Download Intro to Crowding Out

Intro to Crowding Out
AP Macroeconomics
Guiding Questions…
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What are the sources of economic growth?
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How do monetary and fiscal policies
encourage economic growth?
Where did we come from?
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In a previous lesson, we will discussed the
lags associated with policy-making.
We talked about the inside lag and the
outside lag. Which type of policy is
associated with each of these lags (that is,
monetary or fiscal policy?)
Where are we going?
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In this lesson, we will discuss Crowdingout, or the decrease in private demand
for funds that occurs when the
government’s demand for funds causes
the interest rate to rise.
That is, the demand by government for
loanable funds decreases or crowds-out
the private demand for loanable funds.
What is a loanable funds market?

According to Krugman, this market “brings
together those who want to lend money
(savers) and those who want to borrow (firms
with investment spending projects)…[and the]
price that is determined in the loanable funds
market is the interest rate…” (277)
Government Demand for Funds Increases
the Demand for Money
As the interest rate rises, so too
does the demand for money, and
vice versa. Investment decreases.
As we know, a decrease in
investment causes aggregate
demand (real GDP) to decrease,
as well. If the interest rate
decreases, the opposite will
happen.
Unit 5 Visual 5.1 Macroeconomics
Council for Economic Education
Analyze this…
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So let’s say the government
implements expansionary
fiscal policy. In turn, this
increases aggregate demand
(AD1). When aggregate
demand increases, so too
does money demand (MD1).
This causes the interest rate to
rise (which discourages
investment) and AD to
decrease because private
businesses reduce investment.
This is crowding-out!
Let’s also say that, to this
point, monetary policy has
not changed (MS). Could
monetary authorities do
anything to prevent the
reduction in investment?
MD1
MD
AD1
AD AD2
MS MS1
So…what is crowding out?


The effect on private investment when the
government implements certain fiscal
policy. When the government implements
expansionary fiscal policy, this increases the
demand for money which increases the
interest rate causing private businesses to
reduce investment.
SIGH!
And now…

Some resources:
Reffonomics:
http://www.reffonomics.com/
Morton workbook: Activity 44 Part A
Works Cited
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Economics of Seinfeld.
http://yadayadayadaecon.com/
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.