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.

Negative Externalities of Smoking

The article: http://www.bbc.co.uk/news/health-21067532

This article talks about how the “number of children admitted to hospital with severe asthma” has decreased by 12% in the first year after the ban on smoking in public places. It is also thought that people are opting for smoke – free homes as well, further reducing the negative externalities of consumption that are generated by smoking.

An externality occurs when the production or consumption of a product has an effect on a third party. Although the externality that is generated can be positive, the externalities of consumption generated by smoking are all negative, and this is one of the biggest examples of a negative externality of consumption.

When consuming a product, if negative externalities are produced, it will mean that the marginal social benefits are less than the marginal private benefits. The consumers are will not think about the negative effects that the consumption will have on third parties, they will only think about the benefits/costs to them. In the case of smoking, the smokers will not think about the effect of passive smoking on children which can cause asthma, but of the benefits to themselves. This means consumers will maximise their utility and consume at the quantity of Q₁, where the marginal social costs equal the marginal private benefits, rather than the socially desirable level of Q^*, where the marginal social benefits equal the marginal social costs. This results in a welfare loss to society, as shown by the blue, shaded area.

The article outlines how after the government intervened, the effect of the negative externality of smoking decreased by 12% in the first year. Government intervention is defined as actions on the part of the government that affect activity. The government can intervene in many ways, all of which have advantages and disadvantages.

 

The government could ban smoking altogether. The effects of this can be shown on a diagram.

In the diagram, the ban on smoking has shifted the Marginal Private Benefit Curve to the left, meaning it is closer to, or meets, the socially desirable level of Q^*. This would obviously reduce the negative externalities generated by smoking, and the effects of those negative externalities, including the reduction of cases of serious asthma in children.

Although this is likely to stop many people smoking, it has very many disadvantages. Firstly, it would have a huge effect on the tobacco industry, and the revenue made by the government from selling cigarettes, and due to the inelastic demand for cigarettes, it is likely to make people very angry, meaning the government will lose many voters. It could also result in a black market for cigarettes, where they are sold illegally for higher prices. Due to this it is not in the government’s best interests to completely ban smoking; however some governments do compromise by placing partial bans on cigarettes, as is described in the article. This partial ban has been shown in the article to have had a positive effect, reducing the cases of serious asthma in children, and even decreasing smoking in areas in which smoking was not banned, for example in the home.

 

 

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