KOMILLA CHADHAʼS PROPERTY WWW.KDKCHADHA.BLOGSPOT.COM Using aggregate demand and supply analysis, evaluate the effect on the economy of a cut in spending on schools and education (30) Aggregate demand is the total demand for goods and services produced in an economy over a period of time. Similarly, aggregate supply is measure of the total volume of goods and services produced in an economy over a period of time. Changes in aggregate demand and supply help us examine economic growth and inflation in an economy. Government spending is an injection into an economy even though it has decreased. Typically, it helps increase the circular flow of income but in this as it has decreased it will reduce the circular flow of income. The diagram used shows changes in real GDP and price level. From the changes in price level we can study inflation and deflation. GDP stands for gross domestic product and it is value of the output produced by an economy. The word ʻrealʼ specifies that we are looking at changes in GDP excluding inflation. Aggregate demand is made up of four main components; investment, consumption, government spending and net im/exports. We calculate aggregate demand using the formula AD= Government spending + Investments + Consumptions - (Exports - Imports). So clearly we can now see how if government spending drops then aggregate demand too will fall. The diagram below depicts this. Diagram showing AD shifting to the left was drawn here. The equilibrium A show that the economy started at a price level of P1 and a real GDP level of Y1. Then as we studied before that aggregate demand will drop along with government spending. This shifts the aggregate demand curve to the left. We are now at equilibrium B with a reduced GDP of Y2 and a reduced price level of P2. From this we can interpret that perhaps deflation has taken place.

The government has four macroeconomic objectives and those are (i) keep unemployment low (ii) low and steady inflation (iii) steady economic growth and (iv) a sustainable balance of payments. As we can see that by cutting government spending and the decreased aggregate demand has lead to a smaller GDP. This shows that the government is not fulfilling its third objective. This is not good for the economy because if GDP is low this can spur on other adverse impacts such as increased unemployment. As you have noticed on my diagram, I have showed aggregate demand to decrease once again and shift from AD2 to AD3. This because reduced government spending can lead to the negative multiplier effect. So for example, if government spends less on education and school. There will be less teachers and less equipment such as white boards demanded. This means that many people may end up people unemployed either because schools are full up or because businesses loose out on sales of educational equipment and are not able to cover costs so they make people redundant. (I realise the latter option is probably unlikely). However, from this we have more impacts. These unemployed people have less disposable income hence spend less. This leads to a reduced consumption level within an economy therefore decreasing aggregate demand further. However, we have to remember that if the government is cutting spending in schools and education then it is more than likely that they will be spending this money elsewhere even if it is just reducing the budget deficit that the country faces. Spending on schools rather than the budget deficit might be a bigger opportunity cost so reducing expenditure on education can be counted as a good thing. This is because a big budget deficit may eventually lead to tax rises. If taxes are set too high then once again we can start a negative multiplier effect. It also important for us to examine the long term implications of cutting spending in schools and education compared to the short-term gains of increasing finance for the government. Education helps train and specialise people who are a factor of production: labour. If by reducing spending the quality of education falls or less places are available for people; then the quantity and quality of labour will be affected. Recently, there have been reports that because of cuts in education, universities must raise entry requirements because they cannot cover the cost of many people entering higher education now. The number of applicants has too increased because with the current economic climate being adverse, finding a job is proving difficult.This means the number of trained people will fall. Which means our long-term factor of production, labour, will suffer. Ultimately, as an economy we will not be as efficient and this can lead to drops in economic growth. Therefore, I believe the government should not cut expenditure in schools and education. Furthermore, to evaluate this cut in education accurately it is important to take into account the magnitude of the cut. This is because if the cut is small then

the negative effects such as quality of education wonʼt fall so dramatically and it wouldnʼt be such a bad decision. Although, if the cuts are quite large then the quality if education will fall significantly and in future we will possibly have a problem with an inefficient workforce. Another thing, if less people are going to higher education because it is too competitive, then it is fact that they will earn less money than somebody who goes to university. So by cutting money spent in education we are indirectly increasing the percentage of the population who earns lower incomes than they should have (if they went to university). This can again lead to the multiplier effect because if incomes are small then people will spend less. This will lead to cut in consumption and ultimately a lower aggregate demand level. And the cycle will continue.