Aggregate Demand

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Aggregate Demand and Government Spending

Aggregate Demand and Government Spending

In countries where there is a high level of state intervention, government spending usually forms a higher proportion of aggregate demand than in those countries where free market forces play a bigger role.

The level of economic activity in the economy influences government spending. For example if there is a high level of unemployment, the government may increase their spending in order to increase aggregate demand and the output of the economy. In contrast if there is a high inflation rate, the government may reduce its spending.

Voters can also put pressure on the government to spend money. A government may do this before a general election in attempt to win political support. Often the government will spend more on improving education, health care and transport infrastructure. 

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Aggregate Demand and Government Spending

Fiscal policy- The taxation and spending decisions of a government with the intention of manipulating aggregate demand.

One of the three main economic policies the government use to influence economic activity and achieve their macroeconomic policy objectives (keep inflation low and steady, reduce unemployment, balance payments and for our economy to have sustainable growth

Fiscal policy covers the taxation and spending decisions of a government. The government can change tax rates, the types of taxes it imposes and what is taxed, along with the compostion, amount and timing of government spending.

The KEY AIM of Fiscal policy is to influence aggregate demand. The government can raise AD by increasing its own spending and/or reducing taxes, this is because government spending is a component of Aggregate demand AD= C+I+X-M)
By spending money on computers in schools for example  will directly increase AD, also a cut in income tax will increase people's disposable income. This will cause consumption to rise, therefore also increasing aggregate demand.

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Aggregate Demand and Government Spending

Government Spending

Can also be called public spending or public expenditure can be divided into;

-Capital Expenditure- on for example, hospitals, schools and roads 
-Current Spending- on for example the running of public services, including teachers' pay and the purchase of medicines to be used by the NHS
-Transfer Payments- money transferred from taxpayers to recipients of benefits, for example pensioners and the unemployed. 
-Debt interest payments- payments made to the holders of government debt, for example, interest paid to holders of National savings certificates. 

The five most important areas of government spending recently have been;
social protection, health, education, defence and debt interest. 

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Government Spending

The amount and proportion spent on different areas is influenced by a number of factors. For example spending on social protection is influenced by benefit rates and by the level of economic activity. It rises during periods of falling unemployment.

Expenditure on health and education is affected by government priorities, government policies, and changes in the age composition,  of the population, as well as other factors. The UK's ageing population is putting increasing pressure on government spending on health.

Because people are living longer and are developing diseases of affluence there is increasing demand for NHS treatment and residential care.

Defence spending has been high recently due to the UK's military involvement in Iraq and Afghanistan  

Debt interest payments are affected by the level of government debt and the rate of interest.

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