"Aggregate Demand (AD) and Aggregate Supply (AS) are key concepts in macroeconomics that explain the relationship between total output, prices, and economic equilibrium. Aggregate Demand is the total quantity of goods and services that all sectors of the economy (households, businesses, government, and foreign buyers) are willing and able to purchase at different price levels in a given period. Samuelson and Nordhaus emphasize that fiscal and monetary policies influence AD, while supply-side policies (e.g., investment in education or infrastructure) affect AS in the long run. Aggregate Supply is the total quantity of goods and services that producers in an economy are willing and able to supply at different price levels over a given period.
When the government reduces its spending (savings), it decreases G. This directly lowers aggregate demand, leading to lower national income (GDP) unless the private sector (consumers or businesses) compensates for the reduction by increasing consumption or investment.
Samuelson and Nordhaus explain that a change in government spending has a multiplier effect on the economy. Initial impact, A reduction in G immediately cuts into AD.
Secondary Impact, businesses receive less revenue, leading to lower incomes for households and reduced consumption (C).
Final Outcome, the reduction in C magnifies the overall decline in AD.
The size of the multiplier depends on the marginal propensity to consume (MPC):
Multiplier=1/1−MPC
If MPC is high, the negative impact of reduced government spending on AD is more significant.
In the short run, lower government spending reduces demand for goods and services. This can cause cyclical unemployment as businesses scale down production to match reduced demand. Prices may decrease slightly if demand falls significantly, leading to potential deflationary pressures.
On the supply side, businesses may cut investment due to decreased demand, reducing productive capacity over time. If government spending previously supported infrastructure or R&D, its reduction could lower productivity.
In the long run, the impact depends on how savings are reallocated. If savings are used to reduce public debt, lower debt levels can lead to decreased interest rates, stimulating private investment and boosting aggregate supply (AS) (Positive Scenario) If government cuts reduce spending on critical public goods (e.g., education, infrastructure), it can hinder long-term economic growth by lowering the productive potential of the economy (Negative Scenario).
Samuelson and Nordhaus caution against austerity measures (extensive government savings) during periods of low growth or recession. They argue that in the Recession, cutting government spending amplifies demand deficiencies, worsening unemployment and economic stagnation. During Growth, budget savings are more sustainable since private sector demand can compensate for reduced government expenditure.
The impact of significant government spending reductions on employment can be analyzed through their concepts of aggregate demand (AD), employment-output relationship, and sticky wages in the short and long run. Government spending (G) is a key component of AD. Reductions in G directly lower AD, causing a contraction in output (Y) in the short run.
Lower output leads to reduced demand for labour, resulting in cyclical unemployment (unemployment caused by insufficient demand for goods and services). According to Samuelson and Nordhaus, a reduction in GG triggers a multiplier effect. Businesses earn less revenue, leading them to reduce their workforce. Laid-off workers have lower incomes, leading to decreased consumption (CC). This perpetuates a downward cycle of lower demand and higher unemployment.
Samuelson and Nordhaus explain that wages tend to be sticky downward (they do not adjust easily or quickly to lower levels during downturns due to contracts, labour unions, or social norms). As a result, labour markets fail to clear, leading to higher unemployment levels than would occur if wages were adjusted flexibly.
In the long run, employment depends on how the government’s savings are used. If savings reduce public debt, it may lower interest rates and stimulate private investment (I), creating jobs in capital-intensive industries (Positive Scenario). If spending cuts affect infrastructure, education, or R&D, they can reduce the economy's productive potential, leading to lower employment growth in the future (Negative Scenario).
Samuelson and Nordhaus emphasize the concept of the natural rate of unemployment, determined by structural factors such as skill mismatches and labour market inefficiencies. Government cuts in programs like job training, education, or support for unemployed workers could increase structural unemployment, raising the natural unemployment rate over time.
In Samuelson and Nordhaus's framework, in the short run, government spending cuts likely increase cyclical unemployment due to reduced demand and sticky wages. In the long run, the impact depends on whether savings improve fiscal health and foster private investment or reduce the economy's productive capacity by underfunding critical sectors.
Now let's see how it applies to real-world policies. For example, in Indonesia. President Prabowo Subianto has implemented significant budget cuts totalling approximately 306.7 trillion rupiah (around $18.8 billion) in 2025, aiming to reallocate funds towards key policy initiatives, notably a free meal program for schoolchildren and pregnant mothers. The savings are intended to finance the free meal program, which has been expanded to cover over 82 million beneficiaries, requiring an additional 100 trillion rupiah. Significant reductions in various ministries' budgets have raised concerns about potential disruptions in public services. For instance, the Public Works Ministry faces a 70% budget cut, which could affect infrastructure maintenance and development. Similarly, the Meteorology, Climatology, and Geophysics Agency anticipates reduced capabilities in monitoring natural disasters due to decreased funding.
Economists warn that the austerity measures might hinder economic performance by reducing government spending, which has been a significant contributor to Indonesia's GDP. The hospitality and tourism sectors, reliant on government events and travel, may experience downturns due to reduced official activities.
While the budget cuts aim to reallocate funds without increasing debt, there are apprehensions about the feasibility of funding expansive programs like the free meals initiative. Additional debt could pose risks to Indonesia's fiscal prudence and credit rating, especially amid weaker economic growth forecasts.
In summary, while the budget cuts are designed to fund significant social programs, they carry potential risks to public services and economic growth, necessitating careful implementation and monitoring.
Now, let's analyse President Prabowo's policy on budget savings through Samuelson and Nordhaus' framework. To analyse it requires examining its effects on Aggregate Demand (AD) and Aggregate Supply (AS), as well as the short- and long-term macroeconomic consequences. Samuelson and Nordhaus use the Keynesian cross diagram or the aggregate supply and demand (AS-AD) model to explain this. In the short term, one major component of AD is government spending (G). Prabowo's austerity measures—cutting non-essential expenses like official travel and air conditioning—reduce public sector expenditures. According to Samuelson and Nordhaus, reduced government spending directly shifts the AD curve to the left, resulting in lower total demand in the economy.
While some funds are diverted to social initiatives like free meals for children and pregnant mothers, the net effect depends on the multiplier effect. Social spending tends to have a high multiplier because it increases consumption (C) among low-income households with a high marginal propensity to consume. Thus, while overall AD might contract due to spending cuts, targeted redistribution could mitigate some of the decline.
Businesses may interpret budget cuts as a signal of reduced government demand for infrastructure and services. This could dampen private investment (I) in the short term, further reducing AD.
The contractionary effects of government spending cuts could outweigh the stimulative effects of social program spending. This leads to a possible reduction in AD, causing slower economic growth and higher unemployment in the short run.
Cuts to critical government ministries, like public works and disaster agencies, could impair infrastructure maintenance and reduce productivity. This can shift short-run aggregate supply (SRAS) to the left, increasing costs for businesses and households.
Samuelson and Nordhaus emphasize that reducing wasteful government spending can free up resources for productive use. By eliminating inefficiencies, Prabowo's policy could improve overall productivity and shift the long-run aggregate supply (LRAS) to the right.
Social programs (e.g., free nutritious meals) could enhance labour productivity in the long run. Better nutrition among children and pregnant mothers leads to healthier, more productive future workers, positively impacting AS by increasing the quality of labour.
Severe budget cuts in public infrastructure and disaster management may reduce economic resilience. This could dampen potential output in the long run if essential services or investments are neglected.
Samuelson and Nordhaus' framework predicts a short-term contraction in economic activity due to reduced government spending (AD ↓). This could result in slower growth and higher unemployment if private sector activity does not compensate for the reduction in public spending.
If managed well, the policy could have positive long-term effects. Improved fiscal efficiency and better resource allocation might enhance aggregate supply (LRAS ↑). Social spending on nutrition could raise labour productivity, further boosting long-term economic growth.
A key challenge is balancing austerity with essential public services. Overzealous cuts to critical sectors (e.g., infrastructure, education) could harm the economy's productive capacity, negating potential long-term benefits.
To prevent excessive demand contraction, President Prabowo’s government could complement austerity with fiscal stimulus targeting private investment (I) or infrastructure development. Ensure critical sectors like infrastructure and education remain adequately funded to avoid reducing productive capacity. Transparency in reallocating funds and targeting programs with high economic multipliers will maximize the policy’s benefits and minimize unintended consequences.
In conclusion, using Samuelson and Nordhaus' framework, President Prabowo's budget savings policy could stabilize the economy in the long run by improving resource allocation and enhancing productivity. However, careful management is necessary to avoid short-term demand shocks and long-term structural inefficiencies.
"Cangik, what in the world are you babbling about? I swear, my brain cells are staging a mass exodus," Limbuk groaned, kneading her forehead like she was trying to knead out the confusion itself. "Alright, alright,"
Cangik replied, "Let's just move on to the juicy stuff – Oligarchy! You know, the system where a few folks hog all the power and the rest of us are just ornamental fishes?"
