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1 Describe the crowding-out effect of an increase in government purchases. 2 Is a “strong dollar”...

1 Describe the crowding-out effect of an increase in government purchases.

2 Is a “strong dollar” a good thing? Explain

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Answer #1

Question 1

When government increases its purchases then it generally borrows in order to pay for these increased purchases.

This borrowing by government leads to increase in demand for loanable funds in loanable funds market.

Given the supply of loanable funds, this increase in demand for loanable funds leads to increase in interest rates.

Increase in interest rates increases the cost of borrowing for businesses and households.

This compels the businesses and households to reduce investment and consumption spending backed by credit.

This decrease in consumption spending and investment spending due to increase in interest rate as government has increased its purchases is termed as crowding out effect of an increase in government purchases.

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