Question

In the context of budget deficits, what is crowding out?

A) The reduction of government spending to balance the budget.
B) The increase in private sector spending due to decreased government borrowing.
C) The decrease in private sector spending caused by increased government borrowing.
D) The elimination of budget deficits through increased taxation.

Answer 1

Crowding out is the decrease in private sector spending caused by increased government borrowing in the context of budget deficits.

Step-by-step explanation:

Crowding out in the context of budget deficits refers to the decrease in private sector spending caused by increased government borrowing.

When the government runs a larger budget deficit, it increases its demand for financial capital. This reduces the financial capital available for private investment in physical capital, as less is available due to government borrowing. As a result, private sector spending decreases, and this phenomenon is known as crowding out.