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, it means the government is spending less than it is earning. This reduces the demand for borrowing, allowing the interest rate to decrease. The decrease in interest rates will lead to an increase in investment and capital formation, as borrowing becomes cheaper for firms to finance investments. This can also stimulate economic growth, which can lead to an increase in tax revenues for the government.

Assume the Economy Is Closed and That It Is Operating