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Indian EconomyEasyAsked in: UPSC Civil Services · CSE Prelims 2026, GS Paper I

Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy?

  1. A.A situation where private investment increases due to increased Government spending
  2. B.A situation where Government borrowing leads to higher interest rates, which reduces private investment
  3. C.A situation where an increase in taxes leads to increased private sector investment
  4. D.A situation where Government spending has no impact on aggregate demand

Correct answer

B. A situation where Government borrowing leads to higher interest rates, which reduces private investment

Explanation

The correct answer is B, A situation where Government borrowing leads to higher interest rates, which reduces private investment. When a government runs a large fiscal deficit, it borrows heavily from the same pool of savings that businesses draw on. This extra demand for loanable funds pushes up interest rates, and costlier credit makes firms postpone or drop investment projects. Government spending thus 'crowds out' private spending, and part of the boost from the fiscal stimulus is lost. The effect is strongest when the economy is near full employment and savings are scarce; in a deep slump, with idle savings, it is weaker. This is one reason for fiscal discipline laws such as India's FRBM Act, 2003. Option A is wrong because a rise in private investment caused by government spending is the opposite effect, called crowding in. Option C is wrong because higher taxes reduce disposable income and usually do not raise private investment. Option D is wrong because government spending is itself a part of aggregate demand. Exam tip: crowding out = deficit, more borrowing, higher interest rates, less private investment; crowding in is the reverse.

Practice Questions

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Q1.Indian EconomyAsked in: NDA · NDA-II 2022, GATEasy

Consider the following statements about 'Ude Desh ka Aam Nagrik (UDAN)' scheme :

1. It is an innovative scheme to develop the regional aviation market.

2. It creates affordability yet economically viable and profitable flight on regional routes.

Which of the statements given above is/are correct?

  1. A.1 only
  2. B.2 only
  3. C.Both 1 and 2
  4. D.Neither 1 nor 2
Show answer
Correct answer: C. Both 1 and 2

UDAN is the regional connectivity scheme meant to grow regional air travel and make it affordable while keeping the routes viable for airlines.

Q2.Indian EconomyAsked in: NDA · NDA-II 2026, GATMedium

Which one of the following Five-Year Plan documents was titled as "Towards Faster and More Inclusive Growth"?

  1. A.Eighth Plan
  2. B.Ninth Plan
  3. C.Tenth Plan
  4. D.Eleventh Plan
Show answer
Correct answer: D. Eleventh Plan

The Eleventh Five-Year Plan (2007–2012) carried the title "Towards Faster and More Inclusive Growth". The Eleventh Plan was prepared by the Planning Commission under Prime Minister Manmohan Singh, with Montek Singh Ahluwalia as Deputy Chairman.

Q3.Indian EconomyAsked in: CDS · CDS-II 2018, GKHard

The Fourteenth Finance Commission assigned different weights to the following parameters for distribution of tax proceeds to the States :

1. Income distance

2. Population

3. Demographic changes

4. Area

Arrange the aforesaid parameters in descending order in terms of their weights.

  1. A.1-2-3-4
  2. B.1-2-4-3
  3. C.1-3-2-4
  4. D.4-3-2-1
Show answer
Correct answer: B. 1-2-4-3

Income distance had the highest weight, followed by population, area and demographic change. The Fourteenth Finance Commission, chaired by Y.V.

Q4.Indian EconomyAsked in: CDS · CDS-II 2024, GKHard

Which one of the following statements for a firm's equilibrium in Perfect Competition is not correct ?

  1. A.The market price must be greater or equal to average variable cost in the short run.
  2. B.The market price must be equal to marginal cost.
  3. C.The market price must be equal to average cost in the long run.
  4. D.The marginal cost decreases at the equilibrium output.
Show answer
Correct answer: D. The marginal cost decreases at the equilibrium output.

This statement is not correct, because at the equilibrium of a competitive firm marginal cost must be rising. A firm in perfect competition is a price taker, so the price it gets equals its marginal revenue.