1. CROWDING-OUT EFFECT Definition Graphical Illustration
Partial Crowding out
Full Crowding out
Factors that Affect the Crowding-out
Summary

2. Definition
The increase in government expenditure will lead to the fall of private expenditure, thus resulting in a smaller multiplier effect on the equilibrium level of income.
Underlying assumption:
G
r
I
Y 

3. Multiplier Effect

4. Shifting of IS Curve r Y
IS2
IS1
Distance AB = Y A B Y1 Y2

5. Crowding-out Effect Increase in G
 IS curve shifts to the right by the horizontal distance (Gmultiplier)
 if LM curve is upward sloping, then the rise in interest rate will lead to the fall of I
 the fall of I will lead to the decrease in Y
 eventual  in Y is less than (Gmultiplier)

6. Diagram r Y IS1 IS2 LM G  Y1 to Y2 No Crowding-out C r1 Y3 Y1 Y2 A Br Y
IS1
IS2 LM
G  Y1 to Y2
No Crowding-out C r1 Y3
Y Y2 A B
I  Y2 to Y3
Crowding-out

7. Slope of LM and Crowding-out

8. Steeper LM & Crowding-out (1)r Y
LM1 E A B Y1 Y2
IS2 K H
IS1 Y3

9. Steeper LM & Crowding-out (2)r Y
LM1
LM2 F A B Y1 Y2
IS2 K H
IS1 Y3

10. Steeper LM & Crowding-out (3)r Y
LM1
LM2 G A B
LM3 Y1 Y2 K
IS2
IS1
=Y3

11. Slope of LM and Crowding-out
LESS ELASTIC
MORE ELASTIC
MORE ELASTIC
LESS ELASTIC

12. Slope of IS and Crowding-out

13. Diagram r Y
LM1
IS2
IS1 C
Crowding-out effect Y3 A Y1 r1 Y2 B
Y2 to Y3

14. Diagram r Y
LM1
IS2
IS1
Crowding-out effect C A Y3 Y1 r1 Y2 B
Y2 to Y3

15. Comparison r Y
IS1
LM1 Y1 r1
IS2 A Y2 B C Y3

16. Slope of IS and Crowding-out
More Elastic
Less Elastic
Smaller
Larger

17. Diagram r Y
IS1”
LM1
IS1
IS2”
IS2 C B A r1 Y1
larger MPS
smaller MPS

18. Summary The crowding-out effect depends on
the slopes of IS & LM curves
The steeper the LM curve, the larger the crowding-out effect
The flatter the LM curve, the smaller the crowding-out effect
The existence of crowding-out effect will affect the effectiveness of fiscal policy