Explore BrainMass

Crowding out of private domestic investment

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

How might federal deficits crowd out private domestic investment? How does this crowding out affect future living standards?

© BrainMass Inc. brainmass.com October 24, 2018, 5:43 pm ad1c9bdddf

Solution Preview

How might federal deficits crowd out private domestic investment? How does this crowding out affect future living standards?

There are three different ways in which a national government can fund its spending: 1) taxes 2) printing money 3) borrowing.
When the government has an expansionary fiscal policy, runs a deficit and finances this deficit through borrowing, crowding out takes place. The expansionary fiscal policy and large government ...

Solution Summary

The solution discusses crowding out of private domestic investment because of federal deficits.

See Also This Related BrainMass Solution

U.S. interest rates affect Canadian investment

Please answer the attached questions.

1.How would a fall in U.S. interest rates affect Canadian investment, saving, net foreign investment, and the Canadian real exchange rate?

2.The federal government has made significant efforts to turn the federal deficit into a surplus over the last few years. Explain how this is likely to impact on domestic investment, private saving, the trade balance, and net foreign investment for Canada.

3.If Canada becomes an attractive place for foreign investors, predict the impact of increased foreign investment on Canadian net foreign investment, Canadian private saving and investment, and the long run impact on the Canadian capital stock.

4.The Canadian government has developed several programs to encourage saving in Canada. Why would economists support such programs? In your answer, explain the impact of higher saving on productivity, living standards, the value of the dollar, and net exports.

5.Explain how an increase in world interest rates will affect the Canadian interest rate and net foreign investment. How does the elasticity of national saving with respect to the world interest rate affect your answer.

6.Suppose that Parliament passes an investment tax credit, which subsidizes domestic investment. How does this policy affect saving, domestic investment, net foreign investment, the exchange rate, and the trade balance?

7.What is the theory of liquidity preference? How does it help explain the downward slope of the aggregate- demand curve?

8.Use the theory of liquidity preference to explain how a decrease in the money supply affects the aggregate- demand curve. Consider the effects in both a closed economy and a small open economy.

9.Suppose that survey measures of consumer confidence indicate that a wave of pessimism is sweeping the country.
a. If policy-makers do nothing, what will happen to aggregate demand?
b. What should the Bank of Canada do if it wants to stabilize aggregate demand?
c. If the Bank of Canada does nothing, what might Parliament do to stabilize aggregate demand?

10. Suppose that economists observe that in a closed economy an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion.
a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?
b. Now suppose that the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?

11. Suppose that the government of a closed economy reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is 3/4.
a. What is the initial effect of the tax reduction on aggregate demand?
b. What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand?
c. How does the total effect of this $20 billion tax cut compare with the total effect of a $20 billion increase in government purchases? Why?

12. Suppose that the world interest rate rises. What happens to the position of the aggregate-demand curve in Canada? Assume that the Bank of Canada allows the exchange rate to be flexible. How does your answer change if you assume that the Bank of Canada maintains a fixed exchange rate? Illustrate your answer with diagrams.

13. Suppose that the Bank of Canada decides to expand the money supply.
a. Why would it be counterproductive for the Bank of Canada to fix the value of the exchange rate?
b. What is the effect of this policy on the interest rate in the long run? How do you know?
c. What characteristic of the economy makes the short- run effect of monetary policy on the interest rate different from the long-run effect?

View Full Posting Details