ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The crowding out effect is based on the supply of and demand for money. According to the theory, as the government takes revenue-raising actions, such as increasing taxes or debt security sales, the consumer and business demand for resulting higher interest rate loans decreases.

Detailed explanation-2: -The crowding-out effect is a theory that argues increased government spending reduces private spending in the economy. To spend more, governments have to either hike taxes or borrow, typically by selling bonds.

Detailed explanation-3: -An increase in government purchases (as in the case above) raises incomes, which shifts the demand for money to the right. This raises the interest rate, which lowers investment. Thus, an increase in government purchases increases the interest rate and reduces, or crowds out, private investment.

Detailed explanation-4: -The crowding-out effect refers to the decrease in private investment spending which may accompany an expansionary fiscal policy financed by government borrowing from the public. An expansionary fiscal policy may generate increased spending by government and consumers but reduced spending by investors.

Detailed explanation-5: -The government spending is “crowding out” investment because it is demanding more loanable funds and thus causing increased interest rates and therefore reducing investment spending. This basic analysis has been broadened to multiple channels that might leave total output little changed or even smaller.