What Are Government Purchases?
Government purchases refer to expenditures on goods and services by federal, state, and local governments. These expenditures, excluding transfer payments and interest on debt, are crucial in determining a nation’s gross domestic product (GDP). Transfer payments, like Social Security payments, welfare, and government subsidies, do not entail direct purchases.
Key Takeaways
- Government purchases include any spending by federal, state, and local agencies, excluding debt and transfer payments such as Social Security.
- Overall, government purchases are a key component of a nation’s gross domestic product (GDP).
- According to Keynesian economic theory, government purchases can boost overall spending and rectify a weak economy.
Understanding Government Purchases
GDP, a measure of the market value of all final goods and services produced within a country, can be calculated via four major categories:
- Personal consumption
- Business investment spending
- Government purchases
- Net exports
The U.S. Bureau of Economic Analysis (BEA) categorizes government purchases as federal, state, and local spending. It further distinguishes defense-related federal spending from other expenditures. Imported goods are subtracted from the total GDP value.
Government purchases have increased in real terms over the decades. However, their share of overall nominal GDP has been declining.
Special Considerations in Government Purchases
In Keynesian economic theory, government purchases are considered essential for maintaining a healthy economy. An increase or decrease in government spending is seen as a vital tool for regulating the business cycle.
Government spending boosts demand in two ways: directly by purchasing goods (e.g., steel for bridges) and indirectly by injecting money into the pockets of workers and suppliers, who then spend on other goods and services. This phenomenon is known as the multiplier effect.
Not all economists agree on high government spending. Critics argue it distorts interest rates, supports non-competitive firms, and results in higher taxes.
Types of Government Purchases
Government purchases span a range from spending on infrastructure projects and paying public service employees, to buying office software, equipment, and maintaining public buildings. Transfer payments, which do not involve direct purchases, are not included in this category.
In 2020, the BEA attributed an increase in federal government spending mainly to the purchases of intermediate services for processing and administering Paycheck Protection Program loan applications. Despite the rise in federal spending, state and local government spending dropped. The overall real GDP for 2020 fell by 3.5%, a decline impacted by the economic repercussions of the pandemic and ensuing lockdown measures.
Related Terms: GDP, transfer payments, business cycle, multiplier effect, Keynesian theory.
References
- International Monetary Fund. “What Is Keynesian Economics?”
- U.S. Bureau of Economic Analysis. “GDP and the Economy: Advance Estimates for the First Quarter of 2021”.
- Congressional Budget Office. “An Update to the Budget Outlook: 2020 to 2030”, Page 33.
- U.S. Bureau of Economic Analysis. “Gross Domestic Product, Fourth Quarter and Year 2020 (Second Estimate)”, Page 3.
