Government Budget Surplus Affect the Economy? How

¶ … government budget surplus affect the economy? How does a government budget deficit affect the economy? How would (or should) your company react differently to a government budget surplus vs. A deficit?

A government deficit means that a government is borrowing more money from foreign and domestic sources than the sum it is accumulating by taxation and revenue. The effect of this borrowing often drives down the value of the government's currency abroad. One of the values of deficit spending from a business company's perspective is that it is easier to sell American made products to other nations.

Thus, at times, businesses may look favorably upon deficit-inducing levels of government spending. When the economy has high unemployment, an increase in government purchases can create a market for business output, creating income and encouraging increases in consumer spending. This creates further increases in the demand for business output. Cutting personal taxes can have similar expansionary effects. ("Deficit Spending," Answers.com) But deficit spending can also yield high rates of inflation, as consumer confidence begins to overheat, and costs of production begin to rise in relation to accumulated profits. Also, increased government borrowing to finance government production drives up interest rates.

But, in contrast, a government surplus drives down interest rates. Thus, during times of a rare government surplus, rather than a deficit, even though consumer demand may be lower, a company can still take advantage of the situation. It reinvest in the company's infrastructure because borrowing money is less costly, in contrast to its behavior in times of government deficits, where it can increase production to make a profit from accelerated consumer demand. ("Deficit Spending," Answers.com)

Question 2

Why do Classical economists draw a vertical aggregate supply curve? Why do Keynesian economists draw a horizontal aggregate supply curve?

The classical aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied in an economy. The classical equation for the upward sloping aggregate supply curve, is based upon a short-run view of the economy. When the economy changes, the wage the workers receive cannot adjust immediately. Given that wages are "sticky," that is, less flexible than other costs of production, the chain of events leading from an increase in the price level to an increase in output is fairly straightforward. "When the price level rises, the nominal wage remains fixed because this is solely based on the dollar amount of the wage. The real wage, on the other hand, falls because this is based on the purchasing power of the wage. Thus, a higher price level means that a given wage is able to purchase fewer goods and services but labor is cheaper, thus companies can hire more workers and produce more. (Mann, 2005)

As companies are hiring more workers, competition in the labor market increases and prices go up in the classical model, as any increase in demand and production induces increases in prices, including the price of labor. But Keynes suggested that there is often a failure on the part of real wages to remain at competitive prices. Supply goes up, but wages remain the same. But the wages are worth less in an economy of increased prices, thus causing a spiraling decrease in demand. Once labor supply and demand had no automatic adjustment mechanism, there was no reason to suppose the labor market determines the level of output, and hence a horizontal demand curve as wages do not go up, and workers do not purchase the increased supply of goods.

Question 3

How may an increase in government spending lead to a greater increase in GDP? What can companies do to take advantage of this?

Government spending infuses money into the economy, increasing the rate of production in industry, generating employment, and generating demand. Thus government spending drives up a nation's Gross National Product. Even companies not directly engaged with government related industries can benefit from the increased demand generated by the greater income of consumers and influx of dollars into the economy, by increasing production and deploying more of their available productive resources.