Economics • Economic BasicsHard
Which of the following describes 'Ricardian Equivalence' in macroeconomic theory?
A. Government spending financed by debt has the exact same impact on aggregate demand as government spending financed by taxes.✓ Correct Answer
B. An increase in government borrowing leads to an equivalent decrease in private investment through higher interest rates.
C. Tariffs and quotas have identical protective effects on domestic industries under flexible exchange rates.
D. Taxes and subsidies always neutralize each other in a closed economy.
💡 Solution & Explanation
Ricardian Equivalence posits that government spending financed through debt accumulation has an identical economic impact to taxation because rational consumers anticipate future tax increases to pay off the debt, thereby increasing private savings instead of aggregate demand. Alternative choices misattribute the theory to crowding-out effects or tariff protection mechanisms. The hypothesis was originally theorized by classical economist David Ricardo and later revived by Robert Barro.
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