AP Macroeconomics Flashcards: Crowding Out
Written by AP Content Team, Verified for 2026 AP Exams, Last updated: May 2026
Review key ideas with interactive flashcards. This set includes 11 cards to help you master important concepts.
Which economic model is used to illustrate the crowding out effect?
A loanable funds market model is used to show the effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment.
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Which economic model is used to illustrate the crowding out effect?
A loanable funds market model is used to show the effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment.
Trace the long-run negative impact of a persistent government budget deficit, starting with the loanable funds market.
A persistent deficit leads to continuous government borrowing, keeping real interest rates high. This crowds out private investment, leading to a lower rate of physical capital accumulation and therefore less economic growth over the long run.
Define crowding out.
Crowding out is the adverse effect of increased government borrowing, which leads to decreased levels of interest-sensitive private sector spending in the short run.
Explain the mechanism by which fiscal policy can cause crowding out.
Fiscal policy that increases the budget deficit requires more government borrowing. This borrowing increases the real interest rate, which in turn reduces interest-sensitive private spending.
What government action typically initiates the crowding out effect?
When a government runs a budget deficit, it typically borrows to finance its spending, which can lead to crowding out.
What is a potential long-run impact of crowding out on physical capital accumulation?
A potential long-run impact of crowding out is a lower rate of physical capital accumulation because higher interest rates discourage private investment.
If a government implements expansionary fiscal policy financed by borrowing, what is the likely impact on private investment?
The government borrowing will increase the real interest rate, which will cause a decrease in interest-sensitive private investment, an effect known as crowding out.
How does increased government borrowing affect the real interest rate in the loanable funds market?
Increased government borrowing to finance a deficit increases the demand for loanable funds, which raises the equilibrium real interest rate.
How does crowding out affect long-run economic growth?
By causing a lower rate of physical capital accumulation, crowding out can lead to less economic growth in the long run.
What is the primary short-run consequence of crowding out?
The primary short-run consequence is a decrease in levels of interest-sensitive private sector spending, such as business investment and consumer spending on durable goods.
A government significantly increases its spending to build new infrastructure, financing it entirely through borrowing. What is the adverse effect this policy might have on private sector firms?
The increased government borrowing will raise the real interest rate, making it more expensive for private firms to borrow for their own investment projects, thus crowding them out of the market.