Physical Crowding Out:

Physical crowding out occurs when the government demand for factors and inputs increases in the event of their inelastic supply. This raises their prices and makes private investment schemes unviable and unprofitable thereby reducing private expenditures. Thus physical crowding out results from a shortage of real productive resources. For example, the government increases direct public sector expenditure by starting new industries. It pays higher wages to attract technical experts from private sector industries and increases the demand for other resources, thereby reducing private investment. If the economy is at the full employment level, any rise in government expenditure will inevitably crowd out an equal amount of private expenditure.

Physical crowding out is a temporary and short run phenomenon. In the long run, there is the possibility of increasing real resources. The government can also stimulate private investment by selective industrial subsidies and adopting appropriate fiscal and monetary measures.