Question

If crowding out occurs, then expansionary fiscal policy will shift the aggregate demand curve:

A) to the left by less than if crowding out did not occur (or possibly even to the right).
B) to the right by less than if crowding out did not occur (or possibly even to the left).
C) to the right by more than if crowding out did not occur.
D) to the left by more than if crowding out did not occur.

Answer 1

Crowding out can diminish the intended effect of expansionary fiscal policy, leading to a smaller rightward shift in the aggregate demand curve, or in some cases, even a leftward shift instead of the expected increase in aggregate demand.

Step-by-step explanation:

If crowding out occurs, then expansionary fiscal policy will shift the aggregate demand curve B) to the right by less than if crowding out did not occur (or possibly even to the left). Crowding out is a phenomenon where increased government borrowing leads to higher interest rates, which in turn can discourage private investment and consumption, thereby reducing the efficacy of fiscal policy in stimulating economic activity.

As a result, while expansionary fiscal policy typically aims to increase aggregate demand by increasing government spending or reducing taxes, the presence of crowding out means the actual shift in the aggregate demand curve might be smaller than expected, or in some cases, could potentially offset the intended effects and lead to a leftward shift.