Economics • Economic BasicsMedium
Which of the following describes 'Crowding Out Effect' in macroeconomic theory?
A. A situation where government borrowing leads to a reduction in private sector investment due to higher interest rates.✓ Correct Answer
B. An increase in private consumption caused by expansionary fiscal policy.
C. The reduction of public expenditure resulting from excessive foreign direct investment.
D. A phenomenon where high inflation eliminates low-income earners from the housing market.
💡 Solution & Explanation
The crowding out effect occurs when heavy government borrowing drives up prevailing interest rates, which subsequently discourages or reduces private sector investment expenditure. Expansionary fiscal policies that cause inflation or reduce foreign direct investment do not represent this specific monetary phenomenon. This concept illustrates the limits of government deficit financing in mixed economies.
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