In a neoclassical economy, if consumption increases as the interest rate decreases, then a $10 billion rise in government spending would:
A) still crowd out exactly $10 billion of investment.
B) crowd out between zero and $10 billion of investment.
C) not crowd out any investment.
D) crowd out more than $10 billion of investment.

Question

Quizplus · Accepted Answer

In a neoclassical economy, an increase in government spending would lead to a decrease in investment due to the crowding out effect. However, the extent of crowding out depends on how much consumption increases as a result of the decrease in interest rates caused by the increase in government spending. If consumption increases by a lot, then there will be more crowding out of investment. If consumption increases by only a little, then there will be less crowding out of investment. Therefore, it is likely that a $10 billion rise in government spending would crowd out between zero and $10 billion of investment.

In a Neoclassical Economy, If Consumption Increases as the Interest