Crowding out


  • GDP* = potential GDP
  • LAS = Long-term Aggregate Supply
  • AD = Aggregate Demand



Classical theory - 1930s

According to the Classical school of thought, ( financial policy is only a redistribution of resources ).

  • Flexible prices.
  • Supply is given.
  • Unemployment is voluntary.
  • Government demand increase (G) displaces private demand (I).

  • The economy is determined by the supply-side ( utbudsbestämdSwedish ) which means that fiscal- and monetary policies are pointless in order to influence GDP.



Crowding out

IS-LM diagram: Shift


  1. G↑ => AD-shift = GDP↑

  2. As GDP increases => Demand for money increases => Interest rate↑ => I↓ => AD-shift


Conclusion

G↑ corresponds by decreased investments I↓ => ΔGDP = ±0



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