The reduction in investment spending in the long run results from an increase in government expenditures because:
A) the tax rate increases.
B) real interest rates increase.
C) real interest rates decrease.
D) nominal interest rates decrease.

Question

Quizplus · Accepted Answer

When government expenditures increase, it leads to an increase in the demand for loanable funds. This, in turn, leads to an increase in real interest rates, which raises the cost of borrowing for firms. Thus, firms reduce their investment spending in the long run, resulting in a reduction in investment spending.

The Reduction in Investment Spending in the Long Run Results