In this fiscal policy, the government is trying to combat the 200 billion dollar deficit by holding government spending constant and increasing personal income taxes to gain the required money to balance the budget. This is called contractionary fiscal policy and is beneficial to counteract an economy either in, or heading towards inflation. This action has little direct impact on the business side of economics, but through the changes in evokes in the consumer side, businesses are indirectly influenced. They are tweaking the system by raising the personal income tax, and while it affects spending, it also affects savings, so only a fraction of the change will be seen in a change of spending habits. With the increase in personal income taxes, disposable income declines inversely. This decrease in spend able money decreases aggregate demand as well, as the graph moves from ¬ÜAD ¬!" to ¬ÜAD 1 -
• ¬!". The decrease in demand is a very crucial factor that influences many other factors in the economy. Spending suffers, so output decreases directly. We see that the GDP falls from ¬ÜG 1" to ¬ÜG 2 ¬!". Employment also declines, due to the factor that people aren ¬!"t buying as much, so businesses don ¬!"t have the need or money available to employ as many workers. The decline of demand is the main reason why output and employment decline, and with it, so does the price level fall as well, as it falls from ¬ÜP 1 -
• ¬!" to ¬ÜP 2 ¬!". This price is forced to fall as people on average have less money they can spend on the items they need to live, another influence of demand.
