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Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126

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BuyFindarrow_forward

Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126
Chapter 34, Problem 5CQQ
Textbook Problem
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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.

To determine
Crowding out effect.

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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