Supply-Side vs. Demand-Side Economics: Theories & Differences

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  • 0:04 Supply and Demand
  • 0:41 Supply-Side Economics
  • 2:44 Demand-Side Economics
  • 4:41 Lesson Summary
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Lesson Transcript
Instructor: Christopher Muscato

Chris has a master's degree in history and teaches at the University of Northern Colorado.

Supply and demand are two of the most important concepts in economics, but which matters the most? In this lesson, we'll explore each side and see how their supporters defend them.

Supply and Demand

Economics can get pretty complex, but a lot of it really comes down to a single and relatively simple concept: supply and demand. This is a basic concept of economics which claims that the value of a commodity is determined by its availability (or supply) and how badly people want it (which we call demand). Easy enough, right? Now, supply and demand are both integral factors in an economy, but some people argue that one is slightly more important than the other. As a result, we get a debate between economists. Which side are you on? Let's examine each side and find out.

Supply-Side Economics

In one corner of this debate, we have the supporters of supply-side economics. This economic theory states economic growth is best encouraged through policies that lower barriers on production. Basically, the idea is that the economy grows when the supply grows. You create more products, make those products more accessible to the consumers, and then they are more likely to invest in the economy. In this theory, supply essentially creates demand, so economic policies should be focused on improving the supply side of the economy.

That's the gist, but what does this look like in terms of actual economic policies? One of the biggest beliefs in supply-side economics is that taxes should be kept low. Taxes are very important to this concept. The belief is that high taxes discourage investments and encourage people to hoard their money in tax-free shelters or accounts. Therefore, lowering taxes should encourage freer economic activity and more investment since people expect greater profits. With lower taxes also comes lower government regulation, and the free market is allowed to act independently. According to supporters of supply-side economics, this will actually generate more revenue for the federal government in the long run since the average consumer becomes more economically active.

Lower taxes are central to supply-side economics, but this concept is especially true when talking about the wealthy. Advocates of this policy claim that by giving tax breaks to the richest members of society, you free up the most amount of money. Investment starts at the top as the wealthy are able to put their money into new industries and businesses, and the benefits of this gradually make their way down to the rest of society. This concept is also known as trickle-down economics. In American history, trickle-down and supply-side economics are most associated with the presidency of Ronald Reagan in the 1980s. Reagan's policies focused on the wealthiest members of society, encouraging tax breaks and benefits for the rich, with the assumption that this would encourage them to be freer with their investments, thereby increasing the supply of commodities into the market.

Demand-Side Economics

Of course, not everyone agrees that the economy is really driven by supply. Supporters of demand-side economics claim just the opposite: that the economy is actually driven by consumer demand. In this theory of economics, it is the purchasing power of the lower and middle classes that creates the demand necessary to sustain economic growth. Increased demand encourages the increased production of commodities, so demand creates supply.

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