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Government Spending on Infrastructure and Inflation

Question

Discuss whether increased government spending on a country’s infrastructure will always lead to a rise in the rate of inflation. Use aggregate demand and aggregate supply analysis to support your answer. [12]

Category:

Macroeconomic Factors and Policies

[CIE AS level November 2018]

Preview Answer

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.

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