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By the end of this section, you will be able to:

  • Explain crowding out and its effect on physical capital investment
  • Explain the relationship between budget deficits and interest rates
  • Identify why economic growth is tied to investments in physical capital, human capital, and technology

The underpinnings of economic growth are investments in physical capital, human capital, and technology, all set in an economic environment where firms and individuals can react to the incentives provided by well-functioning markets and flexible prices. Government borrowing can reduce the financial capital available for private firms to invest in physical capital. But government spending can also encourage certain elements of long-term growth, such as spending on roads or water systems, on education, or on research and development that creates new technology.

Crowding out physical capital investment

A larger budget deficit will increase demand for financial capital. If private saving and the trade balance remain the same, then less financial capital will be available for private investment in physical capital    . When government borrowing soaks up available financial capital and leaves less for private investment in physical capital, the result is known as crowding out    .

To understand the potential impact of crowding out, consider the situation of the U.S. economy before the exceptional circumstances of the recession that started in late 2007. In 2005, for example, the budget deficit was roughly 4% of GDP. Private investment by firms in the U.S. economy has hovered in the range of 14% to 18% of GDP in recent decades. However, in any given year, roughly half of U.S. investment in physical capital just replaces machinery and equipment that has worn out or become technologically obsolete. Only about half represents an increase in the total quantity of physical capital in the economy. So investment in new physical capital in any year is about 7% to 9% of GDP. In this situation, even U.S. budget deficits in the range of 4% of GDP can potentially crowd out a substantial share of new investment spending. Conversely, a smaller budget deficit (or an increased budget surplus) increases the pool of financial capital available for private investment.

Visit this website to view the “U.S. Debt Clock.”

The patterns of U.S. budget deficits and private investment since 1980 are shown in [link] . If greater government deficits lead to less private investment in physical capital, and reduced government deficits or budget surpluses lead to more investment in physical capital, these two lines should move up and down at the same time. This pattern occurred in the late 1990s and early 2000s. The U.S. federal budget went from a deficit of 2.2% of GDP in 1995 to a budget surplus of 2.4% of GDP in 2000—a swing of 4.6% of GDP. From 1995 to 2000, private investment in physical capital rose from 15% to 18% of GDP—a rise of 3% of GDP. Then, when the U.S. government again started running budget deficits in the early 2000s, less financial capital became available for private investment, and the rate of private investment fell back to about 15% of GDP by 2003.

Questions & Answers

the is the situation in which the need of individuals exceed the available resource. increase in population rate and wrong decision making
esther Reply
what is the different between wants and demand?
importance of economic
Zakaria Reply
satisfaction of human wants
economics is about to economise . discuss
Angel Reply
Underlines the efficiency aspect. Economise towards what: Economise factors to reach equal distribution of Material wealth or Just to operate optimally to Service demand, i. e. Run markets efficiently?
join the conversation
abba Reply
what is terms of trade
Ibrahim Reply
different btn import and export
No question... This is nice
Gbenga Reply
hw can we solve problem of scarcity
scarcity is not necessarily a problem but a constant condition of the world. there are not enough resources to satisfy the unlimited wants.
wee need to be cooperative
by unlimited resourses and abundant want
why do compute GDP?
steven Reply
can anyone shortly determine the word inflation.
Ibrahim Reply
Continous increase in the general level of prices or in the cost of living.
persistent increased in general price level
all correct...
the father of economics
Reuben Reply
Adem smith
Adem smith
Adem smith sure
the father of economic regarding to adam Smith
the father of political of economic and capitalism in his book and inquary in to the wealth of the nation.
Adam Smith his the father of economic
difference between injection and leakage
what is monopoly
Monopoly is a market structure where there is one firm who dominate the industry
hi,, I am new here. please welcome me.
you are welcome
monopoly is the one characterized by a mkt power in which a firm is a price maker
Some member just ask questions but not answering so y this happen
Monopoly is a market where only one seller exists. No competition
how long does the patent right prevail the monopoly
no attempt
what is state farming
anybody to attempt
different types of price elasticity of demand with the aid of graphs
Tshepo Reply
what about mean median and mode
Dike Reply
mode is the most occurred number and median is the middle digit
the mean is the sum of all the data divided by the number eg: 2+4+4+5+3+5+1 =24÷7
what is exchange rate
thanks guys
What is Equilibrium?
that when supply equals demand. that's where the supply curve and the demand curve intercept.
equilibrium is when the both side of the price is balanced
Thanks Asuquo Agwuu
what is paradox Of drift
doris Reply
it's thrift not drift
so what is it sir
what are the causes of unemployment
Afful Reply
lack of job in the rural areas
High level of illiteracy
Unfulfilled government promises
this one no be problem waii
low rate of industrialisation
elements of economic
Muhammad Reply
Supply demand consumer and money.
please would you explain further about short run and long run
Doris Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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