Demand side policy is a deliberate manipulation by the government of aggregate demand in order to achieve macroeconomic objectives. A fiscal policy refers to the use of government spending and/or taxation to manage the level of aggregate demand.
Fiscal policy can decrease unemployment by helping to increase aggregate demand and the rate of economic growth. The government will need to pursue expansionary fiscal policy; this involves cutting taxes and increasing government spending. Lower taxes increase disposable income and therefore help to increase consumption, leading to higher aggregate demand. With an increase in AD, there will be an increase in Real GDP. If firms produce more, there will be an increase in demand for workers and therefore lower demand-deficient unemployment.
There are however limitations to its effectiveness as it only potentially only deceases demand deficient unemployment but not any of the other three forms of unemployment: structural unemployment, frictional unemployment and real wage unemployment, which are mostly long term and will be better solved by the application of supply side policies. Furthermore, a cut in taxes depends on It depends on other components of AD. For example, if confidence is low, cutting taxes may not increase consumer spending because people prefer to save. Moreover, if the economy is close to full capacity an increase in AD will only cause inflation. Expansionary fiscal policy will only reduce unemployment if there is an output gap.
Supply side policies include any action by the government intended to increase the amount that firms are willing to supply at any given price level in which they seek to shift the aggregate supply curve to the right. If supply side policies are effective then an economy can achieve a sustained improvement in the trade-off between inflation and unemployment.
The government could reduce the rate of unemployment by increasing price flexibility and signalling in a market. If prices...