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Chapter 13: Q.19 (page 298)

Recall that the Keynesian spending multiplier equals 1 /(1-M P C). Suppose that in Figure 13-4, the MPC is equal to 0.9. In addition, the amount of the horizontal leftward shift from AD2 to AD3 caused by a crowding-out effect on planned investment spending was 0.5\( trillion, or \) 500 billion. How much investment spending was crowded out?

Short Answer

Expert verified

investment spending of $50billion was crowded out

Step by step solution

01

introduction

Arranged Investment Spending alludes to the sum that the private area firms intend to spend on stock and acquisition of capital merchandise during a given timeframe.

Marginal Propensity to Consume alludes to the extent of the absolute expansion in discretionary cash flow that families give to utilization.

02

explanation

Given,

MPC = 0.9

Calculating the spending multiplier,

=11−MP=11−0.9=10

Crowded out planned investment spending = ∆I

A leftward shift in AD curve = ∆AD

Crowded out planned investment spending is calculated

ΔI=ΔADspending multiplier

ΔI=$500billion10ΔI=$50billion.

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Most popular questions from this chapter

Determine whether each of the following is an example of a situation in which there is indirect crowding out resulting from an expansionary fiscal policy action.

a. The government provides a subsidy to help keep an existing firm operating, even though a group of investors otherwise would have provided a cash infusion that would have kept the company in business.

b. The government reduces its taxes without decreasing its expenditures. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. Government expenditures fund construction of a high-rise office building on a plot of land where a private company otherwise would have constructed an essentially identical building.

Every 1-percentage-point increase in the marginal income tax rate induces some workers to supply less labour, which cuts real GDP by \( 0.2 trillion. At the same time, each 1-percentage point increase in the marginal income tax rate causes spendable income to drop, which induces some workers to supply labour that yields \) 0.1 trillion more in real GDP. Is the net outcome consistent with the supply-side theory? Why?

Assume that the Ricardian equivalence theorem is not relevant. Explain why an income-tax-rate cut should affect short-run equilibrium real GDP.

Determine whether each of the following is an example of a situation in which a direct expenditure offset to fiscal policy occurs.

a. In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use.

b. The government increases its expenditures without raising taxes. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. The government finances the construction of a classical music museum that otherwise would never have received private funding.

Discuss ways in which indirect crowding out and direct expenditure offsets can reduce the effectiveness of fiscal policy actions.
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