Question

In January, the interest rate is 5 percent and firms borrow $50 billion per month for investment projects. In February, the federal government doubles its monthly borrowing from $25 billion to $50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back their borrowing to only $30 billion per month.
Which of the following is true?

a. There is no crowding-out effect because the government's increase in borrowing exceeds rm's decrease in borrowing.
b. There is a crowding-out effect of $20 billion.
c. There is no crowding-out effect because both: government and firms are still borrowing a lot.
d. There is a crowding-out effect of $25 billion.

Answer 1

Answer:

B, There is a crowding-out effect at $20,000,000

Explanation:

Crowding ot effect is an economic theory that shows that the more the public sector of an economy spends through borrowing, the lesser or non-existent is the ability of the private sector to borrow or spend. This is because there is a lot of deficit and this drives the interest rates higher. This goes on to affect the personal consumption of goods and services as well.

In the above question, because the government has increased its borrowing from $25 billion to $50 billion, firms wuld have to cut their own borrowing levels because it would require more than the usual amount to offset the loans the firms are used to taking seeing that interest rates have moved form 5% to 7%.

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