Crowding Out Effect
Definition
The crowding out effect refers to the phenomenon where increased government spending leads to a decrease in private investment due to higher interest rates and reduced availability of loanable funds.
Analogy
Imagine you're at a popular concert and there are limited seats available. As more people arrive, the venue becomes crowded, making it harder for new people to find seats. Similarly, when the government increases its spending, it competes with private investors for loanable funds, causing interest rates to rise and making it more difficult for businesses to borrow money.
Related terms
Loanable Funds Market: The loanable funds market is where borrowers (such as businesses) seek funds from lenders (such as households or financial institutions) through loans or investments.
Interest Rates: Interest rates represent the cost of borrowing money or the return on lending money. They are determined by supply and demand in the loanable funds market.
Government Spending: Government spending refers to expenditures made by the government on goods, services, infrastructure projects, or transfer payments such as welfare programs.
"Crowding Out Effect" appears in:
Additional resources (2)
Practice Questions (1)
- What is crowding out effect in the context of government borrowing?
Resources
© 2024 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.