Investment is "crowded out" by an increase in government spending when
A) an increase in government spending causes output and prices to rise, which in turn causes interest rates to rise.
B) an increase in government spending causes output and prices to fall, which in turn causes interest rates to rise.
C) an increase in government spending causes output and prices to rise, which in turn causes interest rates to fall.
D) an increase in government spending causes output and prices to fall, which in turn causes interest rates to fall.

Question

Quizplus · Accepted Answer

When government spending increases, it puts upward pressure on output and prices. This can lead to inflation and higher interest rates as lenders demand higher returns to compensate for the increased risk of inflation. As a result, investment may be "crowded out" as borrowers opt for government securities over private investment opportunities. Choice A is the best answer as it correctly identifies the relationship between government spending, output, prices, and interest rates, which can lead to crowding out of private investment.

Investment Is "Crowded Out" by an Increase in Government Spending