Increased government spending affects prices, real output, and employment in both the short and long run (Tejvan Pettinger, 2017b). An increased government spending is an expansionary policy aimed at increasing demand and therefore enhancing the performance of an economy. An increase in government expenditure causes an increase in Aggregate demand, as indicated by a shift to the right from AD0 to AD1. The economy shifts from equilibrium point A to B. The increase in aggregate demand is accompanied by an increase in prices from P0 to P1. The output also increases from Q0 to Q1.
Increased Government Spending can cause an increase in employment rates
The expansion of demand, prices, and output indicate a more industrious economy where most of the resources are employed, and hence the economy registers higher employment rates (Ackermann, 2023). The changes occur in the short-run period of an economy. In the long run, the effect of increased government expenditure is defined by the nature of the supply curve. Unlike the short-run aggregate supply curve, the long-run Aggregate supply curve is vertical. In the long run, increased government spending causes a rise in prices and output. However, continued increases in spending may be inflationary in the long run.
The Long Run Aggregate Supply Curve (LRAS) is a macroeconomic concept that illustrates the relationship between output and price level in an economy in the long run. This curve is usually represented as a vertical line, which indicates that the quantity of real output produced is independent of the price level in the long run (Sagal, 2022). This is because, in the long run, prices are assumed to be flexible, and therefore, the LRAS curve shows that firms can increase their output without having to increase prices. The LRAS curve means that market changes in demand do not affect the quantity of commodities supplied in the market. In this case, it means that all the resources in the economy are fully employed. Therefore changes in demand affect prices only.
The natural unemployment rate refers to the minimum unemployment rate that an economy sustains after full employment of resources (Tejvan Pettinger, 2017a). In the model above, the natural rate is indicated by Q1-Q0. Output Q1 indicates the amount of output that the economy is willing to produce at its full potential, while Q0 indicates the output that the economy is able to produce in the long run. The difference is the natural rate of resource unemployment that cannot be avoided.
References
Ackermann, N. (2023). Aggregate Supply & Aggregate Demand Model | Overview, Features & Benefits. Study.com. https://study.com/learn/lesson/aggregate-supply-demand-model-overview-features-benefits.html
Sagal, S. (2022). Long-Run and Short-Run Aggregate Supply Curve. Study.com. https://study.com/learn/lesson/long-run-aggregate-supply-curve-theory.html
Tejvan Pettinger. (2017a). The Natural Rate of Unemployment | Economics Help. Economicshelp.org. https://www.economicshelp.org/macroeconomics/unemployment/natural_rate/
Tejvan Pettinger. (2017b, March 19). Impact of Increasing Government Spending | Economics Help. Economicshelp.org. https://www.economicshelp.org/blog/2731/economics/impact-of-increasing-government-spending/
