How is Investment determined according to the Classical Model?

How is Investment determined according to the Classical Model?

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Expert Solution

According to the Classical model, investment is determined by the level of savings. The more the saving, more is the investment.

Savings are positively related to the rate of interest. And investment is negatively related to the rate of interest prevalent in the economy.

As higher the rate of interest, more will people save. While if the rate of interest is high, lower is the borrowing and investment is low.

When savings are lower than investments, the interest rate rises. While when investments are lower than savings, interest rate falls. In this way equilibrium is attained and thus the savings equal the level of investments.

If savings are not equal to investments. Then the rate of interest will change to create a change in the level of investments and make it equal to the savings.

Thus investment is determined by the level of savings in an economy which are determined by the rate of interest prevalent in the economy.

Rahul Sunny answered 1 year ago

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