Question

Which of the situations is an example of the crowding-out effect on investment as it pertains to macroeconomics?

The government of Walla Walla spent $4.3 billion dollars and collected $2.2 billion dollars in tax revenue.

Candex, an eyeglass frame company, decides to cut the price on all of its frames to $10, which successfully drives out all other firms from the market.

The government deficit is at an all-time high in the United States. As such, people begin to save more money in fear that taxes will increase in the future.

Jack wants to borrow money to create a cowboy-themed inflatable bounce house for kids called "Wild Wild West." However, the government is running a deficit which has increased interest rates so much that Jack can no longer afford to borrow the money.

Answer 1

Jack wants to borrow money to create a cowboy-themed inflatable bounce house for kids called "Wild Wild West." However, the government is running a deficit which has increased interest rates so much that Jack can no longer afford to borrow the money.

Step-by-step explanation:

Crowding-out is when government borrowing results in higher interest rates and less capital available for private investment.

For example, if the government runs a deficit, it must enter the market for loanable funds as a borrow (demander). Holding all else equal, the increase in demand will result in higher interest rates. Due to the interest rate increase, Jack can no longer afford to borrow the startup money needed to create his bounce house business. The government has crowded Jack out of the market by increasing the demand for loanable funds.

Walla Walla is running a budget deficit, which can lead to crowding out, but there is no evidence that investment has been crowded out. Government deficits may lead to increased taxation to bridge the deficit, and people saving more as a result is an example of Ricardian equivalence. Candex is engaging in predatory pricing.