AP Macroeconomics 5.5: Crowding Out

Use the loanable-funds model to explain how government borrowing raises real interest rates and reduces private investment and long-run growth.

[Maximum number: 3]

Assume the economy of Vanderlandia is in short-run equilibrium with a real GDP of $500 million. The full-employment level of real GDP is $550 million.

(a)

Draw a correctly labeled graph of the loanable funds market, and show the effect of the change in government spending in part (c)(i) on the equilibrium real interest rate.

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(b)

Based on the change in the real interest rate shown on your graph in part (d), what will happen to each of the following?

[ 1 ]

(i)

The rate of economic growth in the long run. Explain.

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5.5 Crowding Out question 1

Question (a)

Question (b)

Question (i)