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

In a standard AD-AS model, the economy is at a level of output below potential with high unemployment. The government implements a successful supply-side reform that shifts long-run aggregate supply to the right, while aggregate demand is unchanged. Compared with a purely demand-side stimulus of the same eventual output gain, which statement is correct?

A successful supply-side reform expands potential output and, with demand unchanged, tends to raise actual output while lowering the price level. A demand stimulus instead raises output only along the supply curve and puts upward pressure on prices, without raising potential output.

  1. AThe supply-side reform raises output and puts upward pressure on the price level more than the demand stimulus
  2. BBoth policies raise output and the price level by the same amount
  3. CThe supply-side reform raises potential output and, with demand unchanged, tends to lower the price level while raising output, whereas the demand stimulus raises pricesCorrect
  4. DThe supply-side reform lowers potential output but raises employment
  5. The demand stimulus raises potential output permanently while the reform has no effect

Explanation

A rightward shift of aggregate supply with unchanged aggregate demand moves the equilibrium to a higher output and a lower price level. A demand stimulus moves along the supply curve, raising output only with higher prices. The reform also raises potential output, which demand policy does not.

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