Student Reader

Supply-side vs Demand-side economics

Demand-siders put aggregate demand at the heart of the economy. They focus on consumption.

At the core of modern demand-side economics is the assertion that aggregate demand drives the American economy. Consumer spending (personal consumption) is the major component of aggregate demand; also, it comprises two-thirds of the American economy Garfinkle 2007, p 174. A fluctuation in consumer spending will cause a corresponding shift in the GDP.

Also, a core demand-side view is that personal consumption not only drives GDP growth, but also growth in business investment and employment Garfinkle 2007, p 176 After all, risk-averse managers will invest and hire in response to demand for their goods. The chief incentive for production is demand.

Demand-siders argue that while levels of business investment may vary substantially from year to year, consumption is the principal factor that drives the business cycle. As the late Nobel laureate economist James Tobin wrote, "Economy-wide recessions and booms reflect fluctuations in aggregate demand rather than in the economy's productive capacity." Demand-side policies, therefore, "work by stimulating or discouraging spending on goods and services." A demand-side stimulus to the economy may be applied via either fiscal policy (reducing taxes and/or increasing government spending) or monetary policy (reducing interest rates and increasing the supply of money). In either case, the focus is on producing an increased overall demand for goods and services within the economy. Garfinkle 2007, p 175
Supply-siders put supply at the heart of the economy. They focus on business investment.

It's not only important to drop the bottom rate; it's important to drop the top rate, as well. By dropping the top rate, we encourage growth, capital formation, and the entrepreneurial spirit. ...

Many small businesses in our society are sole proprietorships or Subchapter S's. They don't pay the corporate tax rate; they pay high personal rates. And when you drop the top rate, we're sending a strong signal that says we want the small business to flourish. We want the small business to become the big business.

No, tax rates need to be cut. We can afford tax cuts, and the way our economy is behaving today, we can't afford not to have tax cuts. George Bush, May 2001 Garfinkle 2007, p 165

Topic Shared Demand-side Supply-side
Taxes "Both sides acknowledge that tax cuts can stimulate the economy during a downturn, but the two sides view the problem, as it were, through opposite ends of the telescope" (Garfinkle, p 163). Tax cuts must increase consumer spending, which in turn stimulates production. Cuts must therefore return money to consumers. Since middle- and lower-class spend more of any money they receive, these groups are targeted for tax cuts. Tax cuts are across the board, to increase the incentive for work. However, the key contention is that a progressive tax code hurts most those very people most likely to invest in business.

Studies

Garfinkle, 2007

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