questions about Aggregate demand.

[Guest]

About the cause of changes in government spending. 

 

   Increase in G means increase in the real GDP. But if the government changes their priority, their spending will increase or decrease in response to the change in priority. 

 

I kinda grasp that part but my questions are.

 

1,What do they mean by government spending ?? If a government spends more on the welfare system or the pension scheme , but didn't actually purchase any goods and services ( Assume ), would that count as government spending?

 

2, is there any example for that??

 

 

Also, why income is not a factor of causing shift in aggregate demand?? Increase in national income leads to more disposable income for consumers, thus, more consumption will occur. It makes perfect sense in my head but my textbook says NO. I am so confused. Whereas increase in national income from abroad will increase the AD via increasing the net export..... Economics doesn't make any sense to me..... 

 

 

thank you.

Edited February 15, 2015 by Guest

[Guest]

unrelated but you are already doing macroeconomics?! are you in sl or hl?

SL

 

 

You are german??  Your name......

Edited February 15, 2015 by Guest

[EconDaddy]

Hi,

 

Government spending (G) is all the expenditure that the gov't spends on goods and services, but not transfer payments (e.g. unemployment benefits, pension, money for veterans etc.). Therefore G can include money spent on developing infrastructure (e.g. building roads, dams, sewage system etc.) or even the cash used to buy politicians' cars, but it also includes the salaries of those whose employer is the state/gov't (e.g. doctors, teachers, politicians etc. all providing services).

 

So based on that, spending more on the welfare system (which is basically the redistribution of tax revenue) does not contribute to the increase of G as it is not part of it (unless for example the gov't hires professionals to research how the welfare system could be improved - their salary would add to G as they provide a service). At the same time it is quite impossible for the gov't not to spend anything on goods and services. You might want to assume this (e.g. in a Laissez-faire approach where the gov't does not intervene in the economy), but in real life it is hardly ever the case. So the short answer to the 2nd part of your 1st quesion is NO.

 

Answer to Q2: not really in real life.

 

Q3: To start with, this is a really great question! Here is the answer: Indeed, you're right, income WOULD count towards AD IF (and only if) all of your income were spent consuming goods and services produced by your home country. However, part of the money that people receive will be spent on buying imports, which obviously does not increase the home country's GDP. Other parts of that income has to be paid as tax to the gov't (so it does not end up fostering the economy - not at least until it is injected back into the economy in the form of G). Lastly, people also tend to save a part of their income. Therefore, money spent on imports, taxes and put into savings are called leakages as these parts of income do not increase AD (and therefore GDP). So economists are really interested in the proportion of your income spent on consumption © as that is a very (in some cases the most) important part of AD. That said, an increase in the average income level will only affect AD, if some part of it is spent on C. But even then, it is highly unlikely that all of the increase in income in a nation will ALL be spent on consumption as leakages always occur.

 

And then it's another story that these leakages will later re-enter the economy in the form of injections: 1) foreigners buying our domestic products (contributing to our exports) from the money that we have given to them in exchange for the goods/services we imported from them; 2) gov't spending from the tax revenues collected; 3) our savings will be turned into investments (as banks provide loans to companies from our savings). What I have described here is the circular flow model of income. Have a look at it in one of your books, this must also be in there.

 

Let me know if anything is still unclear.

[Guest]

Hi,

 

Government spending (G) is all the expenditure that the gov't spends on goods and services, but not transfer payments (e.g. unemployment benefits, pension, money for veterans etc.). Therefore G can include money spent on developing infrastructure (e.g. building roads, dams, sewage system etc.) or even the cash used to buy politicians' cars, but it also includes the salaries of those whose employer is the state/gov't (e.g. doctors, teachers, politicians etc. all providing services).

 

So based on that, spending more on the welfare system (which is basically the redistribution of tax revenue) does not contribute to the increase of G as it is not part of it (unless for example the gov't hires professionals to research how the welfare system could be improved - their salary would add to G as they provide a service). At the same time it is quite impossible for the gov't not to spend anything on goods and services. You might want to assume this (e.g. in a Laissez-faire approach where the gov't does not intervene in the economy), but in real life it is hardly ever the case. So the short answer to the 2nd part of your 1st quesion is NO.

 

Answer to Q2: not really in real life.

 

Q3: To start with, this is a really great question! Here is the answer: Indeed, you're right, income WOULD count towards AD IF (and only if) all of your income were spent consuming goods and services produced by your home country. However, part of the money that people receive will be spent on buying imports, which obviously does not increase the home country's GDP. Other parts of that income has to be paid as tax to the gov't (so it does not end up fostering the economy - not at least until it is injected back into the economy in the form of G). Lastly, people also tend to save a part of their income. Therefore, money spent on imports, taxes and put into savings are called leakages as these parts of income do not increase AD (and therefore GDP). So economists are really interested in the proportion of your income spent on consumption © as that is a very (in some cases the most) important part of AD. That said, an increase in the average income level will only affect AD, if some part of it is spent on C. But even then, it is highly unlikely that all of the increase in income in a nation will ALL be spent on consumption as leakages always occur.

 

And then it's another story that these leakages will later re-enter the economy in the form of injections: 1) foreigners buying our domestic products (contributing to our exports) from the money that we have given to them in exchange for the goods/services we imported from them; 2) gov't spending from the tax revenues collected; 3) our savings will be turned into investments (as banks provide loans to companies from our savings). What I have described here is the circular flow model of income. Have a look at it in one of your books, this must also be in there.

 

Let me know if anything is still unclear.

I am still not really sure about Q3, as in my textbook, ( Cambridge ), it says the national income cannot be counted as a determinant of aggregate demand as , the national income is already measured in the real GDP , and real GDP is the horizontal axis, so a change in national income , which is a change in the x axis will not cause a shift in the curve. And it really makes no sense.

Edited February 15, 2015 by Guest

[EconDaddy]

Again, good question. I guess you have learnt about the different approaches of calculating GDP (expenditure, income and output approach). We have to get the same GDP value in all cases. The AD (curve) shows the nation's GDP (or national income) at different price levels. So at a given price level an increase on overall AD will also increase GDP/national income. Of course the price levels will also change thanks to the elasticity of the AS curve. But the answer to the question is that if there is an increase in AD (because of the increase of one or more of C + I + G + X or the decrease of M) then this should be followed (at least in the short-run) by a general increase in national income. Why? Because as money is spent on C + I + G + X-M, this money will be in the form of income for those who receive it. This is why we should arrive to the same GDP value no matter if we use the expenditure or the output approach.

 

So basically the book says that a change in AD might influence national income, but not vice versa (as the x axis is national income, while AD is a function).

 

Did this help?

Edited February 15, 2015 by EconDaddy

[Guest]

Again, good question. I guess you have learnt about the different approaches of calculating GDP (expenditure, income and output approach). We have to get the same GDP value in all cases. The AD (curve) shows the nation's GDP (or national income) at different price levels. So at a given price level an increase on overall AD will also increase GDP/national income. Of course the price levels will also change thanks to the elasticity of the AS curve. But the answer to the question is that if there is an increase in AD (because of the increase of one or more of C + I + G + X or the decrease of M) then this should be followed (at least in the short-run) by a general increase in national income. Why? Because as money is spent on C + I + G + X-M, this money will be in the form of income for those who receive it. This is why we should arrive to the same GDP value no matter if we use the expenditure or the output approach.

 

So basically the book says that a change in AD might influence national income, but not vice versa (as the x axis is national income, while AD is a function).

 

Did this help?

It does help !! Thank you for posting  such a long comment to help me.   Thank you so much.

[EconDaddy]

You're more than welcome.