How do the multiplier effect and the crowding-out effect change the consequences of an increase in government spending?
A) They both amplify the consequences.
B) They both diminish the consequences.
C) The multiplier effect diminishes the consequences, while the crowding-out effect amplifies the consequences.
D) The multiplier effect amplifies the consequences, while the crowding-out effect diminishes the consequences.

Question

Quizplus · Accepted Answer

The multiplier effect amplifies the consequences of an increase in government spending because it leads to increased consumption, increased investment, and increased output in the economy. This leads to even more spending and a further boost to the economy.

The crowding-out effect, on the other hand, works to diminish the consequences of an increase in government spending. When the government spends money, it increases the demand for goods and services, which can lead to higher prices. This, in turn, can cause interest rates to rise, which makes it more expensive for businesses and consumers to borrow money. As a result, investment and consumption may decrease, which can offset the initial boost to the economy from government spending. However, in modern times, the crowding-out effect has been found to be weak or nonexistent due to the fact that we live in a global economic environment with spare capacity. Therefore, in contemporary economies, the multiplier effect dominates the crowding-out effect.

How Do the Multiplier Effect and the Crowding-Out Effect Change