How does an increase in government spending influence aggregate demand?

An increase in government spending directly raises aggregate demand by injecting money into the economy. This phenomenon occurs because government expenditures usually involve purchasing goods and services, which stimulates production and increases consumption. When the government spends money, it creates a flow of income to businesses and individuals engaged in providing those goods and services.

As businesses receive payment for their goods or services, they may invest in expanding production or hiring more employees, leading to increased income and, consequently, higher consumption among households. This chain reaction boosts overall economic activity since the initial increase in spending multiplies through the economy—this is often referred to as the multiplier effect.

Moreover, government spending can also encourage investment by private firms, as they anticipate increased demand for their products and services. Overall, a rise in government spending increases aggregate demand, shifts the aggregate demand curve to the right, and has the potential to improve overall economic performance.