Macroeconomics Chapter 121 Government Expenditure C h a p t e r 1 2.

Macroeconomics Chapter 12 1

Government Expenditure

C h a p t e r 1 2


Data on Government Expenditure

Government expenditure is the dollar amount spent at all levels of government for

purchases of goods and services

transfer payments (amounts given to households and businesses)

interest payments










Data on Chinese Government Expenditure

中国（ 2007）

美国（课本上的数据）

占 GDP比重

占财政比重占 GDP比重占财政比重

财政开支 19.80 32

国防 1.41 7.14 3.2 10

教育 2.83 14.31 5.1 15.94

社保 2.96 14.94 9.2 28.75


The Government’s Budget Constraint

Government budget constraint:

total uses of funds = total sources of funds

Gt + Vt = Tt + ( Mt− Mt−1)/ Pt

real purchases+ real transfers = real taxes+ real revenue from money

creation



Gt represent government purchases in real terms for year t. Ct + It + Gt, is the aggregate real spending on

goods and services in year t.

Vt represent the government’s real expenditure on transfers.

The real value of this revenue for year t is (Mt −Mt−1)/Pt

Tt be the total real taxes collected by the government in year t.



Government budget constraint

Gt + Vt = Tt

real purchases+ real transfers= real taxes


Public Production

The government subcontracts all of its production to the private sector. Public investment, publicly owned

capital, and government employment are zero.

Public services have zero effect on utility and production.


The Household’s Budget Constraint

Household budget constraint Ct + (1/P)·∆Bt+∆Kt

= (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1)

With Government Ct + (1/P)·∆Bt+∆Kt

= (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1)

+Vt − Tt


The Household’s Budget Constraint

Multiyear household budget constraint with transfers and taxes:

C1 + C2/(1+r1) + · · · =

(1+r0)·( B0/P+K0)

+(w/P)1·Ls1 +(w/P)2 · Ls

2 /(1+r1) + ·· ·

+( V1 − T1) + ( V2 − T2)/( 1 + r1)

+( V3 − T3)/[(1+ r1) · ( 1 + r2) ] + ·· ·


Permanent Changes in Government Purchases

Theory G+ V = T or V − T = −G G rises by one unit each year, V − T

falls by one unit each year. household’s disposable real income

falls by one unit each year.



Theory Since the typical household has one

less unit of real disposable income each year, we predict that the decrease in C each year will be roughly by one unit.



An increase in G does not shift the curves for the demand or supply of capital services. the market-clearing real rental price,

(R/P)∗, and quantity of capital services, (κK)∗, do not change.



κK is unchanged, and A and L are fixed. Therefore, Y is unchanged.

Important conclusion that a permanent increase in government purchases does not affect real GDP.



r = ( R/ P) · κ − δ(κ)

a permanent increase in government purchases does not affect the real interest rate.



G does not shift labor supply, Ls, which is fixed at L, and does not shift the labor-demand curve, Ld. the market-clearing real wage rate,

(w/P)∗, does not change.

We conclude that a permanent increase in government purchases does not affect the real wage rate.



Since r does not change => no intertemporal-substitution effect.

Intratemporal substitution effect involves consumption and leisure ： labor and, hence, leisure is fixed. In any event, this substitution effect depends on

the real wage rate, w/P, which does not change



Theory our prediction is that a permanent

increase in government purchases by one unit causes consumption to decrease by about one unit.



Theory

Y= C+ I + G

the changes in C and G fully offset each other and, thereby, allow I to remain unchanged.



We predict that a permanent increase in G, Reduces consumption, C, roughly one

to one. The variables that do not change

include real GDP, Y; gross investment, I; the quantity of capital services, κK; the real rental price, R/P; the real interest rate, r; and the real wage rate, w/P.



Useful government expenditure G

Ct + (1/P)·∆Bt+∆Kt

= (W/P)t·Lst + rt−1·(Bt−1/P + Kt−1)+Vt − Tt

Ct +λG+ (1/P)·∆Bt+∆Kt

= (W/P)t·Lst + rt−1·(Bt−1/P + Kt−1)+Vt − Tt + λG



∆G=1

∆(Vt − Tt + λG)=-1+λ

∆(Ct + λG)=-1+λ

∆Ct + λ∆G=-1+λ

∆Ct =-1




Temporary Changes in Government Purchases

Theory Assume now that year 1’s real

government purchases, G1, rise by one unit, while those for other years, Gt, do not change. That is, everyone expects that Gt in future years will return to the original level.



Theory Vt− Tt= −Gt

Vt− Tt falls by one unit, and households have one unit less of real disposable income. In subsequent years, Vt − Tt and, hence, real disposable income return to their original levels.



Households would spread their reduced disposable income in year 1 over reduced consumption, Ct, in all years t.

Therefore, the effect on year 1’s consumption, C1, will be relatively small.

The propensity to consume out of a temporary change in income is greater than zero but much less than one.



Theory

Y= C+ I + G

Gross investment, I, must fall.

The real interest rate will rise in the long run.



Theory When the change in G was temporary,

year 1’s extra G comes mainly at the expense of I, rather than C.

When the change in G was permanent, we predicted that most or all of the extra G came at the expense of C.


Government Purchases and Real GDP During Wartime: Empirical

We test the model by studying the response of the economy to the temporary changes in government purchases that have accompanied U.S. wars.





The data also show that the rises in real GDP are by less than the increases in government purchases.

Aside from military purchases, the totals of the other components of real GDP are down during wartime. The model accords with this pattern.

However, the components of real GDP other than military purchases do not fall nearly as much as predicted by the model.


Wartime Effects on the Economy

Employment during wartime The basic pattern is that the military

took in a significant number of persons total employment expanded a little more.



Effects of war on labor supply At this point, there is no settled view among

economists about the best way to understand labor supply during wartime.

A large expansion of real government purchases, G, means that households have less real disposable income.

Casey Mulligan (1998) argues that labor supply, Ls, increases during wartime because of patriotism.

the military draft would affect the labor supply of single woman.





Employment Effects on Labor Markets

Prediction that a war reduces the real wage rate, w/P



Effects of war on the rental market

a wartime increase in labor supply, Ls, led to an increase in labor input, L.

the rise in L tends to increase the MPK (for a given κK).

The demand curve shifts right






For a given K, the rise in κK corresponds to an increase in the capital utilization rate, κ.

r = ( R/ P) · κ − δ(κ) increases in R/P and κ imply that r

increases.




The predictions for higher real interest rates during wartime conflict with the U.S. data.

Macroeconomics Chapter 121 Government Expenditure C h a p t e r 1 2.

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