What this lesson teaches
I can explain the main areas of government spending and the reasons and effects of each.
Syllabus K343, 4.2.2. Reasons for government spending: main areas of government spending and the reasons for and effects of spending in these areas
Make a guess
Why does the government pay for national defence instead of leaving it to private firms?
- Private firms are not allowed to own weapons.
- Everyone benefits anyway, so firms cannot charge.
- Defence is too cheap for firms to bother with.
Show the answer
Everyone benefits anyway, so firms cannot charge.
Defence is a public good. Everyone is protected whether they pay or not, so a private firm would earn too little to supply it.
Governments spend on health, education, defence, infrastructure and welfare to provide public and merit goods and support the economy.
Health: public hospitals and subsidised care. Healthcare is a merit good, and a healthier workforce is more productive.
Education: schools, universities and training. Education is a merit good that raises the quality of labour and future growth.
Defence and law and order: the armed forces, police and courts. These are public goods the market would not provide.
Infrastructure: roads, rail, ports and water supply. These cut firms' costs and raise productivity. Welfare: payments to the elderly, unemployed and low-income households reduce poverty and redistribute income. All spending has an opportunity cost: more on one area means less on another, or higher taxes.
- Main areas
- Health, education, defence, infrastructure, welfare.
- Reasons
- Provide public and merit goods, raise productivity, reduce poverty.
- Opportunity cost
- More spending in one area means less elsewhere or higher taxes.
Worked example: Effects of spending on rail infrastructure
Suppose the government builds a new rail line.
- Short-term effect: construction firms hire workers, so employment and incomes rise.
- Long-term effect: faster travel cuts journey times and costs for workers and firms, raising productivity.
- Wider effect: it may reduce car use and pollution.
- Opportunity cost: the money could have funded hospitals or schools instead.
Watch out for this
Government spending is wasteful because it does not make a profit.
Government spending aims at public and merit goods, fairness and growth, not profit. Its value lies in benefits the market would under-provide.
Check your understanding
Vaccinations and school places get public money even though firms could sell them. What is the economic reason?
- They are merit goods, which people would under-consume.
- They are public goods, which no private firm could charge for.
- They are demerit goods, which the market over-provides.
Show the answer
They are merit goods, which people would under-consume.
Right. People underrate the benefits to themselves and others, so the market alone would provide too little.
Check your understanding
Why does a government usually pay for street lighting itself?
- It is a public good that markets would not supply
- It makes a large profit for the government
- Private firms are not allowed to make lights
- People would buy too much of it in a market
Show the answer
It is a public good that markets would not supply
Right. No one can be charged for using it, so private firms would not provide it.