Assume the economy is closed and that it is operating at full employment. Which statement is TRUE when the size of the budget deficit decreases?
A) The interest rate will decrease, leading to an increase in investment and capital formation.
B) Demand and supply of credit will increase.
C) A reduction in the growth of productivity, and a reduction in society's standard of living will occur.
D) The increased amount of public goods will crowd out privately produced goods.

Question

Quizplus · Accepted Answer

When the size of the budget deficit decreases, there is less borrowing by the government, which decreases the demand for loanable funds, leading to a decrease in the interest rate. A lower interest rate leads to an increase in investment and capital formation as businesses find it cheaper to borrow and invest in new projects. Therefore, choice A is the correct answer. B, C, and D are incorrect because they do not accurately describe the impact of a decrease in the budget deficit on the economy.

Assume the Economy Is Closed and That It Is Operating