The contraction of private investment spending due to deficit spending

The contraction of private investment spending due to deficit spending by the Government is called

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crowding out

crowding in

pump priming

dumping

Answer is Right!

Answer is Wrong!

This question was previously asked in

UPSC CDS-1 – 2023

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The correct answer is A) crowding out. Crowding out is an economic phenomenon where increased government spending, financed through borrowing, leads to a decrease in private sector investment. This happens because increased government demand for loanable funds pushes up interest rates, making it more expensive for private businesses to borrow money for investment projects.

– Deficit spending by the government means the government is spending more than it collects in revenue, requiring it to borrow money.
– Increased government borrowing increases the demand for funds in the financial markets.
– Increased demand for funds, with a given supply, leads to higher interest rates.
– Higher interest rates increase the cost of borrowing for private firms and individuals.
– This higher cost discourages private investment spending (e.g., on new factories, equipment, or housing), hence ‘crowding out’ private investment.

Crowding in is the opposite effect, where government spending stimulates private investment. Pump priming refers to government spending to stimulate a depressed economy. Dumping is an international trade practice.

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