government spending and taxation directly affect the overall performance of the economy. for example, if the government increases spending to build a new highway, construction of the highway will create jobs. jobs create income that people spend on purchases, and the economy tends to grow. the opposite happens when the government increases taxes. Households and businesses have less of their income to spend, they purchases fewer goods, and the economy tends to shrink.
when the government spends more than it receives, it runs deficit. governments finance deficits by borrowing money. deficit spending - that is, spending funds obtained by borrowing or printing instead of taxation - can be helpful for the economy. for example, when unemployment is high, the government can undertake projects that use workers who would otherwise be idle. the economy will then expand because more money is being pumped into it. however, deficit spending also can harm the economy. when unemployment is low, a deficit may result in rising prices, or inflation. the additional government spending create more competition for scarce workers and resources and this inflates wages and prices.
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