How does a change in government spending shift AD?

An increase in government spending shifts the aggregate demand (AD) curve to the right, while a decrease shifts it to the left.

Government spending is a key component of aggregate demand, which is the total demand for goods and services within an economy. Aggregate demand is calculated as the sum of consumer spending, investment spending, government spending, and net exports. Therefore, any change in one of these components, including government spending, will directly affect the aggregate demand.

When the government increases its spending, it is injecting more money into the economy. This could be through public works projects, government salaries, or social benefits. This additional spending increases the demand for goods and services, as there is more money circulating in the economy. As a result, the aggregate demand curve shifts to the right. This shift indicates an increase in the quantity of goods and services demanded at each price level.

On the other hand, if the government reduces its spending, it is withdrawing money from the economy. This could be due to austerity measures or efforts to reduce a budget deficit. This reduction in spending decreases the demand for goods and services, as there is less money circulating in the economy. Consequently, the aggregate demand curve shifts to the left. This shift indicates a decrease in the quantity of goods and services demanded at each price level.

It's important to note that the impact of changes in government spending on aggregate demand can be influenced by other factors. For example, if the economy is already operating at full capacity, an increase in government spending may simply lead to inflation rather than an increase in output. Similarly, if there is a high level of saving in the economy, a decrease in government spending may not lead to a significant decrease in aggregate demand. Therefore, the context of the economy should always be considered when analysing the impact of changes in government spending on aggregate demand.