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Macroeconomics Public Finance:

Macroeconomics Public Finance “ How does Government Spending affect the economy ”

Economics 2:

Economics 2 Reporter: Gheffrey S. Irinco Professor: Ms. Geraldine Lim

Content:

Content Government Expenditures Government Final Consumption Expenditure Government Gross Capital Formation/Investment Transfer Payments Sources of Funds Seigniorage Taxes Government Borrowing Theory: Economics of Government Spending, How does affect economy Cost vs. Benefits Extraction cost Displacement cost Negative Multiplier cost Behavioral Subsidy cost Behavioral Penalty cost Market Distortion cost Inefficient cost Stagnation cost

Government Expenditures :

Government Expenditures Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as GOVERNMENT FINAL CONSUMPTION APPROACH. Government final consumption expenditure (GFCE) is a transaction of the national account's use of income account representing government expenditure on goods and services that are used for the direct satisfaction of individual needs (individual consumption) or collective needs of members of the community (collective consumption). It consists of the value of the goods and services produced by the government itself other than own-account capital formation and sales and of purchases by the government of goods and services produced by market producers that are supplied to households - without any transformation - as social transfers in kind Example: Housing Program - Pag ibig Family Planning Expenditures - RH Bill Health and Youth Development - Phil Health Educational Program - Pubic Schools

Slide 5:

Government acquisition of goods and services intended to create future benefits, such as infrastructure investment or research spending, is classed as GOVERNMENT INVESTMENT (gross fixed capital formation), which usually is the largest part of the government gross capital formation. Investment is putting money into something with the expectation of profit. More specifically, investment is the commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, income (dividends), or appreciation (capital gains) of the value of the instrument. Example: Transactions with other nations

Slide 6:

Acquisition of goods and services is made through own production by the government (using the government's labour force, fixed assets and purchased goods and services for intermediate consumption) or through purchases of goods and services from market producers. Government expenditures that are not acquisition of goods and services, and instead just represent transfers of money, such as social security payments, are called TRANSFER PAYMENTS . Example: Military Training done by the Government for country’s security. Social Security Payments – Retirement Benefit ( Like what happening today with the officers of the AFP ) and other government officials.

Government spending can be financed by seigniorage, taxes, or government borrowing. :

Government spending can be financed by seigniorage , taxes , or government borrowing . Seigniorage- Ordinarily seigniorage is only an interest-free loan (for instance of gold) to the issuer of the coin or paper money. Seigniorage is a convenient source of revenue for some governments. Example: Interest Free Loan, for example for safekeeping (Gold or Precious Metals).

Slide 8:

Taxes - (from the Latin taxo ; "I estimate") is to impose a financial charge or other levy upon a taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law. Example: Value Added Tax, Income Tax and etc. Government Borrowing/debt - (also known as public debt, national debt) is money (or credit) owed by any level of government; either central government, federal government, municipal government or local government. Example: Government Bonds

Slide 9:

The first two types of government spending, namely government final consumption expenditure and government gross capital formation , together constitute one of the major components of gross domestic product. John Maynard Keynes was one of the first economists to advocate government deficit spending as part of the fiscal policy response to an economic contraction. In Keynesian economics, increased government spending is thought to raise aggregate demand and increase consumption, which in turn leads to increased production. Keynesian economists argue that the Great Depression was ended by government spending programs such as the New Deal and military spending during World War II . According to the Keynesian view, a severe recession or depression may never end if the government does not intervene. According to Austrian economists, the reason the Great Depression lasted as long as it did was because of significant government spending and government regulation of the economy.

The Theory: Economics of Government Spending :

The Theory: Economics of Government Spending Economic theory does not automatically generate strong conclusions about the impact of government outlays on economic performance. Indeed, almost every economist would agree that there are circumstances in which lower levels of government spending would enhance economic growth and other circumstances in which higher levels of government spending would be desirable. If government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very difficult if there were no government at all . In other words, some government spending is necessary for the successful operation of the rule of law. Economic activity is very low or nonexistent in the absence of government, but it jumps dramatically as core functions of government are financed. This does not mean that government costs nothing, but that the benefits outweigh the costs.

Costs vs. Benefits. :

Costs vs. Benefits . Economists will generally agree that government spending becomes a burden at some point, either because government becomes too large or because outlays are misallocated. In such cases, the cost of government exceeds the benefit. The downward sloping performance portion of the government and the Negative cause to the Economy can exist for a number of reasons, including:

The extraction cost:

The extraction cost Government spending requires costly financing choices. The federal government cannot spend money without first taking that money from someone. All of the options used to finance government spending have adverse consequences. Taxes discourage productive behavior, particularly in the current U.S. tax system, which imposes high tax rates on work, saving, investment, and other forms of productive behavior. Borrowing consumes capital that otherwise would be available for private investment and, in extreme cases, may lead to higher interest rates. Inflation debases a nation's currency, causing widespread economic distortion.

The displacement cost. :

The displacement cost. Government spending displaces private-sector activity. Every dollar that the government spends necessarily means one less dollar in the productive sector of the economy. This dampens growth since economic forces guide the allocation of resources in the private sector, whereas political forces dominate when politicians and bureaucrats decide how money is spent. Some government spending, such as maintaining a well-functioning legal system, can have a high "rate-of-return." In general, however, governments do not use resources efficiently, resulting in less economic output.

The negative multiplier cost. :

The negative multiplier cost . Government spending finances harmful intervention. Portions of the federal budget are used to finance activities that generate a distinctly negative effect on economic activity. For instance, many regulatory agencies have comparatively small budgets, but they impose large costs on the economy's productive sector. Outlays for international organizations are another good example. The direct expense to taxpayers of membership in organizations such as the International Monetary Fund (IMF) and Organization for Economic Co-operation and Development (OECD) is often trivial compared to the economic damage resulting from the anti-growth policies advocated by these multinational bureaucracies.

The behavioral subsidy cost:

The behavioral subsidy cost Government spending encourages destructive choices. Many government programs subsidize economically undesirable decisions. welfare programs encourage people to choose leisure over work. Unemployment insurance programs provide an incentive to remain unemployed. Flood insurance programs encourage construction in flood plains. These are all examples of government programs that reduce economic growth and diminish national output because they promote misallocation or underutilization of resources.

The market distortion cost:

The market distortion cost Government spending distorts resource allocation. Buyers and sellers in competitive markets determine prices in a process that ensures the most efficient allocation of resources, but some government programs interfere with competitive markets. In both health care and education, government subsidies to reduce out-of-pocket expenses have created a "third-party payer" problem. When individuals use other people's money, they become less concerned about price. This undermines the critical role of competitive markets, causing significant inefficiency in sectors such as health care and education. Government programs also lead to resource misallocation because individuals, organizations, and companies spend time, energy, and money seeking either to obtain special government favors or to minimize their share of the cost of government.

The inefficiency cost:

The inefficiency cost Government spending is a less effective way to deliver services. Government directly provides many services and activities such as education, airports, and postal operations. However, there is evidence that the private sector could provide these important services at a higher quality and lower cost. In some cases, such as airports and postal services, the improvement would take place because of privatization. In other cases, such as education, the economic benefits would accrue by shifting to a model based on competition and choice.

The stagnation cost:

The stagnation cost Government spending inhibits innovation. Because of competition and the desire to increase income and wealth, individuals and entities in the private sector constantly search for new options and opportunities. Economic growth is greatly enhanced by this discovery process of "creative destruction." Government programs, however, are inherently inflexible, both because of centralization and because of bureaucracy. Reducing government-or devolving federal programs to the state and local levels-can eliminate or mitigate this effect.

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Content:

Content Government Expenditures Government Final Consumption Expenditure Government Gross Capital Formation/Investment Transfer Payments Sources of Funds Seigniorage Taxes Government Borrowing Theory: Economics of Government Spending, How does affect economy Cost vs. Benefits Extraction cost Displacement cost Negative Multiplier cost Behavioral Subsidy cost Behavioral Penalty cost Market Distortion cost Inefficient cost Stagnation cost