4.5.1 - Expenditure

Question 1

What is public expenditure to GDP

Answer 1

the proportion of public expenditure to GDP is a measure used to compare levels of public spending both over time and between different countries

Question 2

Three types of public expenditure

Answer 2

Current Expenditure
Capital Expenditure
Transfer Payments

Question 3

what is current expenditure

Answer 3

government’s day-to-day expenditure on goods and services. Examples include wages and salaries of civil servants, and drugs used by the NHS, school utility bill, NHS medicine, food for NHS patients, prison officer wage

Question 4

What are transfer payments

Answer 4

payments made by the state to the individual acting as a redistribution of income and wealth by the government when they make payments to individuals without goods or services being received in return

Question 5

what is capital expenditure

Answer 5

government expenditure on capital items and infrastructure. This spending should generate a future income stream.

• 5G network, airport, bridge, college, new trainline

Question 6

What are reasons for the changing size and composition of public
expenditure in a global context

Answer 6

• Economic Development/Rising Incomes
• Changes in the structure of the population
• Stage in the business cycle
• Financial crises
• Levels of government debt

Question 7

why is gov spending likely to rise in a recession

Answer 7

1) Unemployment benefits will rise
2) Income tax revenue will fall as incomes fall and unemployment rises
3) Expansionary fiscal policy may be used to recover from the recession

Question 8

What is the multiplier effect

Answer 8

A description of the effect that injections of new demand for goods and services into the circular flow of income stimulate further rounds of spending – in other words “one person’s spending is another’s income”. This can lead to a bigger eventual final effect on output and employment.

Question 9

Describe history of public spending

Answer 9

● The Global Financial Crisis led to huge increases in government spending as
governments had to increase welfare payments and some governments used
taxpayer money to bail out the banks. In the UK, the government bought stakes in
Lloyds and the Royal Bank of Scotland.

● However, since 2010 the UK government has been following a policy of austerity in
an attempt to reduce the debt. They have been consistently attempting to reduce
expenditure where they can. Therefore, the size of spending depends on government
aims.
● In the next decades, Europe and Japan will see pressure on government spending
due to aging populations meaning larger pension bills and higher levels of care
needed.

Question 10

Define crowding in

Answer 10

When an increase in government spending/investment leads to an
expansion of economic activity (real GDP) which in turn incentivises private sector firms to raise their own levels of capital investment and employment (so higher private sector spending)

Question 11

Define crowding out

Answer 11

The crowding out view is that a rapid growth of government spending
leads to a transfer of scarce productive resources from the private sector
to the public sector where productivity might be lower. Can also lead to
higher taxes and interest rates which squeezes profits, investment
employment in the private sector.

simple: when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment

Question 12

Why does corwding out occur?

Answer 12

1) a reallocation of resources towards public sector spending when the economy is at full employment will reduce private sector spending.

2) if the increased government spending is financed through borrowing, this may increase interest rates due to the increase in demand for borrowed funds. This will then discourage private sector borrowing for consumption and investment.

Question 13

evaluate crowding out

Answer 13

may not occur even at full employment if government spending leads to higher economic growth as overall productive capacity of the economy is larger

Question 14

evaluate crowding in

Answer 14

when increased government spending results in higher private sector spending.
Evaluation: depends on the size of the multiplier, government spending may be used ineffectively

Question 15

What does government expenditure impact on?

Answer 15

Productivity
Living standards
Taxation
Inequality
Crowding out
Crowding in

Question 16

How does gov spending impact productivity

Answer 16

● Free market economists argue that government spending is wasteful and causes inefficiency. However, the government is able to enjoy economies of scale when it provides goods, and this improves productivity.

● They also provide the infrastructure, such as roads, necessary for the economy to
run efficiently.

● Education creates the human capital necessary for growth whilst the healthcare
system reduces the number of days workers lose from serious illness. Spending on research and development may not be done by the private sector and the
government will undertake it to give businesses a long term competitive edge.

● Through spending, the government can create a multiplier effect and this can be
focused on areas of the country with high unemployment, creating growth.

Question 17

How does gov spending affect living standards

Answer 17

● Government spending can cause large improvements in living standards. The
government corrects market failure and provides public goods , which improves
social welfare.

● They are also important since they reduce absolute poverty by providing benefits
and basic goods, such as education and healthcare. In developing countries,
governments do not have the resources to do this and this leads to malnutrition, poor
water etc.

● There is some debate about how much the government can contribute to improved living standards. It is argued that the government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall.

● It can be argued that the government suffers from the principal agent problem
since they make decisions on behalf of the people and individuals may have spent
that money differently. As a result, there is a loss in welfare and so a fall in living
standards. However, the political system means that society decides the government and so therefore decides to an extent where it would like money to be
spent.

Question 18

How does gov spending affect taxation and equality levels?

Answer 18

Level of taxation:
● In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive
effect.
● Oil-rich countries tend to be an exception, where revenue from oil can pay for most
of government spending.

Equality:
● Spending should increase equality as it leads to redistribution and helps to provide
a minimum standard of living for the poorest in society. It ensures everyone has
access to basic goods, such as education and healthcare, which will help to give
them a fair start in life.

Question 19

Two effects of crowding out

Answer 19

● In order to spend money above their tax revenues, the government has to borrow
from individuals and businesse s. However, the amount of money in the economy
available to borrow does not increase. The government will therefore be competing
with the private sector for finance and will cause higher interest rates . This will
discourage firms from investing and individuals from buying on credit.
● On top of this, the limited number of resources in the economy means that for
every resource used in government spending, there are less resources available for the private sector. The result is that government borrowing crowds out private sector borrowing and spending and may lead to no real increase in AD.

Question 20

exceptions to crowding out

Answer 20

● Free market economists argue that investment would be more efficient if done by the private sector and that the government targets investment poorly and is wasteful.
● The crowding out effect is felt most at full employment, but it is not always the case.
Transfer payments have no impact on output and so would not cause crowding out as resources are simply taken from one group and given to another; the government isn’t taking resources from the economy. Moreover, when levels of unemployment are high then extra government spending could lead to crowding in where it encourages investment through the multiplier.