Question

How would you expect larger budget deficits to affect private sector investment in physical capital? Why?

a) Increase investment due to higher government spending
b) Decrease investment due to higher interest rates
c) Have no impact on investment
d) Lead to inflation and reduced investment

Answer 1

Larger budget deficits are expected to decrease private sector investment in physical capital due to higher interest rates. which drives up interest rates. Higher interest rates make it more costly for businesses to borrow money for investment, leading to a decrease in private sector investment in physical capital.

Step-by-step explanation:

Larger budget deficits are expected to decrease private sector investment in physical capital due to higher interest rates. When the government has larger budget deficits, it typically needs to borrow more money to finance its expenditures.

This increases the demand for financial capital in the market, which drives up interest rates. Higher interest rates make it more costly for businesses to borrow money for investment, leading to a decrease in private sector investment in physical capital.