Government Spending and Aggregate Demand

http://www.independent.co.uk/news/uk/politics/david-cameron-and-vince-cable-at-war-over-route-to-recovery-8523397.html?origin=internalSearch

    This article describes how the Liberal Democrat Business Secretary, Vince Cable, believes that the £5bn increase in government spending was not enough and had ‘little effect on demand’, but proposes that the spending should be ‘greatly expanded’. However, David Cameron disagrees, and believes that helping with the cost of living by cutting down spending to keep taxes down is the answer.

    This article focuses on Government Spending, and the monetary policy of the government, announced last December, to increase government spending by £5bn. A Monetary policy is defined as the set of official policies governing the supply of money and the level of interest rates in the economy. Government Spending is money spent by the government which can be divided into current and capital expenditure. In this case, it is capital spending, which is defined as money which is spent on goods that will be used in the long term. Government spending can have a big effect on aggregate demand, which is the total spending on goods and services in a period of time at a given price level, and it is one of the components of aggregate demand, represented on the model of the circular flow of income by G.


The model of the circular flow of income is a simple model of the nation’s economy and features withdrawals; savings, taxations, and imports, as well as injections; investment, government spending, and exports. These things will all have an effect on aggregate demand; however this article focuses specifically on government spending, or the lack of it. In this case, Cable believes that the £5bn increase had ‘little effect’ on aggregate demand. However, as capital expenditure is expenditure on goods that will be used in the long term, it may be that the effects of the expenditure will be more long term as well.

However, David Cameron disagrees with Cable, saying that it would be better to try and help with the cost of living, which means cutting spending in order to keep the taxes down. The government want to encourage greater consumption by reducing income tax, and this would increase Aggregate demand in the same way the government expenditure would. Furthermore, if the government would like to encourage greater investment in order to increase Aggregate demand, then lowering corporate taxes will mean that firms will have higher after-tax profits in order to invest with. This shows that taxes, as well as government spending, can have an effect on aggregate demand, meaning the question is which will cause the greatest increase?

    In conclusion, we can see that the article shows two different options that the government could take in order to increase aggregate demand. Firstly, the government could increase capital expenditure, in the hope that it will have positive long term effects, such as increasing efficiency, and will increase aggregate demand. Secondly, the government could ‘help with the cost of living’ by cutting spending to keep taxes down. This will result in greater consumption, and therefore would also increase aggregate demand. It is difficult to see which of these will have the biggest effect in the long term.

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2 thoughts on “Government Spending and Aggregate Demand

  1. Bare Hilary says:

    Well this is most amusing.

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