Ricardian equivalence theorem?

1. Jan 29, 2009

phynoob

Ricardian equivalence theorem??

Hi all..could anyone care explain what is ricardian equivalence theorem and how it is useful in the understanding of our economy?i would try to explain my understanding of Ricardian equivalence in my own way and please correct me if Im wrong :D Thanks

Assuming we live in 2 periods. T1 and T2.
Government who undertakes a tax cut in T1 will trigger inviduals to save up or buy more bonds from the government as people like us will forsee a tax increase in the future. Thus, savings increases and the extra (1+r)S* is used to pay the increased tax in period 2. AM i right?

This part below is the section that i dont understand from my lecture notes.. It says that consumption choices remains unchanged!?!?

Lemem try to give a feeble attempt on why?Do give me some pointers please!~ :D It is because....Since C=Y-T-S , where c=consumption, y=income, t=tax, s= savings. So from this equation, if taxes decrease, the change of T <0 and has the same magnitude as the change of S>0 . However, consumption this remains the same.

Please feel free to add additionals info. Appreciate all views and inputs and thx for ur time !!

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