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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

If the central bank in the preceding question instead holds the money supply constant and allows the interest rate to adjust, the change in aggregate demand resulting from the increase in government purchases will be

a. larger.

b. the same.

c. smaller but still positive.

d. negative.

To determine

Crowding out effect.

Explanation

Option (c):

Even though multiplier effect is present on government spending, crowding out effect reduces the aggregate demand that results from an increase in the interest rate due to government purchases (expansionary policy). Thus, the overall increase in the aggregate demand would be smaller than the previously calculated value but is still positive. Thus, option ‘c’ is correct.

Option (a):

Due to a crowding out effect, the change in aggregate demand would be smaller. Thus, option ‘a’ is incorrect...

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