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Chapter12
Government Expenditure
Macroeconomics Chapter 12
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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
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Data on Government Expenditure
Macroeconomics Chapter 12
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Data on Government Expenditure
Macroeconomics Chapter 12
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Data on Government Expenditure
Macroeconomics Chapter 12
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Macroeconomics Chapter 12
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Macroeconomics Chapter 12
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Data on Chinese Government Expenditure
美国（课本上
的数据）
中国（2007）
占GDP比重
占财政比重
占GDP比重
占财政比重
财政开支
19.80
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
32
Macroeconomics Chapter 12
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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
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The Government’s Budget Constraint




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.
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The Government’s Budget Constraint

Government budget constraint


Gt + Vt = Tt
real purchases+ real transfers= real
taxes
Macroeconomics Chapter 12
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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.
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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
Macroeconomics Chapter 12
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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 · Ls2 /(1+r1) + ·· ·
+( V1 − T1) + ( V2 − T2)/( 1 + r1)
+( V3 − T3)/[(1+ r1) · ( 1 + r2) ] + ·· ·
Macroeconomics Chapter 12
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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.
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases

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.
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases

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.
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Permanent Changes in Government
Purchases



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.
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Permanent Changes in Government
Purchases


r = ( R/ P) · κ − δ(κ)
a permanent increase in government
purchases does not affect the real
interest rate.
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Permanent Changes in Government
Purchases

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.
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Permanent Changes in Government
Purchases


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
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases

Theory

our prediction is that a permanent
increase in government purchases by
one unit causes consumption to
decrease by about one unit.
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases

Theory


Y= C+ I + G
the changes in C and G fully offset each
other and, thereby, allow I to remain
unchanged.
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases

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.
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Permanent Changes in Government
Purchases

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
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Permanent Changes in Government
Purchases

∆G=1

∆(Vt − Tt + λG)=-1+λ

∆(Ct + λG)=-1+λ

∆Ct + λ∆G=-1+λ

∆Ct =-1
Macroeconomics Chapter 12
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Permanent Changes in Government
Purchases
Macroeconomics Chapter 12
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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.
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Temporary Changes in Government
Purchases

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.
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Temporary Changes in Government
Purchases



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.
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Temporary Changes in Government
Purchases

Theory

Y= C+ I + G

Gross investment, I, must fall.

The real interest rate will rise in the
long run.
Macroeconomics Chapter 12
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Temporary Changes in Government
Purchases

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.
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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.
Macroeconomics Chapter 12
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Government Purchases and Real GDP
During Wartime: Empirical
Macroeconomics Chapter 12
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Government Purchases and Real GDP
During Wartime: Empirical



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.
Macroeconomics Chapter 12
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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.
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Wartime Effects on the Economy

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.
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Wartime Effects on the Economy
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Wartime Effects on the Economy

Employment Effects on Labor
Markets

Prediction that a war reduces the real
wage rate, w/P
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Wartime Effects on the Economy

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
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Wartime Effects on the Economy
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Wartime Effects on the Economy

Effects of war on the rental market


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.
Macroeconomics Chapter 12
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Wartime Effects on the Economy

Effects of war on the rental market

The predictions for higher real interest
rates during wartime conflict with the
U.S. data.
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