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Question
Statistics
Posted 5 months ago
Which of the following is the most likely long-run impact of government deficits?
Choose 1 answer:
(A) A higher money multiplier
(B) Higher potential output
(C) More private investment
(D) Less government borrowing
(E) A smaller stock of capital
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Answer from Sia
Posted 5 months ago
Solution by Steps
step 1
To understand the long-run impact of government deficits, we refer to the loanable funds market model
step 2
Government deficits increase demand for loanable funds, which leads to an increase in the real interest rate according to the model
step 3
Higher real interest rates discourage private investment, as the cost of borrowing funds increases
step 4
Less private investment can lead to a smaller stock of capital in the long run, as investment is a key component of capital formation
Answer
E
Key Concept
Crowding out effect
Explanation
Government deficits can lead to higher real interest rates, which in turn can crowd out private investment, potentially resulting in a smaller stock of capital in the long run.
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