Government Spending Influences Economy
There are quite a few of explanations as to why an increase in government spending might not have the expected effect on an economy. Aggregate demand and aggregate supply curves "enable us to study how output and prices are determined in both the short run and in the long run
which provide the framework in which we can study the role the government can play in stabilizing the economy through its spending, tax, and money creation policies." (O'Sullivan/ Sheffrin 2006) Factors responsible
There are several different factors responsible in shifting the demand curve, they are ; changes in the supply of money, changes in taxes, changes in government spending, and any changes in demand.
Decreases in taxation, increases in government spending, and increases in the supply of money to consumers all increase the aggregate demand. A swell in aggregate demand is defined by the total demand for all the goods and services enclosed in real GDP have increased.
If government spending has not increased GDP as expected that could mean that some of the other factors that influence the demand curve will need to be adjusted as well. A slight decline of taxes could possibly nudge the economy to their prospective point or possibly lowering the discount rates freeing up more money to banks who can then turn around and let it out to consumers, who will hopefully spend it to fuel the economy, at a reasonable interest rate.
The government can also increase the money supply by purchasing bonds. Purchasing bonds stimulates the economies money supply because it puts more money into the economy.
The aggregate supply curve reflects the suggestion that in the long run output is determined exclusively by the factors of price, technology, and capital.
Decrease in tax rates will typically increase labor supply and output, therefore changes in taxes can shift the aggregate supply curve as well.
References: O 'Sullivan, A., & Sheffrin, S.M. (2006). Economics Principles & Tools (4th ed.)
Upper Saddle River, NJ: Prentice Hall.
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