The term crowding-out effect refers to:a. The reduction in aggregate supply that results when a moneta1Y expansion causes the interest rate to decrease. b. The reduction in aggregate demand that results when a monetary expansion causes the interest rate to decrease. c. The reduction in aggregate demand that results when a fiscal expansion causes the interest rate to increase. d. The reduction in aggregate demand that results when a decrease in government spending or an increase in taxes causes the interest rate to increase.

Question

Gavyn Maynard

Business

25 January, 19:42

The term crowding-out effect refers to:a. The reduction in aggregate supply that results when a moneta1Y expansion causes the interest rate to decrease. b. The reduction in aggregate demand that results when a monetary expansion causes the interest rate to decrease. c. The reduction in aggregate demand that results when a fiscal expansion causes the interest rate to increase. d. The reduction in aggregate demand that results when a decrease in government spending or an increase in taxes causes the interest rate to increase.

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Eduardo Livingston · Answer 1

c. The reduction in aggregate demand that results when a fiscal expansion causes the interest rate to increase.

Explanation:

The crowding out effect occurs when spending by the private sector falls or are eliminated by an increasing spending by the public sector. When government wants its increase its expenditure, it can finance it either by increasing borrowing or tax or a combination of both.

An increased borrowing by the government usually increases the interest rate, while an increased tax reduces profit that can be plough back into the business. Both of these activities therefore reduces the available funds that the private sector can spend on demand and invest.

Therefore, the term crowding-out effect refers to the reduction in aggregate demand that results when a fiscal expansion causes the interest rate to increase.