The Crowding-Out Effect When the government increases its purchases by $20 billion, the aggregate demand for goods and services could rise by more or less than $20 billion, depending on whether the multiplier effect or the crowding-out effect is larger.
The Money Market and the Slope of the Aggregate Demand Curve... Aggregate demand (b) The Aggregate Demand Curve Quantity of Output 0 Price Level (a) The Money Market Quantity of Money Quantity fixed by the Fed 0 r1r1 Money supply Interest Rate Money demand at price level P 1, MD 1 Y1Y1 P1P1 Money demand at price level P 2, MD 2 2. …increases the demand for money… 1. An increase in the price level… P2P2 3. …which increases the equilibrium equilibrium rate… r2r2 4. …which in turn reduces the quantity of goods and services demanded. Y2Y2
The Multiplier Effect... Aggregate demand, AD 1 Quantity of Output 0 Price Level AD 2 1. An increase in government purchases of $20 billion initially increases aggregate demand by $20 billion… $20 billion AD 3 2. …but the multiplier effect can amplify the shift in aggregate demand.