Question

Crowding out occurs when A. increases in taxes cause interest rates to​ rise, reducing investment and consumption. B. increases in investment and consumption cause interest rates to​ rise, reducing the ability of the government to borrow funds. C. decreases in government spending cause interest rates to​ rise, reducing investment and consumption. D. increases in government spending cause interest rates to​ fall, reducing investment and consumption. E. increases in government spending cause interest rates to​ rise, reducing investment and consumption.

Answer 1

Answer:

The correct answer is option E.

Explanation:

Crowding out effect refers to the situation when an increase in the government spending causes investment spending to decline. When government increases spending it borrows fund. This causes an increase in the demand for loanable funds. As a result, the interest rate increases.

This increase in interest rate causes private investment to decline. this further causes a reduction in consumption.