Question

1. A decline in the interest rate is unlikely to have no effect on GDP? Agree or disagree? Why?
2. “Households tend to increase their spending during a recession because they realize that more spending will cause firms to hire more workers and the problem of unemployment will be solved.” Do you agree or disagree? Explain.

Answer 1

Answer : 1) Disagree.

GDP include consumption, investment, government expenditure and net export (export - import). So, if any of these component increase or decrease then the GDP will increase or decrease respectively. This means that the changes in GDP depends on the changes of these four components. If interest rate fall then people spend more on consumption and save less. Due to increase in consumption the GDP will increase. Again, with lower interest rate people borrow more and invest more. As investment increases at lower interest rate hence the GDP will increase. Again, when interest rate fall then the value of domestic currency fall. As a result, export increase and import decrease which increase the net export. As net export increases then the GDP will increase. So, as with lower interest rate the consumption, investment and net export increases hence the GDP will increase when interest rate fall. Hence I am disagree with the given statement.

2) Disagree.

During recession the economic growth fall and unemployment increase. In this situation people save more and consume less. Due to less consumption the aggregate demand decrease. Due to less aggregate demand firms decrease the production level. As a result, more workers lose their job which increase the unemployment level. Due to increase in unemployment level the consumption spending decrease more. Hence I am disagree with the given statement.