In the new classical model, a $100 billion increase in government purchases financed by borrowing will
A) increase the real interest rate, which will crowd out private spending.
B) lead to a $100 billion increase in real GDP.
C) lead to a $400 billion increase in real GDP if the marginal propensity to consume is three-fourths.
D) leave the interest rate, aggregate demand, and real output unchanged.

Question

Quizplus · Accepted Answer

In the new classical model, government purchases financed by borrowing do not affect aggregate demand or real output. The increase in government spending is offset by an equal decrease in private spending because of the crowding-out effect, which leaves the interest rate unchanged. Therefore, the correct choice is D, which states that there will be no effect on the interest rate, aggregate demand, or real output.

In the New Classical Model, a $100 Billion Increase in Government