Read " $\rightarrow$ " as "leads to" in the options below.
Which of the following best describes the chain of events in the relationship between deficits and potential output?

Choose 1 answer:
(A) Deficit $\rightarrow$ higher real interest rates $\rightarrow$ more private investment $\rightarrow$ larger capital stock $\rightarrow$ faster growth of potential output
(B) Deficits $\rightarrow$ lower real interest rates $\rightarrow$ more private investment $\rightarrow$ larger capital stock $\rightarrow$ faster growth of potential output
(C) Deficit $\rightarrow$ higher real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ slower growth of potential output
(D) Deficits $\rightarrow$ higher real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ faster growth of potential output
(E) Deficits $\rightarrow$ lower real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ slower growth of potential output

Question

Read " $\rightarrow$ " as "leads to" in the options below.
Which of the following best describes the chain of events in the relationship between deficits and potential output?

Choose 1 answer:
(A) Deficit $\rightarrow$ higher real interest rates $\rightarrow$ more private investment $\rightarrow$ larger capital stock $\rightarrow$ faster growth of potential output
(B) Deficits $\rightarrow$ lower real interest rates $\rightarrow$ more private investment $\rightarrow$ larger capital stock $\rightarrow$ faster growth of potential output
(C) Deficit $\rightarrow$ higher real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ slower growth of potential output
(D) Deficits $\rightarrow$ higher real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ faster growth of potential output
(E) Deficits $\rightarrow$ lower real interest rates $\rightarrow$ less private investment $\rightarrow$ smaller capital stock $\rightarrow$ slower growth of potential output

Accepted Answer

∻Solution by Steps∻ ‖ step 1 ⋮ Understand the economic theory behind the relationship between budget deficits and real interest rates: According to the loanable funds theory, a budget deficit increases the demand for loanable funds, which leads to higher real interest rates. ‖ ‖ step 2 ⋮ Analyze the impact of higher real interest rates on private investment: Higher real interest rates make borrowing more expensive for businesses, which typically reduces the level of private investment. ‖ ‖ step 3 ⋮ Consider the effect of reduced private investment on the capital stock: Less private investment means that there is less capital formation, which leads to a smaller capital stock over time. ‖ ‖ step 4 ⋮ Evaluate the impact of a smaller capital stock on the growth of potential output: A smaller capital stock limits the economy's productive capacity, which slows the growth of potential output. ‖ ∻Answer∻ ***C*** ∻Key Concept∻ ⚹Budget deficits and potential output growth⚹ ∻Explanation∻ ⚹A budget deficit leads to higher real interest rates, which in turn leads to less private investment, resulting in a smaller capital stock and slower growth of potential output.⚹◊What is the impact of deficits on potential output growth based on the given multiple-choice question and answer choices?⍭ Generate me a similar question◊

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