ECON 20 Lecture Notes - Lecture 29: Government Spending, Aggregate Demand

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19 Oct 2020
Jeff Koo
Econ 20
Introductory Economics
Fall 2018
4 Units
The Government Sector
1. Size and trends of government spending
a) Spending on goods and services: the contribution to GDP and b) Transfer payments
In 2010, total federal government spending was about a quarter of US GDP. Federal
government spending on goods and services constituted about 8% of GDP. The difference
between these two figures is the result of transfer payments, most obviously payments for
Social Security, Medicare, and Medicaid.
G, government spending on goods and services, is the final component of economy we will
discuss. It includes such things as military spending, hiring firms to build roads, and
payments to government employees.
o While we mostly hear about government spending in terms of federal government
spending, G includes state and local government spending on goods and services.
o The spending in G includes both government consumption and government
o The amount the government spends on goods and services is directly added to GDP
and it is a component of aggregate demand.
The course website has a link to charts that show the trends of recent government spending
and tax variables. The chart shows that total government spending rose as a share of GDP
from the 1960s to the mid 1980s and then leveled off. There is a notable increase in total
federal spending (including transfers) at the beginning of the Great Recession
o Government spending on goods and services had actually been on a declining trend,
as a share of GDP, since the late 1960s. It turned upward modestly in the Great
Recession, although it is coming back down again as the economy recovers.
The growing gap between total government spending and direct spending on goods and
services implies that transfer payments, primarily Social Security and Medicare, have risen
substantially. This trend is likely to continue as the baby boomers reach retirement.
Total government spending is now above one third of GDP, but the direct effect of
government on resource allocation and demand (that is, government spending on goods and
services) is about one fifth of GDP.
c) Federal government versus state and local spending
Total federal spending is larger than state and local spending, but state and local expenditures
are far from trivial.
If one looks just at the direct spending on goods and services that contributes to demand and
GDP, state and local spending exceeds federal spending on goods and services.
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