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Chapter 18: Q.10 (page 451)

What is the theory of Ricardian equivalence?

Short Answer

Expert verified

Current taxes (and current deficits) or future taxes (and current deficits) will have the same effect on the overall economy.

Step by step solution

01

Concept

Ricardian equivalence happens when people realize that paying lower taxes today means paying higher taxes later, so rather than using their tax reduction, they save it to pay future taxes.

02

Explanation

Reductions in income taxes will not enhance aggregate demand, according to Ricardian equivalence theory, because people will save the majority of the extra income. Due to a slump in the economy over the last nine months, the government has decided to lower income taxes. The overall impacts of funding government spending with current taxes or future taxes (and current deficits) are the same.

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Most popular questions from this chapter

The U.S. government has shut down a number of times in recent history. Explain how a government shutdown will affect the variables in the national investment and savings identity. Could the shutdown affect the government budget deficit?

Why have many education experts recently placed an emphasis on altering the incentives that U.S. schools face rather than on increasing their budgets? Without endorsing any of these proposals as especially good or bad, list some of the ways in which incentives for schools might be altered.

What are some steps the government can take to encourage research and development?

What are some fiscal policies for improving a society’s human capital?

Illustrate the concept of Ricardian equivalence using the demand and supply of financial capital graph.
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