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IAI Actuarial Core Principles · Business Economics · Supply-side policies and their impact on businesses

A government cuts the marginal rate of income tax on salaried workers as part of a market-based supply-side package. Which is the main intended effect on the economy's productive capacity?

The main intended effect is that lower marginal income tax rates raise the reward for working, encouraging more people to supply labour and work harder. This increases the economy's productive capacity and shifts long-run aggregate supply to the right, rather than operating mainly through demand.

  1. AIt raises the incentive to work and so increases labour supply, shifting long-run aggregate supply to the rightCorrect
  2. BIt reduces the money supply and so lowers inflation expectations
  3. CIt raises government spending and so increases aggregate demand directly
  4. DIt lowers the exchange rate and so makes exports cheaper
  5. It increases the minimum wage and so raises labour productivity

Explanation

Market-based supply-side policies work through incentives. Lower marginal income tax rates raise the reward from working, which is expected to increase labour supply and effort, shifting long-run aggregate supply right. The other options describe demand-side, monetary or exchange-rate effects that are not the intended mechanism.

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