What Are Government Purchases?
Key takeaways
– Government purchases (G) = government spending on goods and services by federal, state and local governments. They are a core component of GDP but exclude transfer payments and interest on the public debt. (Source: Investopedia; BEA)
– In the expenditure approach to GDP: GDP = C + I + G + (X − M). Government purchases are the G term. Imports are subtracted via the net exports term. (Source: Investopedia; BEA)
– Government purchases can be split by level (federal, state, local) and by function (defense vs nondefense, investment vs consumption). BEA provides detailed breakdowns. (Source: BEA)
– Economists differ: Keynesian theory emphasizes government purchases to stabilize demand (multiplier effect); critics warn of distorted markets, crowding out, and long-term fiscal costs. (Source: Investopedia)
Understanding government purchases
Definition
– Government purchases are expenditures on final goods and services bought by government entities to provide public goods and services (infrastructure, defense, public-sector wages, equipment, maintenance, etc.). They do not include transfer payments (Social Security, unemployment benefits, most subsidies) or interest payments on government debt, because those are not payments made in exchange for current production.
Role in GDP
– One standard way of measuring GDP—the expenditure approach—sums four components:
– Consumption (C)
– Investment (I)
– Government purchases (G)
– Net exports (X − M)
– Government purchases directly add to aggregate demand and output. They also have indirect effects through incomes paid to workers and suppliers (the multiplier effect).
Types of government purchases (examples)
– Federal:
– Defense equipment and weapons systems
– Federal employee wages and benefits
– Grants for research that involve purchased services or goods
– Intermediate services (contract processing, IT services)
– State and local:
– Public education (salaries, school upkeep)
– Road and bridge construction and maintenance
– Public safety and sanitation services
– Municipal buildings and equipment
– Distinction: capital purchases (construction, durable equipment) vs current purchases (services, supplies).
Special considerations and exclusions
– Transfer payments are excluded: e.g., Social Security, SNAP, unemployment insurance — these are redistributions, not purchases of goods/services.
– Interest on government debt is excluded from government purchases.
– Imports are subtracted when calculating GDP (net exports term); purchases of imported goods/services by government do not increase domestic GDP.
– BEA classification: BEA breaks government purchases down by level (federal/state/local) and by function (defense vs nondefense). BEA noted a 2020 rise in federal purchases was partly due to purchases of intermediate services related to Paycheck Protection Program (PPP) loan processing. (Source: BEA; Investopedia)
Economic perspectives
– Keynesian view: Increasing government purchases can stabilize output during downturns because of the multiplier (direct purchases + induced consumer spending). Timing and targeting matter.
– Critics: Large or sustained increases in government purchases can lead to higher interest rates, crowding out of private investment, inefficiencies from politicized allocation, and future tax burdens.
Fast fact
– In 2020 federal government purchases rose (partly due to increased intermediate services for PPP processing) while state and local purchases fell; overall U.S. real GDP declined that year. (Source: BEA; Investopedia)
Practical steps: How to analyze government purchases (for students, analysts, or policymakers)
A. To find and quantify government purchases
1. Data source
– Use the U.S. Bureau of Economic Analysis (BEA) NIPA tables on bea.gov for time series of government consumption expenditures and gross investment by level (federal, state, local).
2. Identify nominal vs real
– Retrieve nominal government purchases and the appropriate price deflator (BEA publishes deflators such as the GDP deflator or government consumption deflator).
3. Convert to real terms
– Real Government Purchases = Nominal Government Purchases ÷ (Price index/100).
4. Compute share of GDP
– G share = Government purchases ÷ Nominal (or real) GDP × 100.
5. Adjust for imports
– When assessing domestic GDP effects, ensure import components are accounted for via the net exports term (X − M).
6. Break down the composition
– Use BEA subsectors to separate defense vs nondefense, capital vs current, and level of government.
B. To estimate the macroeconomic impact (multiplier and fiscal effects)
1. Define the policy change clearly (one-time vs permanent; targeted vs broad).
2. Gather parameters: marginal propensity to consume (MPC), openness of the economy, spare capacity, monetary policy stance.
3. Use simple multiplier formula as a starting point:
– Simple closed-economy multiplier ≈ 1 / (1 − MPC), but note: open economy, taxes, and monetary offset will reduce it.
4. For more precision, run a macro model (e.g., simple Keynesian model, DSGE model, or use CBO/B.E.A. multipliers if available).
5. Account for timing and implementation lags, and financing (deficit-financed spending may have different effects than tax-funded).
C. For policymakers designing government purchases
1. Targeting: prioritize high-multiplier, labor-intensive, and “shovel-ready” projects in recessions (e.g., infrastructure, maintenance) for quicker stimulus.
2. Cost-effectiveness: conduct benefit-cost analyses and procurement transparency to minimize waste.
3. Financing: evaluate short-term stimulus benefits vs long-term fiscal sustainability; consider temporary vs permanent programs.
4. Coordination with monetary policy: communicate with central bank to minimize crowding out and interest-rate surprises.
5. Measurement: ensure robust data collection and incorporate independent evaluation of program impacts.
D. For investors and businesses tracking government purchases
1. Monitor BEA releases and federal/state budget proposals to see changes in procurement or investment plans.
2. Track sectoral allocations (defense, infrastructure, education) for opportunities in suppliers and contractors.
3. Watch municipal finance indicators for state/local construction and services demand.
Important
– Don’t conflate government purchases with transfer payments—only the former directly purchases current output.
– Real (inflation-adjusted) trends matter more than nominal levels when comparing across time.
– Short-term increases in G can boost GDP quickly, but long-term effects depend on financing, efficiency, and macroeconomic context.
Sources and further reading
– Investopedia. “Government Purchases.” https://www.investopedia.com/terms/g/governmentpurchases.asp
– U.S. Bureau of Economic Analysis (BEA). Measuring the Economy: A Primer on GDP and the National Income and Product Accounts. (BEA primer)
– U.S. Bureau of Economic Analysis. Gross Domestic Product, Fourth Quarter and Year 2020 (Second Estimate).
– Congressional Budget Office (CBO). An Update to the Budget Outlook: 2020 to 2030.
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.