Government Expenditure (G)
- Government expenditure is fairly self-explanatory. It is how the government uses their money to influence the level of aggregate demand in a country.
- It contributes to 25% of AD, being the second largest component.
There are 2 primary influences on the level of government spending:
- The trade cycle – this is defined as the pattern of economic growth for an economy, with a regular pattern of economic booms and recessions.
- During a boom period, government expenditure will fall. This is since less Jobseeker’s Allowance will have to be paid as jobs become more readily available. Also, due to the fact more individuals are working, income tax revenue rises.
- However, during a boom period, levels of economic growth can be unsustainable, and inflationary effects can arise from this. Therefore, the economy may enter a period of recession, and this requires higher levels of government spending to stimulate the economy once more.
- Changes in tax revenue and welfare payments are known as automatic stabilisers, and cause the actual growth line to tend towards the trend growth line – i.e. have less violent deviations.
- Discretionary policy is when the government target their spending or taxation, e.g. increasing subsidies to domestic firms in a recession.
Trade Cycle Model
- Fiscal policy – this is the manipulation of government spending and taxation to influence the level of AD within an economy. It is a demand-side policy, and hence has no impact on the level of aggregate supply.
- During periods of economic decline, expansionary fiscal policy may be used. This involves increasing the level of government spending and reducing the levels of taxation to stimulate the level of AD.
- Contractionary fiscal policy may be used during periods of high economic growth, whereby government spending falls and taxes are higher. This is used to reduce the size of the government deficit created from previous levels of high spending.