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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

Assume that MPC= 45when answering the following questions.

a. If government expenditures rise by \( 2 billion, by how much will the aggregate expenditure curve shift upward? By how much will equilibrium real GDP per year change?

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