Q.21 Explain whether or not you agree... [FREE SOLUTION]

Chapter 31: Q.21 (page 761)

Explain whether or not you agree with the premise of the Ricardian equivalence theory that rational people might reason: 鈥淲ell, a higher budget deficit (surplus) means that I鈥檓 just going to owe more (less) taxes in the future to pay off all that government borrowing, so I鈥檒l start saving (spending) now.鈥� Why or why not?

Short Answer

Expert verified

It would be quite difficult to accept as true with the premise of Ricardian equivalence due to the subsequent reasons listed below:

a. People aren't much rational for saving more for the longer term and consume less today. People cannot expect the precise tax cut today which ends up in hike within the future taxes.

b. People don't believe saving today because sometimes the required purchases don't allow saving today.

Step by step solution

Concept Introduction

They know that a cut of rate today will ends up in increase within the taxes in future so on balance the govt budget. This theory implies that any changes in government deficit would offset the change within the private savings.

Explanation of Solution

In Ricardian equivalence theory, people tries to avoid wasting the money today so as to pay the taxes within the upcoming future. A tax cut today doesn't cause increase within the aggregate demand within the short run.

It would be quite difficult to accept as true with the premise of Ricardian equivalence due to the subsequent reasons listed below:

a. People aren't much rational for saving more for the longer term and consume less today. People cannot expect the precise tax cut today which ends up in hike within the future taxes.

b. People don't believe saving today because sometimes the required purchases don't allow saving today.