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Business Economics Federal Reserve Opinion

A Gentle Conceptual Introduction to Supply-Side and Demand-Side Economics

Whether or not one may agree with supply or demand-side economics, one has to note that either policy has to contend with the times and the current market.

By Justin Chan | United States

Supply Side Economics

This theory developed most prominently in the 1970s and was firmly established in the 1980s with the rise of conservatism and Ronald Reagan. Supply-side economics is in direct contrast to Keynesian thought, such that it favors the producers as influencers of the market. In its essence, the theory of supply-side economics is that by increasing production factors such as capital, labor, and land, it would lead to economic growth.

Production factors can be influenced by the government in multiple ways. The main three being, influencing the marginal-tax rates or capital-gains, regulatory policies, and monetary policies—or the printing of money. Proponents of this theory focus on businesses, and one major way that they promote production is through tax cuts and fewer regulations. They argue that this would produce organic unity. For example, if a business were to receive fewer regulations they would be allowed to invest in more capital, and thus contributing more to the economy through hiring more workers, expanding their market or their production, etc. If companies oversupply due to production incentives, there will be an excess of good/services that would yield in lower prices, and thus consumers would increase their purchases of these goods and services. This method of thinking is similar to that of trickle-down economics, such that what is good for the business will eventually go down to the worker and be contributed back into the economy. 1

Experimentation of these ideas was used most prominently in the 1980s and 2000s during the Reagan era and with the George W. Bush Tax Cuts. What was empirically determined was that tax cuts to the lower class yielded in increased consumer spending, while tax cuts to the upper class provided more ability to pay off debts, and this saw a boost to the stock market. 2

Critics often cite that during these two eras, there was an increase in the national deficit and a recession seen during George H. W. Bush’s tenure and in 2008. They argue that the multiplier effects are less than a one to one ratio, and this produced middling growth, soaring deficits, and broad-based debt. Moreover, critics also cite that giving tax-cuts to the upper-class has seen little to no economic growth in production values. Non-partisan agencies such as the Congressional Research Service have found no correlation between low taxes on the wealth and of high growth rates in the economy or in employment rates. 3 4 5

Demand-Side Economics

Often called Keynesian economics, these sets of policies and ideas are focused on the high purchasing power of the consumer, and that by improving the purchasing power, consumer spending will increase business expansion and create a multiplier effect for economic growth. This is in direct contrast to the aforementioned supply-side economics. As noted before, proponents of Keynesian economics see the flaws in supply-side economics such that the tax breaks produce little economic benefits, and through government spending, it would help increase employment opportunities in the economy. 6

First, one has to realize that in order to reduce unemployment and to grow the economy, the government must overcome the low aggregate demand. There are four main ways that government can help increase the purchasing power of the consumer. The government can help spur the consumption of goods and services, investment by industry on capital goods, government spending projects and works, and increase net exports. One of the popular ways of doing this is by having the government sell bonds and altering interest rates, or printing money—monetary policy. This would increase the frequency that money is used to buy goods or services, and thus increasing the aggregate demand. 7

What these policies may do is that by an increase in the consumer purchasing power, there may be an increase in prices to offset the growth. The government handles this by trying to control inflation through interest rates to absorb the excess capital from the private sector. If inflation is too high, they would increase the interest rates. 8

Critics of demand-side economics often cite that it would balloon the national deficit through government spending in order to increase employment and the volatility that comes with it. In addition to this, there is the risk to the central bank by printing an excess amount of money to spur growth. Finally, when the government borrows more money, the interest rates on bonds would increase, and thus the higher interest rates would discourage investment from the private sector. 9

Conclusion

Whether or not one may agree with supply or demand-side economics, one has to note that either policy has to contend with the times and the current market. It should be the principle of the politicians and citizens to seek the best economic policy for their current state to best serve the people of all demographics and socio-economic status. There should not be an argument about which theory is better, but which theory is better for the current time period we live in.


Bibliography

Amadeo, K. (2018, January 8). Does supply-side economics work?. The Balance. Retrieved from https://www.thebalance.com/supply-side-economics-does-it-work-3305786

Demand-side economics. (n.d.). Business Dictionary. Retrieved from http://www.businessdictionary.com/definition/demand-side-economics.html

Demand-side policies. (2017, December 8). Intelligent Economist. Retrieved from https://www.intelligenteconomist.com/demand-side-policies/

Ettlinger, M., & Linden, M. (2012, August 1). The failure of supply-side economics. Center for American Progress. Retrieved from https://www.americanprogress.org/issues/economy/news/2012/08/01/11998/the-failure-of-supply-side-economics/

Freeman, R. (2006, May 14). A tale of two theories: supply side and demand side economics. Common Dreams. Retrieved from https://www.commondreams.org/views06/0514-20.htm

Gwartney, J. (2008). Supply-Side Economics. Library of Economics and Liberty. Retrieved from http://www.econlib.org/library/Enc/SupplySideEconomics.html

Harper, D. (n.d.) Understanding supply-side economics. Investopedia. Retrieved from https://www.investopedia.com/articles/05/011805.asp

Investopedia. (2018, January 16). What is demand-side economics?. Investopedia. Retrieved from https://www.investopedia.com/ask/answers/040915/what-demandside-economics.asp

Robinson, N. (2017, April 24). Supply-side vs. demand-side economics. Sciencing. Retrieved from https://sciencing.com/supply-vs-demand-side-economics-5923769.html

Tanden, N. (2013). Burying supply-side once and for all. Democracy A Journal of Ideas. Retrieved from https://democracyjournal.org/magazine/29/burying-supply-side-once-and-for-all/

Weinberger, D. (2017, October 18). Why supply-side economics is right and Keynesian economics is wrong. The Federalist. Retrieved from http://thefederalist.com/2017/10/18/supply-side-economics-right-keynesian-economics-wrong/

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1 comment on “A Gentle Conceptual Introduction to Supply-Side and Demand-Side Economics

  1. Pingback: A Gentle Conceptual Introduction to Supply-Side and Demand-Side Economics via /r/economy | Chet Wang

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