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A-Level Economics · Loanable funds (crowding out) diagram question

EVALUATION: when does government spending CROWD IN private investment instead?

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The answer

In a demand recession with high spare capacity — public spending lifts demand, infrastructure and expected returns, so private investment rises rather than falls. Boost demand and the roads firms operate on, and their expected return on investment goes UP. Private I rises rather than falls. The Keynesian counter: in a demand recession, public spending raises private-sector profitability and expectations. Infrastructure in particular complements private activity — lower logistics costs, new commercial opportunities — and firms find demand for their goods has risen, so the expected return on investment improves. Private I rises. Weak evaluation says 'it depends'; strong evaluation says WHAT it depends on and resolves it — here the hinge is spare capacity.

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This is one of 6 questions on the loanable funds (crowding out) diagram — every corner lettered, every wrong answer diagnosed.

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