Question

Explain why less spending and higher taxes would both translate to slower economic growth

Answer 1

Answer

Less spending and higher taxes directly impacts the Aggregate Demand in an economy. Less spending means Consumption and Government Expenditures have fallen. Also, higher taxes mean less income for consumption. It can be illustrated as below:

Aggregate demand is measured by the following mathematical formula-

AD = C + I + G +(X-M)

Aggregate Demand = Consumer Spending + Investment Spending + Government Spending + (Exports-Imports)

Thus, when Aggregate Demand (GDP) falls, the economic growth slows down as they are directly correlated.