Government Times Three

• Government Expenditures: This is the term for ALL spending by the government sector. It includes spending for the purchase of goods and services which falls under the title of government purchases. It also includes expenditures that are NOT for goods and services, which are termed transfer payments.


• Government Purchases: This is the specific term referring to actual expenditures on final goods and services, or gross domestic product, by the government sector. It specifically excludes transfer payments.


• Government Consumption Expenditures and Gross Investment: This is the official measure of the government purchases component of aggregate expenditures used in the calculation of gross domestic product This term reflects the fact that the government sector purchases both consumption goods and capital goods.

Stabilizing Business Cycles

The two alternatives are expansionary and contractionary:

• Expansionary Fiscal Policy: If the economy is in, or heading toward, a business-cycle contraction with resulting high rates of unemployment, then the recommended stabilization policy is a discretionary increase in government purchases. If the government sector buys more production, then the business sector produces more output, which entails more resource employment and household sector income. This can correct or prevent a general economic downturn.


• Contractionary Fiscal Policy: If the economy is experiencing, or likely to experience, high rates of inflation associated with a business-cycle expansion, then the recommended stabilization policy is a discretionary decrease in government purchases. If the government sector buys less production, then the business sector produces less output, which entails less upward pressure on prices. This can correct or prevent the expansionary pressure on the price level that triggers inflation.

Who Buys What?

• Federal: The primary functions at the federal level are national defense, assorted regulation, and maintaining law and order. Shady Valley is home to several military bases and a wide assortment of federal agency offices. When the Major General Air Force Base, located southwest of the city, buys jet fuel needed to fly an aircraft, the result is a government purchase. When the government workers at the Sylvester J. Peabody Federal Office building buy paper to print off official government reports, the result is a government purchase. When the Federal District Judge is paid a wage to pass judgement on alleged criminals, the result is a government purchase.


• State: At the state level, government is primarily concerned with such things as education and transportation. Shady Valley is also home to the Ambling Institute of Technology, a state-supported, comprehensive university. When the Ambling Institute constructs new classroom buildings, buys new computer equipment, or pays faculty salaries, then the result is government purchases.


• Local: Local government functions also include education and transportation, as well as fire and police protection. The expense of operating Shady Valley's city government, including the salaries of Mayor Victor Thurgood and other city employees, is a government purchase. Buying asphalt to repave a city street is a government purchase. Renovating dilapidated grade school is also included in the government purchases category.

The Circular Flow

The Circular Flow

A basic representation of the circular flow is displayed to the right. The components of this model are the four macroeconomic sectors--household, business, government and foreign--and the three macroeconomic markets--product, resource, and financial.

The household sector at the far left contains the consuming population of the economy. The business sector at the far right includes all of the producers. The government sector is positioned in the middle of the diagram and the foreign sector is at the very top.

The product markets near the top of the flow direct production from the business sector to the household sector in exchange for payment flowing in the opposite direction. The resource markets at the bottom of the flow direct factor services from the household sector to the business sector in exchange for payment flowing in the opposite direction. The financial markets located just above the resource markets divert saving from the household sector to business and government borrowing.

The circular flow indicates that the income used by the household sector to purchase goods through the product markets is obtained by selling factor services through the resource markets. It also indicates that the revenue used by the business sector to pay for factor services obtained through the resource markets is generated by selling goods through the product markets.

Government purchases are the flow between the government sector and the product markets. In particular, the government sector purchases a portion of gross domestic product through the product markets. The government sector pays for these purchases with income from the household sector, either that obtained directly through taxes or indirectly by selling legal claims through the financial markets.

Taxes and Borrowing

• Taxes: Taxes are involuntary payments to the government sector. Taxes are commonly placed on specific items or activities, including income, retail sales, and property. Fees or user charges, which are payments to the government sector for the purchase of specific goods or services (such as a drivers license), are also included in the general category of tax revenue. The bulk of the revenue used by the government sector for spending comes from taxes.


• Borrowing: When the government sector has more spending than tax revenue, it makes up the difference through borrowing, that is by selling legal claims through the financial markets. This borrowing, like taxes, ultimately comes from household sector income. However, in this case, the government sector must eventually repay the loans, which it does with future tax revenue.

Determinants

• Stabilization policies are near the top of the list of influences on government purchases. At the federal level, the desire to counter business-cycle instability caused by other expenditures is always a possibility. If other expenditures decrease, then the government sector is likely to spend more to fix or avoid unemployment problems of a business-cycle contraction.


• Political considerations invariably bubble near the surface of government purchases. Perhaps the political winds blow in the direction of reducing the federal deficit (the difference between total federal spending and tax collections). This could decrease government purchases. Or maybe a rather vocal and financially powerful interest group might convince government leaders to spend more (or less) on a worthy activity, like the space program, national defense, or environmental quality.


• State and local government purchases, which account for half of government purchases, are largely dependent on tax collections. When state and local tax collections grow, which usually happens when the economy is strong, state and local purchases increase. And when the economy is weak, tax collections are down, and so too are state and local purchases.

Three More Expenditures

• Consumption Expenditures: Consumption expenditures are the expenditures by the household sector on final goods and services undertaken in a given time period. The official measure of consumption expenditures is termed personal consumption expenditures and is generally divided into three categories--durable goods, nondurable goods, and services. Consumption expenditures are the largest and most stable of the four expenditures. They are about 60 percent to 70 percent of aggregate expenditures.


• Investment Expenditures: Investment expenditures are the expenditures by the business sector on final goods and services, in particular, capital goods like factories and equipment, undertaken in a given time period. The official measure of investment expenditures is termed gross private domestic investment and is also divided into three categories -- nonresidential fixed investment, residential fixed investment, and changes in private inventories. Investment expenditures are the most volatile of the four expenditures. They are about 10 percent to 15 percent of aggregate expenditures. Investment expenditures are the primary source of business cycles.


• Net Exports: Net exports are the difference between exports (goods and services produced by the domestic economy and purchased by the foreign sector) and imports (goods and services produced by the foreign sector and purchased by the domestic economy). The official measure of net exports is simply termed net exports of goods and services. The two components of net exports are exports from the domestic economy to the foreign sector and imports from the foreign sector to the domestic economy. They are typically around 2 percent of aggregate expenditures. Net exports play a relatively small role in the macroeconomy.

AE = C + I + G + (X-M)