The Ricardian equivalence theorem suggests that an increase in the government budget deficit created by a tax cut will
A) increase real Gross Domestic Product (GDP) in both the short and long run.
B) decrease real Gross Domestic Product (GDP) in the short run, but increase it in the long run.
C) increase real Gross Domestic Product (GDP) in the short run, but decrease it in the long run.
D) have no effect on real Gross Domestic Product (GDP) in either the short run or the long run.

Question

Quizplus · Accepted Answer

The Ricardian equivalence theorem suggests that individuals are forward-thinking and will save any extra income from a tax cut in anticipation of future tax increases to pay off the government debt. Therefore, the increase in the government budget deficit created by a tax cut will have no effect on real GDP in either the short run or the long run.

The Ricardian Equivalence Theorem Suggests That an Increase in the Government