Question

Considerthepossibilitythatgovernmentspendingincreasestheamount of hours to be worked in a given time period, say by providing child care. Assume again that the initial amount of consumption and leisure are still affordable after an increase in spending. How will an increase in government spending affect consumption, hours worked, output and welfare? [Hint: think about how we constructed the bounds on our labor leisure model in terms of hours worked] Suppose instead of do- mestic government spending we consider remittances sent from abroad (think of this as a model of GNP). What if the remittances increase la- bor productivity in the long run? Where would you look for evidence in currently collected data for these channels for either the US or Mexican economy? [Both countries are OECD countries.]

Answer 1

Increase in government spending would lead to an increase in Aggregate Demand in an economy which would lead to an increase in output and consumption becuase increase in government spending means that the government is taking an expansionary economic policy which leads to higher money supply in the economy and the real output increases also due to an increase in the money supply would help firms to grow and they would hire more resources and the income level of the people rise leading to an increase in consumption level. Also we know that real output (Y) = C + I + G + (X-M) in this case G is the level of government spending therefore with the increase in government spending the real output in economy increases. If the government spending is made on increasing the welfare benefits than that could reduce the incentives for the people to work as they would be getting everything from the government welfare scheme but the implication could be different in a poor or a developing country.