The figure given below depicts the macroeconomic equilibrium in a country. Figure 11.3 Refer to Figure 11.3.Assume that the increase in aggregate demand from AD₁to AD₂ was the result of government spending that was financed by borrowing.Assuming that the Ricardian equivalence holds and people expect taxes to rise in future, the equilibrium income will be: A)$800. B)less than $500. C)more than $800. D)less than $700. E)$700.

Question

Quizplus · Accepted Answer

According to the Ricardian equivalence, people will anticipate future taxes rising when the government borrows to finance spending. As a result, this will reduce their current disposable income, causing them to increase their savings. Because of the increase in savings, consumption will decrease, lowering the aggregate demand. This means that the final equilibrium income will be lower than it would have been if the spending had not been funded by the government borrowing. Hence, the new equilibrium income will be less than $700. Only option D is less than $700, so it is the correct answer.

The Figure Given Below Depicts the Macroeconomic Equilibrium in a Country