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-(Figure: Loanable Funds Market III)Use Figure: Loanable Funds Market III.If the government in a closed economy is running a budget balance of zero when it decides to increase defence spending by $200 billion and then finances the spending by selling bonds,the government will crowd out a maximum of _____ in private investment spending.

Question

Use the following to answer questions: 
-(Figure: Loanable Funds Market III)Use Figure: Loanable Funds Market III.If the government in a closed economy is running a budget balance of zero when it decides to increase defence spending by $200 billion and then finances the spending by selling bonds,the government will crowd out a maximum of _____ in private investment spending.

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When the government increases defence spending by $200 billion, it will increase the demand for loanable funds in the market. As a result, the interest rate will increase from r1 to r2. This increase in the interest rate will lead to a decrease in private investment spending from I1 to I2. The maximum amount of crowding out will be equal to the initial increase in government spending, which is $200 billion, minus the decrease in private investment spending, which is $100 billion. Therefore, the maximum crowding out will be $100 billion.

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