5. How is it possible for investment spending to increase even in a period in which...

5. How is it possible for investment spending to increase even in a period in which the real interest rate rises? Explain three reasons for this ( answer in your own words)

Expert Solution

Answer:-

(a) The supply of loanable funds is upsloping because savers will make more funds available at higher interest rates than lower interest.

(b) The demand for loanable funds is downsloping because there are few investment and R&D projects that yield a high rate of return and many more that will yield a lower rate of return.

(c) The equilibrium interest rate is determined where the interest rate (cost of borrowing the funds) is equal to the expected rate of return (the expected benefit from borrowing the funds and engaging in the investment or R&D project). The supply of loanable funds may change because of a change in households' attitudes about saving (tax policies, macroeconomic conditions) or changes in Federal Reserve policies relative to the money supply. The demand for loanable funds could change as a result a change in technology or a change in the demand for the final product. If there is either a change in the supply of or demand for loanable funds, the interest rate will change.

Rahul Sunny answered 2 years ago

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