BBC News (29th September 2019)

Government plans 40 hospital projects and a mental health services pilot

Syllabus Links

Aggregate Demand (Edexcel 2.2.1, AQA 4.2.2.3, OCR 2.1.2)

The Multiplier (Edexcel 2.4.4, AQA 4.2.2.4, OCR 2.1.5)

Potential questions

Using a suitable diagram, show the impact of additional government spending on the UK economy.

By boosting expenditure on the NHS, this will boost not only jobs in the short term, but the whole economy in the long term. If government spending is so good, why have we lived through ten years of austerity?

Some ideas to consider:

The government, at its Conservative party conference, has announced an extra £13bn of spending to create 40 new hospitals. This is good news for the economy, in particular, aggregate demand, but we do need to question some aspects of this promise.

Boris Johnson continues to offer spending promises (he sounds more like his esteemed colleague, Mr Corbyn, on the other side of the House of Commons at times!) after loosening the hold of austerity over recent years. Education and the health service have been blessed with promises to help boost these sectors. Government spending is a key component of Aggregate Demand, the total value of all goods and services produced in an economy over a given period of time. The formula for Aggregate Demand, essential for your studies of economics, is C+I+G+(X-M).

In our news story, the G component, representing government spending, will increase. Assuming Ceteris Paribus (other things remining equal), this will boost levels of Aggregate Demand in the economy, shifting the AD curve to the right, from AD1 to AD2, and creating a new higher level of National Income at Y2 instead of Y1.

This probably implies a multiplied increase in the level of National Income. The Multiplier looks at the final increase in GDP (Gross Domestic Product) generated from a boost in government spending (or any other aspect of the economy that puts money into the Circular Flow of Income, such as investment or increasing export levels). The multiplier is worked out by the formula K=1/MPW (although for AQA you only need to know K=1/MPS). The W stands for withdrawals, and considers the impact of savings (S), Imports (M) and taxation (T). Each of these three concepts takes money out of the economy. The lower the level of withdrawals, the greater the boost to the economy through the multiplier.

Let’s assume our £13bn injection (money put into the economy) from this spending promise on the NHS. If we spend 20% of our income on imports, pay 30% in taxes, and save 20% of our income, we have a multiplier figure of: MPW=1/(MPM 0.2 + MPT 0.3 + MPS 0.2). K = 1.43.

Our £13bn injection will boost the economy by £18.59bn (£13bn*1.43). Some quick definitions for you. MPM is the marginal propensity to import and considers the proportion of any increase in income that is spent on imports. MPT is the marginal propensity for taxation and looks at the % of any additional income that the government takes in taxes. MPS (marginal propensity to save) looks at the % of any additional income that is saved.

Each of these withdrawals may however, also have significant benefits for the economy. Savings generate funds for banks to lend out to people and businesses for investments, whether it be buying a car or a house, or building new factories and buying new machines. Imports give us access to materials and products we perhaps do not produce at home.

The taxes aspect needs further development. We cannot build 40 new hospitals without the government. They are merit goods, providing benefits to the wider society, but will be underprovided by the private sector. We do have private hospitals (BUPA etc) but not in sufficient quantity to meet the needs of the whole population. The more taxes the government collects, the more of such services they can provide. When we grumble about taxes, they do give us the NHS, free schools, a police force, defence, the road network and welfare benefits when we need them, including pensions.

With all the recent government promises though, we look likely to enter a period of higher Fiscal deficit (also called a budget deficit), when the level of government spending exceeds the level of tax revenues collected. This is a concern, because the government may then need to borrow money, normally through the sale of government bonds, to finance the difference. The accumulation of government borrowing gives us the value of the National Debt. Currently around £1.85tn in the UK. This may potentially need paying back at some stage.

Could it be that we are likely to see taxes rise in the near future? Mr Johnson is not a great advocate of increasing taxes, and in his promises to the Conservative party members in his bid to win the premiership, he pledged to cut taxes further. If he complies with this promise of both tax cuts and government spending increases, we appear to be entering a period of expansionary Fiscal Policy. Fiscal Policy being the use of government spending, taxation and borrowing to influence the level of economic activity. For those of us with longer memories, I wonder what his idol, Margaret Thatcher would have made of such policies?

We could then also question whether the imminent General Election, still in the hands of the members of Parliament, may have something to do with a distinctly unconservative approach to economic policy making?

Whether you consider Mr Johnson’s spending plans as the right way forward, or as a sweetener to an electorate suffering from too many years of austerity, or as a pre-election promise to win votes, is your choice. Either way, the benefits and the costs of such a way forward remain to be seen.

Check out the YouTube video here.

Additional activities

Beyond spending promises, evaluate the other policy options available to Boris Johnson to take the UK economy forward?

Examine the impact of yet another spending promise on the government macroeconomic objectives.

Additional information

Boris Johnson talk about Margaret Thatcher

YouTube (28th November 2013)

Do Boris Johnson’s tax and spending plans add up?

BBC News (14th August 2019)