2 s y c t from the governments first period budget

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Unformatted text preview: ed from output. (2) S = Y – C –T From the government’s first period budget constraint we know: (3) B = G-T By substitution of (3) into (1) (4) S = G-T By substitution of (4) into (2) G – T = Y – C –T (5) Y = C+ G This is a very, very important result. Why? Because it shows that when the market for goods C and G is in equilibrium that the bond market is also in equilibrium!! Notice we went from (1) to (5). RICARDIAN EQUIVALENCE This is a theorem that you will run across in macroeconomic theory. It is a theorem that essentially says that the timing of tax changes will not affect consumption decisions, because people will foresee any tax changes as changes in their lifetime income and will compensate. Whether this holds empirically is another matter and we will not discuss that here. We are however going to outline the idea of Ricardian equivalence. This treatment is not quite as involved as the one in the text. Suppose our economy is made up of m identical consumers. Each consumer pays taxes in the presen...
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