Keynesian and Neo-Classical Supply Side Policies for Long-Term Economic Growth

Running head: ECONOMICS FOR BUSINESS
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Introduction
The purpose of this assignment is to analyze how the government uses Keynesian and
neo-classical supply side policies to achieve long-term economic growth. Neo- classical or
supply side economics refers to the macroeconomic theory that argues economic growth can be
created effectively by reducing taxes as well as reducing deregulation. According to neo-
classical supply side economics, the consumers might benefit from larger supply of products and
services at low price as well as increase in employment rate. This theory states that enhanced
production enhances economic growth. Neo- classical supply side policies is the contrast of
Keynesian theory, which defines that demand is one of the main driving force (Taussig 2013).
The reason behind why supply- side growth theory might appear to give an alternative to Keynes
as this theory helps to interpret as that of demand management. The supply side attack on the
Keynesian policies is mainly based on return to growth analysis that is put forward by classical
economists and then rediscovered by Harrod, Solow. Neo-classical economists believe in fiscal
policy approach that is designed in promoting economic growth with the stable prices. The study
also focuses on the Keynesian growth framework that provides the long- term growth theory,
which builds upon Keynesian approach to the economic fluctuations. The examples of such
policies that are used by any European government is also discussed in this study.
Discussion
Neo- classical supply side policies and its significance
The major assumption of the Neo- classical economics is that the supply side factors
determines the real output. Neo- classical economists mainly argue that the supply side factors
mainly influences growth of real output as well as productive capacity (Borio 2014). Several
economists pointed out that long-term economic growth can be achieved by the integration of

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supply side policies. The supply side policies refers to the government policies that seek to
enhance efficiency as well as productivity of the nation. This includes- free market and
interventionists supply side policies. The government of a specific nation has some
macroeconomic objectives, such as-
 Low inflation
 Low unemployment
 Equilibrium on BOP( balance of payments)
 Higher or long term economic growth
Evans and Honkapohja (2012) opines that often the conflict occurs among these
macroeconomic objectives. For instance, expansionary fiscal policy imposed by the government
might contribute to high economic growth as well as lower unemployment. Therefore, this would
be at inflation cost and deterioration on current account. Tinkler and Woods (2013) suggests that
it is vital to enhance an economy’s supply side in order to attain all macroeconomic objectives
simultaneously. If government enhances productivity as well as shifts aggregate supply (AS) to
right, then it might improve competitiveness and enable low growth in inflation of that economy.
Neo classical economists argues that long run aggregate supply is inelastic and rise in AD is
inflationary and hence do not impact real output level. One of the major limitations for
enhancing long run economic growth rate is the productivity growth. Mankiw (2014) cites that
trend rate of long run growth cannot be increased through the demand- side policies. However, if
government needs higher sustainable economic growth rate, then it needs effectual supply side
policies that increases the productivity. For instance,

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Proper training schemes that provide laborers more skills might lead to higher productivity of
labour. Governments should try as well as motivate entities to make investment in research and
development (R&D) by providing tax credits. Thus, these effective policies might enable higher
economic growth of the nations. Thus, supply side policies increases long run aggregate supply
(LRAS), which in turn enhances potential growth. In practice, the government faces difficulties
to impose supply side policies in order to achieve long run economic growth. This is because the
productivity growth mainly depends on technological improvements to huge extent but these
improvements becomes independent on government policies.
Figure 1: supply side policies shifting LRAS to right and allowing higher growth
Source: (Economicshelp.org. 2018)
Supply side policies influencing unemployment
Rios, McConnell and Brue (2013) states that supply side policies has huge significance in
decreasing natural unemployment rate. The natural unemployment rate involves structural as
well as frictional unemployment, which are also known as supply side unemployment. In fact,