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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.
Principles of Economics (MindTap C...
Principles of Economics (MindTap C...
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.
Explanation of Solution
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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