5. Which effect does increased government spending have on aggregate demand for goods and services if the multiplier effect is greater than the crowding out effect?
Answer: A
Aggregate demand increases by more than the increase in government spending.
When the multiplier effect exceeds the crowding out effect, increased government spending leads to a rise in aggregate demand that is greater than the initial increase in spending itself. This occurs because the additional income generated from government spending circulates through the economy, prompting further consumption and investment.
A) Aggregate demand increases by more than the increase in government spending.
This option accurately reflects the relationship between government spending and aggregate demand when the multiplier effect dominates. Increased government expenditure stimulates economic activity, leading to heightened consumer spending and business investments, thereby amplifying the overall demand in the economy.
B) Aggregate demand decreases by more than the increase in government spending.
This option is incorrect as it suggests a reduction in aggregate demand resulting from government spending, which contradicts the premise of the multiplier effect. In a scenario where the multiplier effect is greater, increased spending should enhance demand rather than diminish it.
C) Aggregate demand increases by less than the increase in government spending.
This option misrepresents the impact of government spending under the given conditions. If the multiplier effect is indeed greater than the crowding out effect, aggregate demand would not only increase but do so by an amount greater than the initial spending increase.
D) Aggregate demand decreases by less than the increase in government spending.
This choice is also incorrect. It implies that aggregate demand would still decrease, albeit by a smaller margin than the increase in spending, which is not compatible with the scenario where the multiplier effect is greater than crowding out. Instead, demand should increase overall.
Conclusion
The correct answer, A, clearly illustrates that when the multiplier effect exceeds the crowding out effect, government spending results in a more significant increase in aggregate demand than the spending itself. Options B, C, and D fail to recognize the strengthening impact of the multiplier, leading to misconceptions about the relationship between government spending and overall economic demand.