Question

be original and use your own word

1. Please choose one topics of your choice from chapters 5-7 and describe in your own words what you learned providing an explanation of 200 words for each topic.

I choose inflation and interest rates

add your references

Answer 1

Question: 1. Please choose one topics of your choice from chapters 5-7 and describe in your own words what you learned providing an explanation of 200 words for each topic.

Topic: Inflation and Interest Rates

Answer:

Inflation and Interest Rates Summary

Inflation and interest rates are in close relation to each other, and frequently referenced together. Inflation refers to the rate at which prices for goods and services rise. Interest rate means the amount of interest paid by a borrower to a lender, and is set by central banks.

To clarify what interest rates are, let’s pretend you deposit money into a bank. The bank uses your money to give loans to other customers. In return for the use of your money, the bank pays you interest. Similarly, when you purchase something with a credit card, you pay the credit card company interest for using the money that paid for your purchase. In general, interest is money that a borrower pays a lender for the right to use the money. The interest rate is the percentage of the total due that is paid by the borrower to the lender.

Effect of High Inflation on Interest Rates:

To control high inflation: the interest rate is increased.

When interest rate rises, the cost of borrowing rises. This makes borrowing expensive. Hence borrowing will decline and as such the money supply (i.e the amount of money in circulation) will fall. A fall in the money supply will lead to people having lesser money to spend on goods and services. Hence, they will buy a lesser amount of goods and services.

This, in turn, will lead to a fall in the demand for goods and services. With the supply remaining constant and the demand for goods and services declining, the price of goods and services will fall.

As inflation is a continuous increase in the general price level of goods and services so a fall in the general price level of goods and services will lead to a decline in inflation levels.

Effect of Low Inflation on Interest Rates:

In low inflationary situations; the interest rate is reduced. A fall in interest rates will make borrowing cheaper. Hence, borrowing will increase and the money supply will also increase. With a rise in money supply, people will have more money to spend on goods and services.

So, the demand for goods and services will increase and with supply remaining constant this leads to a rise in the price level i.e inflation.

Conclusion on Inflation and Interest Rates:

A very high as well a very low inflation can have an adverse impact on an economy. Thus it is necessary to maintain inflation at a moderate level. Interest rate plays a vital role in maintaining inflation at a moderate level.