Question 1

What does a government do when it is in budget deficit?

Accepted Answer

Borrows to finance its spending

Question 2

What does the loanable funds market model demonstrate?

Accepted Answer

The effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment

Question 3

What is crowding out?

Accepted Answer

The theory that increased government borrowing can lessen or eliminate private sector spending due to budget deficits increasing demand for loanable funds

Increasing demand for loanable funds decreases the amount available for private investors and increases interest rates, leading to less private investment and potentially a recessionary gap

Question 4

Why does crowding out occur?

Accepted Answer

Government borrowing leads to higher demand for loans, which increases interest rates

This makes it harder for private corporations to get loans and reduces economic growth

Question 5

What is the potential long-run impact of crowding out?

Accepted Answer

A lower rate of physical capital accumulation and less economic growth as a result

Question 6

What is the impact of crowding out on an expansionary fiscal policy?

Accepted Answer

It can partially cancel out the effects of the policy, making it less effective in correcting a recessionary gap

5.5 Crowding Out, AP Macroeconomics Flashcards