Question

When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which in turn reduces consumption and investment spending. This argument is called the:

1) Crowding-out effect
2) Multiplier effect
3) Liquidity effect
4) Income effect

Answer 1

The crowding-out effect explains how fixed supply of credit and increased price levels lead to higher interest rates, which in turn reduce consumption and investment.

Step-by-step explanation:

When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which in turn reduces consumption and investment spending. This scenario is best described by the term crowding-out effect. The crowding-out effect occurs when higher government spending leads to increased demand for financial capital, resulting in higher interest rates that discourage private investment.