One of the economic policies we frequently hear or read about in the news and other financial media is the topic of supply-side economics. Whenever there’s not enough economic activity to produce full employment (i.e., no cyclical unemployment), Congress can employ fiscal policy to shift the aggregate demand curve (chapter 13) to the right. Or, in the case of inflation, it can slow the economy down by shifting the aggregate demand curve to the left. The Federal Reserve tries to do the same thing through monetary policy (shift the aggregate demand curve right or left).But you can see, with your knowledge of aggregate demand and aggregate supply analysis (chapter 12), the problem with shifting the aggregate demand curve is that when you fight one macroeconomic problem, you exacerbate the other. Shifting the AD to the right will increase output and reduce unemployment, but it also cause the price level to rise. That is, the government can fight unemployment but it will create inflation. If the government tries to fight inflation by shifting the AD to the left, it intensifies the problem of unemployment. Sketch this analysis out on the back of an envelope just to make sure you understand this concept intuitively.
However, notice what happens when the (short run) AS curve shifts to the right – both inflation and unemployment go down. If the AS curve were to shift to the left, both inflation and unemployment go up (YIKES! – the worst of both worlds). The decade of the 1970’s was a good example of this hell-scape. The price of petroleum was rising sharply, thus causing the cost of producing virtually everything to go up. Firms became less profitable and therefore less willing and able to produce goods and services at each price point. As a result, the aggregate supply curve shifted to the left. The decade of the seventies was characterized by high inflation and high unemployment (sometimes called stagflation – stagnant economy accompanied by inflation). I lived through it and it was really ugly.
Government efforts to shift the AS curve to the right (which would,hypothetically, produce the best of both worlds) are known as supply-side policy. But the aggregate supply curve will only shift to the right if production becomes more profitable. Congressional actions to do this are very unpopular because they seem to be rewarding the rich. In fact, this process has come to be named the derisive term, “trickle down” theory of economics. Today, it is called “top down” (as opposed to “middle out”policy). The big boys get the tax breaks and the benefits eventually trickle down to us peons. By the way, this has also come to be known as the feed-the-horse-to-feed-the-bird theory* and it provides an excellent opportunity for politicians to exploit the economic ignorance of aggregate supply and demand theory by the American public.
In your opinion, does supply side, or trickle down, economic policy work? If you believe so, you’ll want to give an example and explain why it is not utilized more in the federal government’s economic policy. If you believe that it does not, you will need to explain why reality, in your opinion, differs from what AD/AS analysis would indicate. Once again, let me remind you –this is an economics class, not a forum for political diatribe. To earn the full three points, you’ll need to frame your argument as an economist, not a politician or not even a regular person. The forum was initially scheduled to close on Saturday, 4/21 , but let’s extend that deadline to Tuesday, 4/24.
* If you need a graphic explanation of this, here goes (warning, it’s kinda gross). The horses get the oats, eventually they poop, and the birds go picking through the poop for the good stuff.