1. Macroeconomics Chapter 12
Government Expenditure
Macroeconomics Chapter 12

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
Macroeconomics Chapter 12

3. Data on Government Expenditure
Macroeconomics Chapter 12

4. Data on Government Expenditure
Macroeconomics Chapter 12

5. Data on Government Expenditure
Macroeconomics Chapter 12

6. Macroeconomics Chapter 12

7. Macroeconomics Chapter 12

8. 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
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
Macroeconomics Chapter 12

9. 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
Macroeconomics Chapter 12

10. 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.
Macroeconomics Chapter 12

11. The Government’s Budget Constraint
Government budget constraint
Gt + Vt = Tt
real purchases+ real transfers= real taxes
Macroeconomics Chapter 12

12. Macroeconomics Chapter 12
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.
Macroeconomics Chapter 12

13. 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

14. 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

15. 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

16. 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

17. 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.
Macroeconomics Chapter 12

18. 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.
Macroeconomics Chapter 12

19. Permanent Changes in Government Purchases
r = ( R/ P) · κ − δ(κ)
a permanent increase in government purchases does not affect the real interest rate.
Macroeconomics Chapter 12

20. 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.
Macroeconomics Chapter 12

21. 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

22. 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

23. 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

24. 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.
Macroeconomics Chapter 12

25. 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
Macroeconomics Chapter 12

26. Permanent Changes in Government Purchases
∆(Vt − Tt + λG)=-1+λ
∆(Ct + λG)=-1+λ
∆Ct + λ∆G=-1+λ
∆Ct =-1
Macroeconomics Chapter 12

27. Permanent Changes in Government Purchases
Macroeconomics Chapter 12

28. 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.
Macroeconomics Chapter 12

29. 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.
Macroeconomics Chapter 12

30. 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.
Macroeconomics Chapter 12

31. 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

32. 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.
Macroeconomics Chapter 12

33. 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

34. Government Purchases and Real GDP During Wartime: Empirical
Macroeconomics Chapter 12

35. 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

36. 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.
Macroeconomics Chapter 12

37. 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.
Macroeconomics Chapter 12

38. Wartime Effects on the Economy
Macroeconomics Chapter 12

39. Wartime Effects on the Economy
Employment Effects on Labor Markets
Prediction that a war reduces the real wage rate, w/P
Macroeconomics Chapter 12

40. 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
Macroeconomics Chapter 12

41. Wartime Effects on the Economy
Macroeconomics Chapter 12

42. 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

43. 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.
Macroeconomics Chapter 12