Skip to content

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

Critics argue that some market-based supply-side policies may fail to raise long-run aggregate supply in practice. Which of the following is the most valid criticism of income tax cuts as a supply-side measure?

The valid criticism is that higher after-tax pay can make some workers choose fewer hours, because the income effect can outweigh the substitution effect. Labour supply may then not rise, so potential output may not increase as the policy intends.

  1. AHigher after-tax income can lead some people to work fewer hours because the income effect outweighs the substitution effectCorrect
  2. BTax cuts always raise total tax revenue, so government borrowing rises
  3. CTax cuts make labour more expensive and reduce the demand for workers by firms
  4. DTax cuts necessarily reduce aggregate demand, so output falls
  5. Tax cuts remove the incentive to save, so investment collapses

Explanation

A tax cut raises the reward for an extra hour (substitution effect, more work) but also lets people reach target income with fewer hours (income effect, less work). If the income effect dominates, labour supply may not rise. The other claims are wrong: tax cuts typically raise disposable income and demand, and do not make borrowing rise by definition.

Did you get it right without looking?

One question tells you little. A timed set on Supply-side policies and their impact on businesses shows your real accuracy, how long you take and where you lose marks.

Practise Supply-side policies and their impact on businessesFree diagnostic mock

More Supply-side policies and their impact on businesses questions