Government Expenditure
Economics: Edexcel A A Level, topic 3.2.4
Fiscal Policy
Fiscal policy involves changing government spending and taxation, according to the economic conditions: AD = C+I+G+(X-M). So changing G will affect AD.
Expansionary fiscal policy
- Expansionary fiscal policy increases the level of aggregate demand (AD) by either increasing government spending or cutting taxes. This can:
- Increase consumption by increasing disposable income because of tax cuts.
- Increase investment by cutting business taxes.
- Increase government purchases because government spending itself rises (e.g new hospitals & schools).
- Expansionary fiscal policy shifts AD rightwards because AD has increased.
Contractionary fiscal policy
- Contractionary fiscal policy decreases the level of AD by decreasing:
- Consumption.
- Investments.
- Government spending.
- Contractionary fiscal policy shifts the AD curve leftwards as AD has fallen.
The Trade Cycle and Government Spending
The trade (otherwise known as the economic or business) cycle influences government spending.
The trade cycle
- The trade cycle displays a country's economic growth.
- The fluctuations account for different phases:
- Economic boom - building economic growth.
- Peak - climax of economic growth and rates beginning to fall.
- Economic downturn - economic growth rate falling.
- Trough - the bottom of the cycle where growth rates begin to rise.
Impact on government spending
- Government spending is impacted by the trade cycle:
- In an economic boom, there is more spending and higher incomes which means the government receives more tax. The government also pays less benefits.
- In an economic downturn the reverse is true.
Test yourself on Government Expenditure
Which of these are features of expansionary fiscal policy?
Which of the following combinations of policies would most closely resemble contractionary fiscal policy?
Which of the following combinations of policies should lead to the greatest increase in real GDP?
What is government spending impacted by?