Question

According to the​ crowding-out effect, if the federal government increases​ spending, the demand for money and the equilibrium interest rate will​ ___________, which will cause​ consumption, investment, and net exports to​ ___________.

a. increase; decrease
b. decrease; increase
c. decrease; decrease
d. increase; increase

Answer 1

a. increase; decrease

Step-by-step explanation:

The crowding-out effect is one where public spending intended to increase spending in the economy (ie. aggregate demand, and thus stimulate the economy) results in less private spending, causing aggregate demand to increase less than the increase in public spending.

The reason is because as government spend they have to use money. That will raise demand for money, causing the its price (interest rate) to increase. Because money becomes more valuable (people have to forgo higher interest rate to spend their money or pay higher rate to borrow) there will be less spending on consumption and investment. Higher interest rate also causes net exports to decrease (more imports less exports).