Explain the concept of crowding out in the context of government intervention.

Explain the concept of crowding out in the context of government intervention.

Crowding out refers to the phenomenon where increased government spending or borrowing leads to a decrease in private sector spending or investment. When the government increases its spending or borrows more money, it competes with the private sector for available funds in the financial market. This increased demand for funds leads to higher interest rates, making it more expensive for businesses and individuals to borrow money for investment or consumption purposes. As a result, private sector spending and investment decrease, leading to a reduction in economic growth and potential output. Therefore, crowding out occurs when government intervention in the economy displaces or reduces private sector activity.