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

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

Quizplus · Accepted Answer

With a multiplier of 3, a $25 billion increase in government purchases would lead to a $75 billion increase in aggregate demand. However, due to crowding out (the increase in government purchases leading to higher interest rates, which decreases private investment and consumption), the actual increase in aggregate demand is less than $75 billion. Since the horizontal distance between the curves is $40 billion, this means that the extent of crowding out is $35 billion ($75 billion - $40 billion). Therefore, the best choice is C.