Crowding out occurs when increased government spending leads to higher interest rates, which reduces investment spending by businesses and households. This in turn decreases the multiplier effect, meaning that an increase in government spending raises income by less than it otherwise would.

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Crowding Out

Question 54

Multiple Choice

Crowding out:

A) increases the multiplier effect, so that an increase in government spending raises income by more.
B) increases the multiplier effect, so that an increase in government spending raises income by less.
C) decreases the multiplier effect, so that an increase in government spending raises income by more.
D) decreases the multiplier effect, so that an increase in government spending raises income by less.

Correct Answer: