Refer to the above graph.If the economy was initially in equilibrium at point 3 and interest rates increase by 4 percentage points, then the crowding-out effect would be:
A)$10 billion in investment.
B)$20 billion in investment.
C)$30 billion in investment.
D)$35 billion in investment.

Question

Refer to the above graph.If the economy was initially in equilibrium at point 3 and interest rates increase by 4 percentage points, then the crowding-out effect would be:
A)$10 billion in investment. 
B)$20 billion in investment. 
C)$30 billion in investment. 
D)$35 billion in investment.

Quizplus · Accepted Answer

An increase in interest rates would cause the aggregate demand to decrease, leading to a decrease in real GDP from Y3 to Y2, as shown in the graph. This decrease leads to a decrease in investment demand of $20 billion (the distance between I3 and I2). This decrease in investment caused by the increase in interest rates is known as the crowding-out effect.

Refer to the Above Graph