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Chp. 16 - Chp 16 The Influences of Monetary and Fiscal...

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Chp. 16 - The Influences of Monetary and Fiscal Policy on Aggregate Demand The multiplier effect states that an additional dollar of government spending increases aggregate demand by more than a dollar. o The increased government spending provides households with additional income, of which they spend a portion. o The second round of spending adds to aggregate demand. EX. according to the multiplier effect, the $100 billion of government spending increases aggregate demand by more than $100 billion. The crowding-out effect states that an additional dollar of government spending raises interest rates, which causes a reduction in investment, thereby offsetting some of the expansionary effect of the government spending. o Ex. According to the crowding-out effect, $100 billion of government spending increases aggregate demand by less than $100 billion. The ultimate impact of an additional $100 billion of government spending depends upon the relative strength of the multiplier and crowding-out effects.
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