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Pages 6 (1506 words)
Interest rates can be defined as the cost of borrowed funds; it can also be defined as the opportunity cost of borrowed resources. Interest rates are used by policy makers to implement monetary policies that involve adjusting interest rate levels. When interest rates are adjusted they will affect the level of borrowed funds…
This paper discusses the effects of a change in the level of interest rate of investment and on consumption.
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, this is because most investments involves the borrowing of funds and therefore an increase in interest rates will discourage investment while a decline in interest rates will encourage investment.
When interest are at IR1 which are higher than IR2 then the level of investment is I1 which is at a lower level then I2, however when the interest rates are lower and the level is at IR2 then the level of investment increases to I2. This diagram shows the relationship between investment and interest and an increase in interest rates therefore will discourage investment while a decline in investment will increase investment efforts.
Neoclassical theory states that an increase in the interest rates will reduce investment; they state that an increase in interest rate will result into an increase in the cost of capital and as a result of this increase in cost then investment will be reduced. ...
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