Step ➊ : Define ‘inflation’ in the introduction


Since government spending is considered as a component of aggregate demand, an increase in spending on infrastructure will lead to an increase in aggregate demand and this will generally result in inflation. Inflation is defined as a sustained increase in an economy’s price level. However, there are certain circumstances where this is not the case. This can be explained by using aggregate demand and aggregate supply analysis.


Step ➋ : Discuss whether an increase in government spending can lead to inflation due to a rise in aggregate demand.


➤ 2.1 The following diagram shows how an increase in government spending in a country's infrastructure can result in a rise in inflation.