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Government Spending

Wagner’s Law of economic activities applies to every economy. According to this law, there is both an extensive and intensive increase in government activities. There are certain new functions which the government has to perform like industrialization, infrastructural development, etc. and has also to increase its expenditure on the conventional functions like law, order, peace, security, justice, etc. government expenditure has its effect on the national income.

Government Expenditure and Equilibrium Level of National Income

In a three sector model, we introduce government as another sector which influences GDP. To develop this model we assume that government spending is a fixed amount, i.e., it does not change with a change in output and income.

It is important for us to understand the distinction between government spending and government transfer payments. When the government spends on the salary and pension of the employees, stationary, staff vehicles, etc., it directly affects the demand for goods and services in the economy.

Transfer payments of the government are unilateral transfers to households and firms. Transfer payments do affect desired aggregate spending, but only indirectly. Suppose the government gives pension to its retired employees. A part of this income will be spent by the employees on consumption. Thus, it is recorded as personal consumption expenditure in the compilation of national income. Since this expenditure on consumption by employees has already been recorded in the national income, it cannot again be included as transfer payments. It amounts to double counting in the national income.