Aggregate Demand - Government Consumption (G) and net trade (x-m)

Question 1

Government consumption (G)

Answer 1

Government consumption: the day-to-day running costs of government e.g.
wages to public sector workers, energy & rent bills for government offices,
schools and hospitals etc..; also known as current spending by the
government (NB: Public sector capital spending belongs in Investment I)
It does not include transfer payments (e.g. government spending on welfare
benefits or pensions – spending on these is not new income but a transfer of
income from taxpayers to other groups)
Central government: government run at Westminster
Local government: local councils and county councils, city mayors

Question 2

Government spending and the trade cycle

Answer 2

In an economic downturn/recession, government spending on welfare
benefits and support for businesses increases – this is cyclical government
spending; the opposite occurs in a growth phase. The government can also
choose to make discretionary changes to its spending, unrelated to the
economic cycle, e.g. in the Annual Budget.

Question 3

Role of government spending

Answer 3

Changing government spending is a part of FISCAL policy
* Can be used to change the level of AD (with fiscal multiplier)
* Can be used to provide public and merit goods
* Can be used to correct market failures, e.g. positive consumption
externalities
* Can be used to influence economic regions., e.g. ‘levelling up’
* Can be used to achieve greater equity in society by providing public
services, including universal access to healthcare and education
Decisions about how much the government spends in the economy are often
dependent on the government’s economic and political goals

Question 4

Fiscal policy terms

Answer 4

Budget deficit: government spending exceeds tax revenue G>T; government
borrows to fund its spending.
Budget surplus: government spending is less than tax revenue ie
G<T; government can pay back some of its debt.
Balanced budget: government spending equals tax revenue G=T.
Fiscal multiplier: estimates the final change in real national income (GDP)
that results from an initial change in government spending plans.

Question 5

Net trade (X-M)

Answer 5

Net trade (X-M): net export demand is the value of exports less the value of
imports.
Trade surplus: net export demand is positive and adds to AD.
Trade deficit: net export demand is negative and reduces AD.
Trade balance equilibrium: value of exports X equals the value of
imports M, net export demand is neutral and AD does not change.

Question 6

Factors influencing net trade

Answer 6

• Real income: if incomes are increasing at home, this can suck in
  imports reducing X-M; if incomes abroad are increasing, this may
  increase exports, increasing X-M.
• Exchange rate: a depreciation makes imports more expensive and
  exports cheaper, which would increase X-M (unless there is a low
  response ie PED for exports or imports is inelastic).
• State of global economy: strong global growth may increase demand
  for exports, increasing X-M.
• Degree of protectionism: if other countries are cutting their tariffs and
  non-tariff barriers to trade, X-M may rise.
• Non-price competitiveness: if a country improves its non-price
  competitiveness (quality, design, speed of delivery, after-sales service)
  this could increase X-M.
• Price competitiveness: if a country improves this so its product are
  better value for money, then X-M should increase.
  (And vice versa for factors causing a fall in net export demand)