3a Define and explain the crowdingout and crowdingin effects

3.a) Define and explain the crowding-out and crowding-in effects. Hints: See the Week 6 edition of the TANSTAAFL TRIBUNE and pages 524- 528 of Chapter 16 in the course text. b) How do budget surpluses and budget deficits affect the consumption and investment components of GDP? OType here to search CD 2 3 4

Solution

1) Crowding Out Effect : Crowding out is a situation which occurs from government deficit spending or when expenditure is higher than income . In such a case the government spends more than it has, forcing it to borrow the rest to cover the shortfall . Deficit in the economy have a tendency to increase interest rates which ultimately reduces corporate investments because private investment becomes costlier due to high interest rate . The government, in an attempt to raise more funds, will issue government bonds which will attract most savers away from private bonds . This situation results in the crowding out effect where the private institutions suffer a reduction in their access to the economy’s savings .

Crowding In Effect : Crowding in also happens due to government deficit spending but relies mostly on how much the government puts in to increase economic activity . An increase in economic activity creates an opportunity for businesses to increase their operations towards profitability . Thus the private sector crowds in to satisfy increasing consumer needs . Deficit spending causes increase in money supply which provides an impetus to economic growth and rise in aggregate demand , this crowds in private sector .