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Difficulty: MediumGovernment Budgets and Budgetary Control

A government experiencing a persistent fiscal deficit decides to curtail its capital expenditure on vital infrastructure projects while simultaneously increasing recurrent expenditure to fund administrative overheads. Which of the following is the most likely long-term economic consequence of this budgetary control measure?

  1. A reduction in the economy's productive capacity and long-term economic growthAnswer
  2. B
    An immediate surge in private sector investment and industrial productivity
  3. C
    An automatic decrease in the national debt stock and general price level
  4. D
    A permanent elimination of structural budget deficits in subsequent fiscal years

Answer

A reduction in the economy's productive capacity and long-term economic growth
Capital expenditure directly contributes to physical capital formation (e.g., transport networks, energy facilities, and public utilities). When a government cuts capital spending to maintain high recurrent administrative expenses, long-term productive capacity decreases, leading to slower economic growth.

Step-by-Step Solution

1
Classify government spending components
Capital expenditure creates long-term physical assets and infrastructure, whereas recurrent expenditure pays for ongoing operational costs such as wages and overheads.
Evaluating the long-term impact of fiscal policy requires distinguishing wealth-creating capital projects from consumable recurrent expenses.
2
Analyze the impact of prioritizing recurrent consumption over capital investment
Diverting financial resources away from roads, power plants, and public works directly weakens national infrastructure and lowers potential Gross Domestic Product (GDP).
Economic development depends on continuous capital accumulation to enhance aggregate supply and competitiveness.

Key Concept

Capital versus Recurrent Expenditure Allocation
Estimated Time:1m 0s
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Topics

Government Budgets and Budgetary Control

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