Government Expenditure

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    Government expenditure is total expenditure by the government on goods and services. The government must provide merit goods like education and healthcare and public goods like roads, parks, the police, national defence and the law.

    An increase (decrease) in government expenditure will increase (decrease) AD and shift AD right (left). Government expenditure depends on:

    1) Business Cycle.

    A government must increase government spending during a recession to boost AD, increase employment and increase real GDP.

    2) Government Debt.

    A government must borrow funds to spend more than its tax revenue. But borrowing means the government gets into debt. A large government debt may eventually mean government spending in the domestic economy falls. A government cannot allow its debt to become too large and unsustainable in the long-run because creditors will fear the government will default on its debt so creditors charge a higher rate of interest to the government, the government’s debt rises further and eventually the government must reduce government spending and increase taxation to repay its debt.

    3) Type of Economy.

    A government intervenes little and spends little in a free market economy, intervenes more and spends more in a mixed economy, intervenes a lot and spends a lot in a command economy.

    4) Merit and Public Goods.

    A government must spend to provide public goods (national defence and street lighting) and subsidize merit goods (health and education) because the market price mechanism fails to allocate these goods efficiently.

    5) Demography.

    An aging population means there are more elderly people so the government must increase spending on healthcare and nursing homes. Also there are less economically active people (i.e. less people working), less people paying income tax, tax revenue falls and the government have less funds to spend. A younger population means there are more babies so the government must increase spending on healthcare. Migration means the population increases, there is more demand for public goods so the government must increase government spending to provide public goods.

    6) Poverty and Inequality.

    The more poverty and inequality there is, the more the government must spend to provide goods and services for those in poverty and benefits and subsidies to those on low incomes.

    7) Elections.

    The government may increase government expenditure on merit and public goods building up to election times.

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