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Effectiveness of the Interest Rate Adjustment - Coursework Example
Macro & Microeconomics
Pages 6 (1506 words)
This paper discusses the effects of a change in the level of interest rate of investment and on consumption. Interest rates can be defined as the cost of borrowed funds or as the opportunity cost of borrowed resources. Interest rates are used by governments to implement certain monetary policies …
This paper offers a comprehensive review of the relationships between interest rates, investment behaviour and level of consumption with the help of the postulates of Keynesian theory. It is shown, that when interest rates are adjusted they will affect the level of borrowed funds. Interest rates will therefore affect the consumption behaviour and at the same case affect the investment behaviour in the economy. Interest rates can also determine the amount of money supply in an economy, and because the higher the money supply then the higher the inflationary pressure interest rates are used as a way to fight inflation in an economy
Investment can be defined as accumulation over time by firms of real capital goods and these goods yield the future flow and acquisition of other goods, investment levels in an economy will be determined by the interest rates which are the opportunity costs of borrowed funds.
Consumption constitutes the largest proportion of expenditure in an economy, however in his theory he defined consumption as a function of income, consumption therefore was equal to the autonomous consumption level plus the marginal propensity to consume which is multiplied by the income minus tax.
Consumption is affected by changes in the level of interest rates, when interest rates are high then the demand for borrowed fund will decline and therefore the less the ability by consumers to spend, when interest rates are low then the demand for borrowed funds increase and for this reason the higher the ability by consumers to spend.