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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

Imagine an economy in which Ricardian equivalence holds. This economy has a budget deficit of 50, a trade deficit of 20, private savings of 130, and investment of 100. If the budget deficit rises to 70, how are the other terms in the national saving and investment identity affected?

To determine

The effect of rise in budget deficit on national savings and investment identity when the Ricardian equivalence holds true is to be determined.

Explanation

It is given that the private savings equals 130, the government budget deficit is equal to 50, trade deficit is 20 and the investment is equal to 100. The budget deficit increases from 50 to 70.

In the case of Ricardian equivalence, people are forward looking. They know that a cut of tax rate today will leads to increase in the taxes in future so as to balance the government budget. This theory means that any changes in government budget deficit would offset the change in the private savings.

As the budget deficit increases by 20, hence the savings also increases by 20. The national savings and investment identity will be affected...

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