Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

L
kY hi
), the value of k is higher; there will be 
greater increase in rate of interest due to greater increase in 
demand for money. As a result, there will be greater fall in 
the private investment and the crowding out is higher. 
The degree to which crowding out take place can also be explained 
with the help of LM curve. 
Crowding effect is lower if the LM curve is flatter. 
Crowding effect is higher if the LM curve is steeper. 
A vertical LM curve (Classical proposition that demand for 
money is totally insensitive to rate of interest) means that 
there is complete crowding out of private investment. 
A horizontal LM curve (Liquidity Trap position where demand 
for money is perfectly elastic to interest) means that there is 
no crowding out effect. 
In the case of vertical LM curve, interest rate rises to such a 
level that private investment is crowded out exactly by the amount 
of addition government spending. 
In the case of horizontal curve, interest rate does not change and 
no private sector investment is cut off. Therefore, there is no 
crowding out. This is explained in the diagram. 

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FIGURE 8.11: EFFECTS OF AN INCREASE IN GOVERNMENT 
EXPENDITURE 
 
LM represents the vertical LM curve. There is no increase in 
income, interest rate rises to i
2
and crowding out is complete. LM
represents the horizontal LM curve. Income increases from Y to Y
(according to Keynesian multiplier) and there is no crowding out 
effect. If the LM curve is sloping upward as shown as dotted LM 
crowding out is partial. The new equilibrium is E
1
and income and 
interest rate are higher. 
 
8.3.4 Monetary Accommodation and Policy Mix: 
 
Crowding out can be avoided by an increase in money 
supply as to prevent the interest rate from rising. The monetary 
policy is accommodating when in the course of a fiscal expansion, 
money supply is increased in order to prevent the interest rates 
from rising. Hence private investment will not decline. This is shown 
in the following diagram.