Question

Let’s assume that parameter b in the investment function is small. How an increase in the rental price (or interest rate) will affect the level of investment in the economy? Why? Explain and use the models and graphs.

Answer 1

INVESTMENT FUNCTION Investment is a function af s, rate of interest. I= f(c), with AI co sunt That is, Change in the value of investment with respect to the change in value of interest rates. The rate of interest to and investment are inversely Interest Investment rate proportional to function. % each other. An increase in the ri I :) rate at interest imblies a decrease I k n in the investment o Iz I Investment level and a decrease in the rate of interest implies a increase in the investment nalue. An increase in the dental price (or interest rate) will of discourage investment in an economy because of the opportunity cost of the investment, which is high. Also, when the rate of interests are high boonowing money from the banks gets expensive. So people will not borrow money to finance investments. And the savings. which the people have in the banks would also be a bad option to finance investments as it would dresult in lower rachu interest payments, because keeping the savings in the banks gives a higher rate of return.

The figure A shows the inverse relationship between the rate of Interest and level of Investment The former is represented on the vertical axis and the latter is represented on the horizontal axis. An increase in the rental price for interest rate) results in a decrease of investment from I, to Ig. The increase being du, to dig. and vice versa

An increase in the rental price(or interest rates) from $ri_{1}$ to $ri_{2}$ results in a decrease of investment from $I_{1}$ to $I_{2}$ . A decrease in the interest rates, on the other hand, will encourage investment in an economy.