OxfordAQA International AS and A-level Economics: Supply-side policies (9640) – Revision Notes

Condensed recall notes for OxfordAQA International AS and A-level Economics (9640), specification version 1.2, section 3.2.4.3 Supply-side policies. Section 3.2 is International AS content. The full explanations are in the study guide. Afterwards, test yourself with the practice questions. Track coverage with the OxfordAQA Economics hub and the printable checklist. The free diagnostics show where to begin. Related background: the macroeconomic performance revision notes. All figures here are invented and illustrative.

Key definitions

Term	Meaning
Supply-side policy	A deliberate government measure aimed at expanding productive capacity or efficiency
Supply-side improvement	Any gain in capacity or efficiency, with or without government, such as innovation or private training
Potential output	The normal capacity level of output, shown by the vertical LRAS curve
Underlying trend rate of growth	The long-run rate at which potential output grows
Deregulation	Removing or loosening rules that limit entry or add costs
Industrial policy	Targeted support for particular industries, regions or activities
Welfare reform	Changes to benefits or their conditions, often to alter incentives to work

The distinction the specification stresses

• Improvements often start in the private sector: invention, innovation, training, investment and productivity gains.
• A policy is a government action. A policy-assisted improvement has government help. An improvement that firms made on their own is not a policy.
• Evaluation test: would it have happened without the policy?

Mechanism chains to memorise

1. Tax change for incentives: lower marginal rate → higher reward for extra work → more hours or more people join the labour force → higher labour supply → LRAS right.
2. Business tax cut or investment incentive: higher post-tax return → more investment → larger capital stock → LRAS right.
3. Education and training: more skills → higher productivity and better matching → lower structural unemployment and lower unit costs → LRAS and SRAS right.
4. Infrastructure: lower transport and energy costs, wider markets → higher productivity and more private investment → LRAS right.
5. Welfare reform: smaller gap between pay in and out of work → more job search → lower unemployment rate at which wage pressure builds.
6. Deregulation: easier entry → more competition → lower prices, more innovation → lower costs → SRAS and LRAS right.
7. Industrial policy: support for chosen sectors → more investment where private firms under-invest → higher capacity there.

Macroeconomic effects

Objective	Likely effect	Condition
Unemployment	Falls at the structural level	Weak when unemployment is due to weak demand
Inflation	Lower costs and a lower price level	Need productivity above wage growth
Current account	Better competitiveness, more exports, fewer imports	Depends on rivals and on exchange rates
Growth	Higher potential output and trend rate	Needs time and enough demand

Quick calculations

Percentage change and index numbers. Output per worker rises from 40.0 to 43.2 units. Change = 43.2 / 40.0 − 1 = 8.0%. With base year 100, the index is 108.0. A second 8% year gives 108.0 × 1.08 = 116.6.

Keeping more of each extra currency unit. The marginal rate falls from 25% to 20%. Of an extra 200 cu, the worker keeps 150 before and 160 after: a rise of 6.7%.

Post-tax return. A project returns 12% before tax. At 25% tax the post-tax return is 12 × 0.75 = 9.0%. At 20% it is 12 × 0.80 = 9.6%. If firms need 9.5%, only the cut makes it worth doing.

Real terms (quantitative skill 7). Nominal training spending is 1.92 billion cu and the price index is 120 (base year = 100). Real spending = 1.92 / 1.20 = 1.6 billion cu.

Potential output. LRAS at 900 rises 3% to 927. If actual output stays at 880, the output gap goes from −2.2% (880 / 900 − 1) to −5.1% (880 / 927 − 1). More capacity does not mean more output unless demand rises.

Compounding. Trend growth of 2.0% for 10 years gives 1.02^10 = 1.219. At 2.5% it is 1.025^10 = 1.280. The second is 5.0% higher.

Cost per net job. A 48 million cu subsidy is linked to 800 jobs. Gross cost = 60,000 cu a job. If 25% would have happened anyway, net jobs = 600 and the cost is 80,000 cu per net job.

Unit labour cost. Wages up 3%, productivity up 4%: 1.03 / 1.04 − 1 = −0.96%. Unit labour cost falls even though pay rises.

Current account (goods). Exports 300 and imports 340, a deficit of 40. After policies exports rise 6% to 318 and imports fall 2% to 333.2, a deficit of 15.2. It narrows but does not close.

Hours response. A tax cut raises net pay per hour by 10%. If hours supplied respond with an elasticity of 0.5, hours rise by 0.5 × 10% = 5%. On 800 million hours that is 40 million more. The elasticity is an assumption. The income effect can push it towards zero.

Gross cost versus net benefit. A training scheme costs 90 million cu and lifts the earnings of 6,000 people by 2,500 cu each a year, so 15 million cu a year in total. Payback to the people trained: 90 / 15 = 6 years. Some of that gain would have come without the scheme, so the true payback is longer.

Unemployment rate. 330,000 unemployed in a labour force of 5.5 million is 6.0%. After a scheme, 275,000 gives 5.0%.

Price elasticity (quantitative skill 8). A fare falls 10% and passengers rise 15%. Elasticity = 15 / −10 = −1.5, elastic, so revenue rises.

Method boxes

Explain a policy (4 steps):

1. Name the policy and what it changes (cost, incentive, skills, rules).
2. Show the effect on factors of production or firms’ costs.
3. Link to LRAS or SRAS and say what moves.
4. State the macro result: growth, unemployment, inflation or the current account.

Evaluate a policy (judgement):

1. Time lag: how long before it works?
2. Cost and opportunity cost: who pays?
3. Size of the response: elasticity or take-up.
4. Whether demand is strong enough to use the extra capacity.
5. Side effects: inequality, the environment, safety, the budget.
6. Conclude: which matters most, and what it depends on.

Must-know distinctions

• Policy versus improvement. Government action versus any rise in capacity.
• LRAS versus SRAS. Policies that change capacity move LRAS. Those that lower firms’ costs in the short run shift SRAS.
• Marginal versus average tax rate. The incentive to work more depends on the marginal rate.
• Allowance versus rate. A higher allowance mainly helps those entering work. A lower rate rewards extra effort.
• Structural versus demand-deficient unemployment. Supply-side policies target the first.
• Gross cost versus net cost. Deduct what would have happened anyway.

Quick self-test

1. Name two sources of a supply-side improvement that need no government.
2. Output per worker rises from 52.0 to 54.6. Find the percentage change.
3. A worker keeps 70 of an extra 100 cu. The marginal rate then falls from 30% to 24%. How much is kept?
4. Nominal spending is 2.4 billion cu with a price index of 125. Find real spending.
5. A project earns 8% before tax. Find the post-tax return at 30% tax.
6. Which type of unemployment do supply-side policies mainly address?
7. LRAS rises from 600 to 636. Find the percentage rise.
8. Unit labour cost: wages up 5%, productivity up 2%. Find the change.
9. Why can a supply-side policy leave unemployment unchanged?
10. A subsidy of 30 million cu supports 500 jobs, 20% of which would exist anyway. Find the cost per net job.

Answers

1. Invention, innovation, private training, firm investment or rising productivity (any two).
2. 54.6 / 52.0 − 1 = 5.0%.
3. Marginal rate 30% means 70 kept. At 24% the worker keeps 76, a rise of 8.6%.
4. 2.4 / 1.25 = 1.92 billion cu.
5. 8 × 0.70 = 5.6%.
6. Structural (and frictional) unemployment.
7. 36 / 600 = 6.0%.
8. 1.05 / 1.02 − 1 = +2.9%.
9. Unemployment may be caused by weak demand, or the policy may not match skills to vacancies, or it may take years to work.
10. Gross cost 60,000 cu a job. Net jobs = 400, so 75,000 cu per net job.

Where marks are usually lost

• Calling any rise in productivity a “policy” without government involvement.
• Naming a policy but not saying what it changes, and so not reaching LRAS or SRAS.
• Writing that tax cuts “increase incentives” without stating whose incentive, and in which direction.
• Leaving out the time lag in education, infrastructure and training.
• Treating a bigger LRAS as automatically higher output, without demand.
• Using the average tax rate when the marginal rate is what matters.
• Quoting nominal spending when a real-terms comparison is needed.
• Stopping at a list of advantages and disadvantages with no judgement.
• Mixing in fiscal or monetary policy points that belong in other sections.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, section 3.2.4.3 Supply-side policies and section 3.5 Quantitative skills. First teaching September 2020; first International AS exams May/June 2021; first International A-level exams May/June 2022. Published by OxfordAQA.