Suppose that the investment demand curve in a certain economy is such that inves

Question

Suppose that the investment demand curve in a certain economy is such that investment declines by $110 billion for every 1 percentage point increase in the real interest rate. Also, suppose that the investment demand curve shifts rightward by $170 billion at each real interest rate for every 1 percentage point increase in the expected rate of return from investment. If stimulus spending (an expansionary fiscal policy) by government increases the real interest rate by 2 percentage points, but also raises the expected rate of return on investment by 1 percentage point, how much investment, if any, will be crowded out?

Explanation / Answer

The slope of the investment curve = - 1/110.

When it shifts to the rightward by 170, it has still the same slope.

If real interest rate increases by 2%, there will be a crowding out of 110x2= - 220

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