No 191: AS Summary for Government Spending as a Part of AD

THIS is the summary I wrote for AS students about G. 

Notice that this is a good topic to bring in some information about the arguments between Keynesian and Free Market economists.


Government Spending as a Part of Aggregate Demand

We studied the component of AD that measures government demand for goods and services, known as government spending (G). This contributes somewhere between 15 and 20% to UK Aggregate Demand.

Various factors influence the amount of G in the economy. These include the demand for merit and public goods, the current stage of the economic cycle, the amount of tax revenue, and technological progress in merit and public goods.

However, another extremely important factor is the economic and political ideology of the government. Free market economists believe that government spending is wasteful, inefficient, and can endanger the economy by too much borrowing. Government interventionists believe a relatively high level of government spending is necessary to correct market failures (especially inequality) and that government spending is the only way to boost the economy in a recession.

This idea (called demand management) was first suggested by the great economist John Maynard Keynes. He said that governments should borrow and spend more in a recession to help the economy. In a boom, they should spend less and try to save money (to be used during a recession).

However, free market critics argue that it is too difficult for governments to correctly decide how much and when to increase or cut spending, and therefore demand management may in fact make the situation worse. They also argue that while many governments during the Credit Crunch spent and borrowed more, very few saved money during the good times. Hence many countries have a huge amount of government debt now, which can cause many problems.

But, for many Keynesian economists, government spending is the most important part of AD, particularly in a recession. Furthermore, the effect of government spending is increased by the multiplier effect. In other words, an increase in G will lead to larger change in the national income of the country.

However, free market economists respond to this by arguing that because government spending is so wasteful, little of it actually gets to households, meaning that the value of the multiplier is in fact quite low.

In summary, this was yet another exciting class on Mr Spottiswoode’s economic course.