Effect on AD
- If govt spends more by borrowing some of the increased spending, higher Government spending should increase AD, (G is a component of AD.) - see: Government borrowing
- However, if tax increases at same rate then net effect on AD is likely to be neutral
- It depends whether government finances by borrowing or by tax
- Also, if higher spending is financed by borrowing it may cause crowding out
- Higher government spending may increase productive capacity in the long run. For example, they may spend it on education and training e.t.c.
- However, if it is spent on paying for pensions e.t.c there will be no increase in productive capacity
- However, there is no guarantee that government spending will actually increase educational standards, there may be government failure
- Again, it depends what the government is spending its money on.
How efficient is government spending compared to private sector spending. Higher government spending means a declining share of private sector spending and investment. Many economists argue government spending is more inefficient. THerefore, in the long run it can reduce productivity of the economy