Government Spending

Government Purchases versus Transfer Payments

• The government spends trillions of dollars a year– GDP = C + I + GDP = C + I + G G + Xn+ Xn

• The GG in our formula refers to Government purchases

• It does NOT refer to transfer payments.

7-7

What is a transfer payment?

Transfer payments is the government taking money from one group and giving it to another group in the economy.

Transfer Payments Include

• Social Security– Transferring between the generations

• Veteran Benefits– Transferring money to veterans

• Unemployment Benefits– Transferring from the employed to the

Unemployed.

Government Purchases vs. Transfers

– Approximately half is “transfer payments”• The largest transfer payment is social security• These payments eventually end up in the “C”

part GDP (after they are spent)

– Approximately half is “government purchases”

• The largest government purchase is defense• These end up in the “G” part of GDP

0

5

10

15

20

25

1960 19651970 1975 1980

Year

1985 19901995

Total Government Purchases

State and Local Purchases

Federal Purchases

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Federal and State and Local Purchases Relative to GDP, 1960-2000

7-8

Total government purchases have been declining since the late 1960s and in 1995 constitute 16 percent of GDP

7-9

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

01960 19651970 1975 1980

Year

1985 19901995

Total GovernmentTransfer payments

State and Local Transfer Payments

Federal Transfer Payments

2

4

6

8

10

12

14

16

Federal and State and Local Transfer Payments as a Percentage of GDP, 1960-2000

Federal transfer payments have risen sharply since the mid-1960s, while state and local transfer payments have also grown substantially since the early 1970s.

Total government transfer payments have risen from just 6 percent of GDP in 1960 to more than 15 percent today

Graphing in “G”

C

C+I

C+I+G

G

Graphing the C + I + G + Xn Line

7-10

Disposable income ($)

45û

2,000 3,0001,000

1,000

2,000

C

3,000

C +I+G

C +I

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

To keep the graph as simple as possible, we are assuming the government spends a constant amount of money regardless of the level of disposable income

Graphing the C + I + G + Xn Line

7-11

Disposable income ($)

45û

2,000 3,0001,000

1,000

2,000

C

3,000

C +I+G

C +I

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

How much is G?

Answer: 400