Economics: Government Spending Effects

Crowding Out

• Occurs when increased government spending, without tax hikes, raises the deficit.
• This leads the government to borrow more from the loanable funds market, raising interest rates.
• Higher interest rates discourage investment and consumption.

Complete Crowding Out

• Graph showing the relationship between government spending, deficit, and its effects on interest rates is not provided.

Supply-Side Economics

• An economic theory advocating for tax cuts as a means to enhance overall economic supply.
• Emphasis on the relationship between taxation and economic growth.

Supply-Side Economics in a Recessionary Gap

• A decrease in taxes (T) can lead to:
  • Increased income (Y).
  • Higher consumption (C), boosting aggregate demand (AD).
  • Improved workforce incentives and supply of labor, ultimately increasing aggregate supply (AS).
• For low and middle-income workers, lower taxes enhance work incentives; however, for high-income workers, reduced taxes may lead to increased leisure and decreased AS.

Graph of Supply Side Under a Recessionary Gap

• Graph not available, but indicates that AS shifts right leading to decreased prices (P) and increased GDP.

Process of Crowding Out

• Begins when government spending exceeds tax revenues.
• Results in a positive government deficit, necessitating borrowing to finance this deficit.
• Increased borrowing raises interest rates throughout the economy.
• Higher interest rates elevate the opportunity cost of borrowing, diminishing consumption and investment.

Graph of Supply Side Under an Inflationary Gap

• Graph not available, shows AS shifting left, resulting in higher prices (P) and decreased GDP.

Lags Associated with Supply-Side Economics

• Data Lag: Delay between the emergence of a problem and policymakers' awareness.
• Wait and See Lag: Time taken for policymakers to determine a suitable response.
• Legislative Lag: Duration for Congress to approve necessary fiscal policies.
• Transmission Lag: Time required to implement approved fiscal policies.
• Effectiveness Lag: Interval needed to observe the impact of fiscal policies on real GDP.