(c) An increase in government expenditure by itself would increase AGGREGATE DEMAND from AD to AD1, but, allowing for the fall in private investment, the net result is to increase aggregate demand to only AD2.
The term ‘crowding-out’ is also used in a broader sense to denote the effect of larger government expenditure in pre-empting national resources, leaving less for private consumption spending, private sector investment and for exports. Such real crowding-out would occur only to the extent that total national resources are fixed and fully employed so that expansion in public sector claims on resources contract the amount left for the private sector. Where unemployed resources can be brought into use, additional claims by both the public and private sectors can be met.
See MONEY-SUPPLY/SPENDING LINKAGES, MARGINAL EFFICIENCY OF CAPITAL/ INVESTMENT.