According to the Ricardian equivalence theorem, what is the effect of each of the following on output in the economy? Explain your answers.
a. Government pays for an increase in spending by raising taxes.
Output increases because people will decrease their consumption by the same amount that spending increases.
Output is not affected because people will increase their consumption by the same amount that spending increases.
Output is not affected because people will decrease their consumption by the same amount that spending increases.
Output decreases because people will decrease their consumption by the same amount that spending increases.
Output increases because people will increase their consumption by the same amount that spending increases.
b. Government pays for an increase in spending by issuing bonds.
Output is not affected because people will decrease their savings, offsetting the increase in the deficit.
Output is not affected because people will increase their savings, offsetting the increase in the deficit.
Output decreases because people will decrease their savings, offsetting the increase in the deficit.
Output increases because people will increase their savings, offsetting the increase in the deficit.
Output decreases because people will increase their savings, offsetting the increase in the deficit.
Output increases because people will decrease their savings, offsetting the increase in the deficit.
c. The implication of your answers to a and b is that government should:
always balance the budget regardless of the state of the economy.
balance the budget only if the economy is in recession.
balance the budget only if the economy is at full employment.
balance the budget only if the economy is expanding.
According to the Ricardian equivalence theorem, what is the effect of each of the following on output in the economy? Explain your answers.
a. Government pays for an increase in spending by raising taxes.
| Output increases because people will decrease their consumption by the same amount that spending increases. | |
| Output is not affected because people will increase their consumption by the same amount that spending increases. | |
| Output is not affected because people will decrease their consumption by the same amount that spending increases. | |
| Output decreases because people will decrease their consumption by the same amount that spending increases. | |
| Output increases because people will increase their consumption by the same amount that spending increases. |
b. Government pays for an increase in spending by issuing bonds.
| Output is not affected because people will decrease their savings, offsetting the increase in the deficit. | |
| Output is not affected because people will increase their savings, offsetting the increase in the deficit. | |
| Output decreases because people will decrease their savings, offsetting the increase in the deficit. | |
| Output increases because people will increase their savings, offsetting the increase in the deficit. | |
| Output decreases because people will increase their savings, offsetting the increase in the deficit. | |
| Output increases because people will decrease their savings, offsetting the increase in the deficit. |
c. The implication of your answers to a and b is that government should:
| always balance the budget regardless of the state of the economy. | |
| balance the budget only if the economy is in recession. | |
| balance the budget only if the economy is at full employment. | |
| balance the budget only if the economy is expanding. |
Related textbook solutions
Related questions
Why does sound finance not depend on the Ricardian equivalence theorem?
| The Ricardian equivalence theorem says that people increase their savings in anticipation of an increase in taxes in the future to pay for that deficit. | |
| Sound finance is based on political grounds, not economic principles. | |
| The Ricardian equivalence theorem says that interest rates will rise when government increases expenditures, fully crowding out private investment. | |
| Sound finance says that governments should make spending and taxing decisions based on their effect on the economy, not moralistic principles. |
Question 1
Which of the following describes the relationship between the change in inventories and aggregate expenditure?
| A. | Aggregate expenditure equals the change in inventories minus GDP. |
| B. | The change in inventories equals GDP divided by aggregate expenditures. |
| C. | Aggregate expenditures equals GDP divided by the change in inventories. |
| D. | Aggregate expenditures equals GDP minus the change in inventories. |
| E. | The change in inventories equals GDP multiplied by aggregate expenditure. |
1 points
Question 2
Suppose the marginal propensity to consume is 0.80 and taxes decrease by $10 billion. Which of the following is true?
| A. | Disposable income and consumption fall by $10 billion |
| B. | Disposable income and consumption rise by $10 billion |
| C. | Disposable income rises by $10 billion and consumption rises by $8 billion |
| D. | Disposable income falls by $10 billion and consumption falls by $8 billion |
| E. | Disposable income rises by $10 billion and consumption falls by $8 billion |
1 points
Question 3
If aggregate expenditure at a particular level of income is less than output,
| A. | output will increase |
| B. | output will decrease |
| C. | output will remain the same |
| D. | output will rise slightly and then level off |
| E. | we cannot determine what will happen to output |
1 points
Question 4
The consumption function
| A. | illustrates the relationship between real disposable income and real consumption spending |
| B. | illustrates the relationship between the price level and real consumption spending |
| C. | is the relationship between productivity and real consumption spending |
| D. | shows how real consumption increases when real disposable income decreases |
| E. | illustrates the relationship between real consumption spending and employment |
1 points
Question 5
The focus of the short-run macro model is on the role of
| A. | spending in explaining economic fluctuations |
| B. | labor in explaining economic fluctuations |
| C. | financial markets in explaining economic fluctuations |
| D. | output in explaining economic fluctuations |
| E. | resources in explaining economic fluctuations. |
1 points
Question 6
If the output level is such that the aggregate expenditure line lies below the 45-degree line, which of the following is true?
| A. | Aggregate expenditure is greater than output, so inventories will increase and output will be raised. |
| B. | Aggregate expenditure is greater than output, so inventories will decrease and output will be increased. |
| C. | Aggregate expenditure is less than output, so inventories will decrease and output will be raised. |
| D. | Aggregate expenditure is less than output, so inventories will increase and output will be lowered. |
| E. | Aggregate expenditure is greater than output, so inventories will increase and output will be lowered. |
1 points
Question 7
If the marginal propensity to consume is 0.7, the expenditure multiplier is
| A. | 7.0 |
| B. | 0.7 |
| C. | 3.0 |
| D. | 3.3 |
| E. | not determinable without additional information. |
1 points
Question 8
Aggregate expenditure is the sum of
| A. | all types of spending by households and firms |
| B. | spending and savings by households |
| C. | spending by households and governments on final goods and services |
| D. | spending by households, government, firms, and foreigners on final goods and services |
| E. | all spending and saving by households, firms, and governments |
1 points
Question 9
If the marginal propensity to consume is 0.5 and disposable income increases by $10,000, by how much will consumption spending increase?
| A. | $10,000 |
| B. | $500 |
| C. | $50 |
| D. | $5,000 |
| E. | $9,524 |
1 points
Question 10
When real consumption expenditure is plotted against real disposable income the resulting relationship is
| A. | very weak. |
| B. | virtually flat . |
| C. | positive and very close to linear. |
| D. | negative and very close to linear. |
|
Income (Y) |
Net Tax (T) |
Disposable Income (YD) |
Consumption (C) |
Saving (S) |
Investment (I) |
Gov. Spending (G) |
Total Expenditure (TE) |
|
10,000 |
1,000 |
1,300 |
2,000 |
1,500 |
|||
|
12,000 |
1,000 |
1,700 |
2,000 |
1,500 |
|||
|
13,000 |
1,000 |
2,000 |
1,500 |
||||
|
15,000 |
1,000 |
2,000 |
1,500 |
||||
|
16,000 |
1,000 |
2,000 |
1,500 |
||||
|
18,000 |
1,000 |
2,000 |
1,500 |
||||
|
20,000 |
1,000 |
2,000 |
1,500 |
a) Fill in the missing values.
b) What is the equilibrium output level?
c) If the current output level is 15,000, what would likely happen to the output level next year? Why?
d) By how much will the equilibrium output level increase (decrease) if the planned investment falls by 500?
e) By how much will the equilibrium output level increase (decrease)if the tax (T) decreases by 400?
f) By how much will the equilibrium output level increase (decrease) if the government spending (G) decreases by 800?
g) By how much will the equilibrium output level increase (decrease) if the government spending (G) decreases by 300 and at the same time, the government cuts taxes by the same amount of 300?
