Figure 34-6. 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 34-6. 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 $40 billion. The extent of crowding out, for any particular level of the price level, is
A) $15 billion.
B) $40 billion.
C) $35 billion.
D) $95 billion.

Question

Figure 34-6. 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 34-6. 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 $40 billion. The extent of crowding out, for any particular level of the price level, is
A) $15 billion. 
B) $40 billion. 
C) $35 billion. 
D) $95 billion.

Quizplus · Accepted Answer

The initial shift in AD from AD1 to AD2 would have been $75 billion (multiplier of 3 times the $25 billion increase in government purchases). However, due to crowding out, the actual shift in AD is only $35 billion (horizontal distance between AD1 and AD3). Therefore, the extent of crowding out is $40 billion ($75 billion - $35 billion).