Economics at Klein Oak High School
Fall 2003

Review Keynesian Economics
 focus on demand side
 aggregate demand (AS) management
 C+I+G+(Ex-Im)=GDP

Keynesian Recession Strategy
 increase AD
 increase G (government spending)
 government spends more
 increase C (consumption)
 decrease taxes (fiscal policy)
 increase money supply (monetary policy)

Keynesian Inflation Strategy
 decrease AD
 decrease G (government spending)
 government spends less
 decrease C (consumption)
 increase taxes (fiscal policy)
 decrease money supply (monetary policy)

Supply Side Perspective
 stagflation is different
 caused by decrease in AS (aggregate supply)
 because lower supply  lower output (GDP) and higher prices (inflation)

Cause of Decrease in AS
 government policy (unintended consequences)
 high taxes
 discourage business investment
 “tax wedge” decreases after tax rate of return
 decrease savings
 same reason
 causes higher interest rate  decreases business investment

Note on “Tax Wedge”
 difference between what is paid and what is received
 ex: to pay $5.50 to an employee costs a business $7.00, due to taxes
 after taxes, the employee receives $4.50
 difference between $7.00 cost to business and
$4.50 incentive to employee is the “tax wedge”

Cause of Decrease in AS (2)
 government policy (unintended consequences)
 high taxes
 discourage work
 “tax wedge” increases after tax cost to business
 “tax wedge” decreases after tax return to employee
 therefore, employment decreases and so does production

Cause of Decrease in AS (3)
 government policy (unintended consequences)
 excessive regulation
 increases cost of production  decreases supply
 supply shock
 little can be done about this but it isn’t a long run problem

Supply Side Goal

Supply Side Policy
 increase AS
 reduce taxes on business
 reduce regulation on business
 reduce taxes on savers
 people with a high “marginal propensity to save”
 i.e. people who save additional dollars
 primarily high income people

The Laffer Curve
 after a point the disincentive effect of higher tax rates will result in high rates reducing tax revenue
 more

Implications of Laffer Curve
 it’s possible to raise rates and get less revenue
 the higher rates cause a “recession”
 it’s possible to lower rates and get more revenue
 if the lower rates stimulate the economy enough

Tax Fairness
 tax cuts will give more $ to wealthy than to others because
 wealthiest 50% pay 96% of income taxes
 wealthiest 5% pay 53% of income taxes

Short-run vs . Long-run

Keynes: “In the long run we are all dead.”
 Keynes ignored the long run complications of the policies he advocated.

Of course, it was the great depression.
 Supply-side policies focus on the long run
 emphasis on incentives
 requires that people and businesses can depend on policies remaining in force for years

Effect of Supply–Side Ideas
 Most economists still primarily Keynesian.
 However, most now acknowledge that we must consider the supply-side effects of our policies.
 Recommendations are now more long-run in perspective.