Public and Private Expenditures...

There is a traditional dichotomy used when exploring the use of government funding for various projects, at least there is among the classical liberals. Either 1) the project is something people are willing to pay for, in which case government funding is redundant and wasteful or 2) the project is not something people are willing to pay for, in which case they don't want it, so why is the government funding something the people, whose interests it is supposed to represent, do not want? As you've probably noticed, this dichotomy contains no reference to supply, demand, or any other economic watchword. This is not to say it is not logical, but rather that it is not in terms that an economics student finds very helpful.

So how does one go about converting this dichotomy into the language of economists? Let's start by going back to Say's Law. In its simplest form, Say's Law states that supply creates its own demand. Basically, if you don't have something that people want, you are going to have trouble getting them to give you anything. Therefore, demand only exists when your wants are backed by supply. In contrast, supply only exists when the goods that you have are demanded by other people with supply to back their wants. If that's causing you a headache, just refer to the third sentence of this paragraph.

Anyway, people create supply for themselves so that they will be able to demand goods from other people's supply. They seek to create the most possible supply and thus naturally as a whole, create the maximum possible aggregate supply. This, in turn, maximizes the aggregate demand for a country. Thus, a country left to its own devices will maximize its own natural output and so on and so forth.

So what happens when we introduce government investment, or public expenditures? Either the government is producing something people already want, in which case even the most efficient system cannot surpass the natural output that would be created by private spending of the same nature, or the government is producing something that people do not want, in which case they are producing goods that are not as greatly demanded as the market would allocate and are reducing the aggregate demand in the economy. From there, it is a simple logical extension that if aggregate demand is kept below its natural maximum, natural output will stay below its natural maximum.

The effects of natural output being lower are clearly problematic for any policy maker. Inflation sets in sooner, which raises the NAIRU and keeps overall unemployment higher. This is the effect of having larger amounts of public expenditures in the economy, as far as I can logically surmise. Policy makers would be wiser to push for a change in public opinion, and as such buying habits, than to force such changes through higher public expenditures which will result in either higher inflation or unemployment.