side policies and state the family or policies you will discuss.
2. Explain one market-based policy with the right diagram, step by step.
3. Explain one interventionist policy, step by step.
4. Add a demand-side effect, since it changes the conclusion on inflation.
5. Evaluate with the constraints and strengths in the guide, tied to the policies you chose.
6. Conclude with a judgement and name the factors it turns on, for instance lag length or the country.

This is advice on how answers earn credit, not a mark scheme.

Must-know distinctions

• Market-based vs interventionist: market-based policies free markets or change incentives; interventionist policies involve direct provision or funding by the government.
• Supply-side vs demand-side: supply-side policies shift LRAS; demand management shifts AD.
• Short run vs long run: many supply-side effects are slow, but some AD effects arrive at once.
• Equity vs efficiency: many market-based reforms gain efficiency but may widen inequality.

Policy by policy: one-line chains

• Deregulation: fewer entry barriers, more firms, more competition, lower costs and prices.
• Privatization: private owners seek profit, so cost control improves; the risk is a private monopoly.
• Trade liberalization: import competition and cheaper inputs, but some domestic firms and jobs may be lost.
• Anti-monopoly regulation: limits on market power keep prices lower and encourage efficiency.
• Weaker unions or lower benefits: lower labour costs and faster job matching, with equity costs.
• Tax cuts: greater reward for work and investment, with a possible fall in tax revenue.
• Education, health, R&D, infrastructure: more and better factors of production, paid for by the government and slow to arrive.
• Industrial policy: support for chosen sectors, with the risk that the government backs the wrong ones.

Evaluation toolkit

For each policy, ask four questions: Who gains and who loses? How long will it take? What does it cost? Which objective does it serve: growth, low unemployment, or low and stable inflation? Then make a judgement and say what it depends on.

Quick self-test

1. List the five goals of supply-side policies.
2. State two market-based policies that encourage competition.
3. Classify: research and development; abolishing minimum wages; privatization; infrastructure.
4. In a fictional economy, potential output rises from 300 to 333 billion crowns. Calculate the percentage increase.
5. Which curve shifts in Diagram 1, and in which direction?
6. In a fictional labour market, Qd = 300 − 10W and Qs = 60 + 10W. Find the equilibrium wage and employment.
7. A minimum wage of 15 is set in that market. Calculate the unemployment.
8. A worker earning 200 sees the tax rate fall from 35% to 30%. Calculate the percentage rise in take-home pay.
9. A project costs 45 million crowns and adds 9 million crowns of output a year. How many years to pay back?
10. Name two constraints on interventionist policies.
11. Name two strengths of market-based policies.
12. Explain one way an income tax cut raises AD.

Answers

1. Long-term growth; competition and efficiency; labour market flexibility to cut labour costs and unemployment; lower inflation for competitiveness; incentives to invest in innovation.
2. Any two of deregulation, privatization, trade liberalization, anti-monopoly regulation.
3. Interventionist: research and development; infrastructure. Market-based: abolishing minimum wages; privatization.
4. (333 − 300) / 300 × 100 = 11%.
5. LRAS shifts to the right.
6. 300 − 10W = 60 + 10W, so 240 = 20W, W = 12. Employment = 300 − 120 = 180.
7. Qd = 300 − 150 = 150. Qs = 60 + 150 = 210. Unemployment = 210 − 150 = 60.
8. Take-home before = 200 × 0.65 = 130. After = 200 × 0.70 = 140. Rise = 10 / 130 × 100 ≈ 7.7%.
9. 45 / 9 = 5 years.
10. Costs and time lags.
11. Improved resource allocation and no burden on the government budget.
12. Take-home pay rises, so households have more disposable income and consumption, a component of AD, increases.

Where marks are usually lost

• Drawing the minimum wage at or below equilibrium, so no surplus appears.
• Shifting AD instead of LRAS for a supply-side policy.
• Leaving axes, curves or equilibrium points unlabelled.
• Describing a policy without explaining the chain to growth, unemployment or inflation.
• Ignoring demand-side effects when the question asks about inflation.
• Writing a list of constraints with no link to the named policy.
• Reaching no judgement in an evaluation answer.
• Calculations with no working shown, or percentage changes taken from the wrong base.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published February 2020 by the International Baccalaureate Organization. Sub-topic 3.7, Supply-side policies, in Unit 3 Macroeconomics.