Which of the following best explains the crowding-out effect?
A) the decrease in the supply of loanable funds that results from an increase in budget deficits
B) an increase in consumption amongst households that crowds out savings
C) the decrease in investment opportunities for small businesses resulting from increased borrowing by larger corporations
D) the decrease in investment from higher interest rates that results from increased government borrowing to finance larger budget deficits

Question

Quizplus · Accepted Answer

The crowding-out effect refers to the decrease in investment due to higher interest rates resulting from increased government borrowing to finance larger budget deficits. This is because as the government borrows more, the supply of loanable funds decreases and interest rates increase, making it more expensive for private firms to borrow and invest. This can lead to a reduction in private investment, offsetting the initial increase in government spending.

Which of the Following Best Explains the Crowding-Out Effect