Sia
Question
Microeconomics
Posted 9 months ago
The nation of Fantastica engaged in borrowing to finance deficit spending.
Which of the following would be the most likely impact on the long-run aggregate supply (LRAS) curve in Fantastica?
Choose 1 answer:
(A) LRAS decreases (shifts to the left)
(B) LRAS increases (shifts to the right)
(c) LRAS will not change
D LRAS will become vertical
(E) LRAS will become horizontal
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Answer from Sia
Posted 9 months ago
Solution
a
Definition of Long-Run Aggregate Supply (LRAS): The LRAS curve represents the total output an economy can produce when it is fully utilizing its resources. It is typically vertical, indicating that in the long run, output is determined by factors such as technology, resources, and institutions, rather than the price level
b
Impact of Borrowing to Finance Deficit Spending: Borrowing to finance deficit spending can lead to higher interest rates as the government competes with the private sector for available funds. This can crowd out private investment, reducing the capital stock in the long run
c
Effect on LRAS: A reduction in the capital stock due to crowding out can decrease the economy's productive capacity. This would shift the LRAS curve to the left, indicating a decrease in the long-run potential output of the economy
Answer
(A) LRAS decreases (shifts to the left)
Key Concept
Crowding Out Effect
Explanation
Borrowing to finance deficit spending can lead to higher interest rates, which may crowd out private investment. This reduction in investment can decrease the capital stock, leading to a decrease in the economy's productive capacity and shifting the LRAS curve to the left.
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