Given below are two statements : one is labelled as Assertion (A) and the other is labelled as Reason (R). Assertion (A) : Deficit spending by the government leads to crowding out effect on private investment. Reason (R) : When the government finances its deficit by borrowing from the market, the bond prices go up and the rate of interest falls. In the light of the above statements, choose the most appropriate answer from the options given below :
Analysis of Assertion (A): Deficit Spending and Crowding Out
Assertion (A) states that deficit spending by the government leads to a crowding out effect on private investment. This is a standard concept in macroeconomics. When a government spends more than its revenue, it often borrows money from the financial markets. This increased government borrowing competes with private sector borrowing, potentially driving up interest rates. Higher interest rates make it more expensive for businesses to borrow funds for investment, thus "crowding out" private investment.
Therefore, Assertion (A) is considered correct.
Analysis of Reason (R): Government Borrowing and Interest Rates
Reason (R) states that when the government finances its deficit by borrowing, bond prices rise, and the rate of interest falls. This is contrary to standard economic theory.
- Increased government borrowing means a higher supply of government bonds.
- To sell these additional bonds, the government must offer them at a lower price or a higher interest rate.
- Bond prices and interest rates have an inverse relationship: as bond prices fall, interest rates rise.
- Therefore, increased government borrowing typically leads to lower bond prices and higher interest rates, not the other way around.
Reason (R) is incorrect because it misstates the relationship between government borrowing, bond prices, and interest rates.
Conclusion
Since Assertion (A) is correct and Reason (R) is incorrect, the most appropriate answer is that (A) is correct but (R) is not correct.
This aligns with Option 3.
Important Questions from Macroeconomics
- Real-factor demand-pull inflection can be caused by:
A. Increase in investment
B. Decrease in consumer demand
C. Decrease in imports given the exports
D. Decrease in exports given the imports
E. Decrease in government expenditure without change in tax revenue.
Choose the correct answer from the options given below : Match List-I with List-II:
List-I (Concepts) List-II (Given by) A. Paradox of thrift I. K. Boulding B. Water-Diamond paradox II. A.C. Pigou C. Wage employment paradox III. J.M. Keynes D. Macroeconomic paradox IV. Adam Smith
Choose the correct answer from the options given below:- Which of the followings are the effects of increase in government spending in IS-LM framework in a closed economy?
A. Increase in income by multiplier times government expenditure.
B. Shift in IS curve to the right leading to disequilibrium in money market at given level of interest rate.
C. Quantity of money demand will be higher.
D. Interest rate will decrease.
Ε. Private investment will increase leading to increase in aggregate demand.
Choose the correct answer from the options given below : - If the marginal propensity to consume is 0.8 and initial increase in tax revenues by the government is Rs. 100, then the impact on national income would be:
- Which of the followings are true about New Classical approach.
A. The main protagonist was R.E. Lucas Jr.
B. It is based on adaptive expectation.
C. It was developed during 1950s.
D. Complete wage and price flexibility.
Ε. Difference between actual and expected price is a random error.
Choose the most appropriate answer from the options given below :
