The crowding-out effect arises from government demand for funds that raises which price?

• A. Interest rate
• B. Wage rate
• C. Exchange rate
• D. Price level

Answer: (A)

The main idea is that increased government borrowing raises the cost of funds in the loanable funds market. When the government needs more money, it competes with private borrowers for savings, pushing up the interest rate. Higher interest rates make borrowing for private investment more expensive, which tends to reduce private investment—the essence of the crowding-out effect. So the price that rises is the interest rate.

Wage rates are set in the labor market, not by the government's demand for loanable funds. The exchange rate can be influenced by many factors beyond this simple borrowing dynamic. The overall price level would rise only if deficits translate into inflation, which is a different mechanism from the direct crowding-out effect in the loanable funds framework.