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Introduction to Economics - Essay Example

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Introduction to Economics

The decrease of the interest rates accounting other factors being stable, leads to the increase of the new equipment among firms, which they plan to purchase, it also increases the number of new houses, and the goods of long-term use. Changes in the price levels through the impact on the amount of money in use also influence interest rates. Changes in the interest rates, caused by the changes in the price levels, changes the aggregate demand on goods and services; however, in graphic form this does not make the aggregate demand curve shift; it only reflects the movement along the already existing line. (Handa: 2000)
However, interest rates also create another impact. No matter what may be the reason of the interest rates' change, their level impacts aggregate demand as a whole. Separately from the price level change, the aggregate demand curve shifts with the changes in interest rates. For example, if the government comes down to the higher expenditures and loans to cover the deficit, with the other conditions stable it leads to the increase of interest rates and negatively influences the plans of expenditures for the firms and individuals. If the supply of the finances for loans increases abroad, the interest rates stay stable, keeping aggregate demand from decrease. (Handa: 2000)
Consumption is the most considerable part of the aggregate demand, and it is wise to start the discussion of the interest rates' decrease with the impact it creates on consumption. Individuals acquire their incomes in the form of salary, and the capital profits. A portion of the income is spent for paying taxes to governmental structures. On the other hand, government also provides individuals with subsidies (social insurance, unemployment payments, etc.). The decision about consumption lies in the choice - whether to consume at present, or to save and to consume in the future. The main factor, which defines consumption, is the income at disposal. Thus, with the interest rates decreasing, individuals take decisions to consume, and moreover, they take the decision to get more loans for the development and satisfaction of their long-terms needs, which ultimately causes the increase of the aggregate demand. This is the first channel, through which the decrease of the interest rates increases aggregate demand in the country. (Makin: 2000)
Investments depend on the interest rates directly. This relation is explained by the fact, that investments are performed with the account of the perspective, thus investment decisions are based on the existing interest rate. Firms face a certain number of the investment opportunities, which are different by their inner yield. Firms compare the yield of different projects with the costs of their financing, that is, with the interest rates. Interest rates for investments appear to be the cost of investments. The rates, which are published in mass media, are nominal, as they are measured in the financial indices. Economics makes special accent on the fact, that individuals don't concentrate on the financial cost of goods, but tend more to look at how many goods can be bought for a certain amount of money. Taking investment decisions, firms take into account real interest rates. They compare real yield of the ...Show more

Summary

At the end of June 2003, the Federal Reserve cut interest by a quarter-point to 1.0 per cent, their lowest level in 45 years. This was the 13th reduction in short term US interest rates, from 6.5 per cent at the start of 2001. The aim of the work is to explain, what the three main channels through which the interest rate will influence aggregate demand are, and how these impacts are applicable to the US economy through the period of 2002-2004.
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Introduction to Economics essay example
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