Question

If the Ricardian equivalence theorem LOADING... is not​ relevant, then an​ income-tax-rate cut A. will result in a multiple times higher increase in equilibrium real GDP in the long​ run; however, a​ tax-rate reduction will increase the​ automatic-stabilizer properties of the tax​ system, so equilibrium real GDP would be more stable. B. will result in a multiple times higher decrease in equilibrium real GDP in the long​ run, however; a​ tax-rate reduction will reduce the​ automatic-stabilizer properties of the tax​ system, so equilibrium real GDP would be more stable. C. will result in a multiple times higher increase in equilibrium real GDP in the short​ run; however, a​ tax-rate reduction will reduce the​ automatic-stabilizer properties of the tax​ system, so equilibrium real GDP would be less stable. D. will result in a multiple times higher decrease in equilibrium real GDP in the short​ run; however, a​ tax-rate reduction will increase the​ automatic-stabilizer properties of the tax​ system, so equilibrium real GDP would be less stable.

Answer 1

The correct answer is D. will result in a multiple times higher decrease in equilibrium real GDP in the short​ run; however, a​ tax-rate reduction will increase the​ automatic-stabilizer properties of the tax​ system, so equilibrium real GDP would be less stable.

Step-by-step explanation:

Ricardian Equivalence is an economic theory that suggests that when a government increases expenses financed with debt to try to stimulate demand, demand does not really undergo any change.

This is because increases in the public deficit will lead to higher taxes in the future. To keep their consumption pattern stable, taxpayers will reduce consumption and increase their savings in order to offset the cost of this future tax increase.

If taxpayers reduce their consumption and increase their savings by the same amount as the debt to be returned by the government, there is no effect on aggregate demand.

The fundamental concept of Ricardian equivalence is that it does not matter which method the government chooses to increase spending, whether by issuing public debt or through taxes (applying an expansive fiscal policy), the result will be the same and demand will remain unchanged.