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Chapter 13: Q. 14 (page 297)

Suppose that Congress enacts a lump-sum tax cut of $750 billion. The marginal propensity to consume is equal to 0.75. Assuming that Ricardian equivalence holds true, what is the effect on equilibrium real GDP? On saving?

Short Answer

Expert verified

As a result, it is evident that tax cuts have no impact on actual GDP or savings.

Step by step solution

01

Introduction 

The given is the assumption of Congress enacting a lump sum tax cut of $750billion

The objective is to determine the effect on equilibrium real GDP on saving

02

Step 1 

According to the Ricardian equivalence theorem, a government's attempt to stimulate demand by raising debt-financed government spending has no impact on aggregate demand.

In general, if the government enacts a $750 billion lump-sum tax cut, aggregate demand will be reduced. Because as taxes rise, the amount of money in circulation decreases. As a result, people will have less purchasing power in this situation.

However, an increase or decrease in tax keeps real GDP and saving constant, according to Ricardian equivalence thesis.

As a result, it is evident that a tax cut has no effect on real GDP or savings.

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Most popular questions from this chapter

2. Why do you suppose that many economists perceive a trade-off between short-term stabilization benefits of unemployment compensation and a contribution to a higher unemployment rate in the long run?

Recall that the Keynesian spending multiplier equals 1 /(1-M P C). Suppose that in Figure 13-4, the MPC is equal to 0.9. In addition, the amount of the horizontal leftward shift from AD2 to AD3 caused by a crowding-out effect on planned investment spending was 0.5\( trillion, or \) 500 billion. How much investment spending was crowded out?

Determine whether each of the following is an example of a situation in which there is indirect crowding out resulting from an expansionary fiscal policy action.

a. The government provides a subsidy to help keep an existing firm operating, even though a group of investors otherwise would have provided a cash infusion that would have kept the company in business.

b. The government reduces its taxes without decreasing its expenditures. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. Government expenditures fund construction of a high-rise office building on a plot of land where a private company otherwise would have constructed an essentially identical building.

Use traditional Keynesian analysis to evaluate the effects of discretionary fiscal policies.

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