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Can Supply-Side Policies Reduce Inflation?


Discuss why whether or not supply-side policy measures can reduce inflation.

(8 marks)


Macroeconomic Factors and Policies

CIE O Level November 2021

Preview Answer

(Step 1: Define inflation and supply side policy)

Governments may employ supply-side policy to correct cost-push inflation.

Inflation occurs when there is a sustained increase in the general price level. Cost-push inflation occurs when prices are pushed up by increases in the cost of production.

Supply-side policies increase the productive potential of the economy, they help to prevent the general price level from rising beyond control. Supply-side policies are long-term strategies aimed at increasing the productive capacity of the economy by using policies to improve the quality and/or quantity of factors of production.

(Step 2: Discuss how supply side policy measures can reduce inflation)

The ability of supply-side policies to reduce inflationary pressures by keeping firms costs of production down will help in lowering cost push inflation.

Increased spending on training can raise labour productivity and so reduce labour costs or at least reduce the upward pressure on labour costs.

Lower corporation tax may encourage firms to buy more efficient capital equipment, which can also put downward pressure on price rises.

A government may decide to provide subsidies to firms facing, for instance, higher fuel costs, so that they do not have to raise their prices.

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