Figure 16-6. On the left-hand graph, MS represents the supply of money and MD represents the demand for money; on the right-hand graph, AD represents aggregate demand. The usual quantities are measured along the axes of both graphs.

-Refer to Figure 16-6. Suppose the multiplier is 3 and the government increases its purchases by $25 billion. Also, suppose the AD curve would shift from AD₁ to AD₂ if there were no crowding out; the AD curve actually shifts from AD₁ to AD₃ with crowding out. Finally, assume the horizontal distance between the curves AD₁ and AD₃ is $30 billion. The extent of crowding out, for any particular level of the price level, is

Question

Figure 16-6. On the left-hand graph, MS represents the supply of money and MD represents the demand for money; on the right-hand graph, AD represents aggregate demand. The usual quantities are measured along the axes of both graphs.

-Refer to Figure 16-6. Suppose the multiplier is 3 and the government increases its purchases by $25 billion. Also, suppose the AD curve would shift from AD₁ to AD₂ if there were no crowding out; the AD curve actually shifts from AD₁ to AD₃ with crowding out. Finally, assume the horizontal distance between the curves AD₁ and AD₃ is $30 billion. The extent of crowding out, for any particular level of the price level, is

Quizplus · Accepted Answer

Crowding out occurs when government spending increases, causing higher interest rates which result in reduced private investment. In this case, the government increases its purchases by $25 billion and the multiplier is 3, so the shift in AD would be 3 times as large, or $75 billion. However, there is crowding out, which means that the actual shift in AD is only $30 billion, the horizontal distance between the two AD curves. Therefore, the extent of crowding out is $75 billion - $30 billion = $45 billion.