Explain why and when government spending leads to inflation

To answer this question we must first understand what is meant by inflation. Inflation refers to the sustained increase in the price level in the economy. To illustrate the role of government spending in causing inflation, we must consider the long run aggregate supply and aggregate demand curves. This graph plots the price level against the national output(GDP). The aggregate supply curve illustrates the amount of inputs required in an economy to produce specific levels of output. These inputs are limited which is why the curve eventually becomes a frontier. The aggregate demand curve is a summation of all demand in the economy at specific level of output. It is therefore a summation of consumption, investment, government expenditure, and net exports.Therefore, government spending is an exogenous variable, which means it is independent of the level of income in the economy. Therefore, a rise in government spending shift the demand curve from D1 to D2 as illustrated by the graph below. When government spending increases further, we see the Aggregate demand curve shift from D2 to D3, where we also see the drastic rise in the price level. This increase shows that when close to the frontier of the Long run aggregate supply curve, an increase in government spending can lead to a drastic increase in the price level. This increase in the price level is evidence of inflation.