Which of the following sequences best represents the crowding-out effect?
A)government purchases ↑ ⇒ GDP ↑ ⇒ supply of money ↓ ⇒ equilibrium interest rate ↑ ⇒ quantity of goods and services demanded ↓
B)government purchases ↓ ⇒ GDP ↓ ⇒ demand for money ↓ ⇒ equilibrium interest rate ↓ ⇒ quantity of goods and services demanded ↓
C)government purchases ↑ ⇒ GDP ↑ ⇒ demand for money ↑ ⇒ equilibrium interest rate ↑ ⇒ quantity of goods and services demanded ↓
D)taxes ↑ ⇒ GDP ↓ ⇒ demand for money ↓ ⇒ equilibrium interest rate ↑ ⇒ quantity of goods and services demanded ↓

Question

Quizplus · Accepted Answer

The crowding-out effect refers to the decrease in private spending as a result of increased government spending. When the government spends more (government purchases ↑), it increases aggregate demand (GDP ↑) which increases the demand for money (demand for money ↑). This leads to an increase in the equilibrium interest rate (equilibrium interest rate ↑) which in turn decreases the quantity of goods and services demanded (quantity of goods and services demanded ↓). Therefore, the sequence that best represents the crowding-out effect is government purchases ↑ ⇒ GDP ↑ ⇒ demand for money ↑ ⇒ equilibrium interest rate ↑ ⇒ quantity of goods and services demanded ↓ (option C).

Which of the Following Sequences Best Represents the Crowding-Out Effect