UPSC Prelims 2026 · GS Paper I

Question 94: Economy and Social Development

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

aA situation where private investment increases due to increased Government spending

bA situation where Government borrowing leads to higher interest rates, which reduces private investment

cA situation where an increase in taxes leads to increased private sector investment

dA situation where Government spending has no impact on aggregate demand

AnswerUPSC’s answer is (b).

Crowding out occurs when government borrowing to finance a deficit raises interest rates by competing for the available savings, which makes borrowing costlier for businesses and reduces private investment. The opposite effect, where government spending raises private investment, is called crowding in. Higher taxes tend to reduce rather than raise private spending, and government spending does affect aggregate demand.

Why each option is right or wrong

(a) Wrong: this describes crowding in.
(b) Right: government borrowing raises interest rates and cuts private investment.
(c) Wrong: higher taxes tend to reduce private investment.
(d) Wrong: government spending does affect aggregate demand.

Only the provisional key (27 May 2026) was found; the final key replaces it when found.

Answer: UPSC’s key. Explanation: written by UPSC Grade, not by UPSC.

Practise this paper timedPrevious question Next question

Source: UPSC, Civil Services (Preliminary) Examination 2026, General Studies Paper I, Series A. The paper on upsc.gov.in.