If interest rates increase, what will be the effect in the investment function A

Question

If interest rates increase, what will be the effect in the investment function A. Investment function will shift down (decrease) B. Investment function will become more steep (slope increases) C. No effect on investment function D. Investment function will shift up(increase E. Investment function will become less steep If interest rates increase, what will be the effect in the investment function A. Investment function will shift down (decrease) B. Investment function will become more steep (slope increases) C. No effect on investment function D. Investment function will shift up(increase E. Investment function will become less steep A. Investment function will shift down (decrease) B. Investment function will become more steep (slope increases) C. No effect on investment function D. Investment function will shift up(increase E. Investment function will become less steep

Explanation / Answer

Answer:- As we know that the investment spending function :I = a - bi , b>0, a is autonomous spending, b is slope, i is interest rate.

So according to the above equation, there exists an inverse relationship between the interest rate and investment. This is because when the firms borrow to purchase investment goods, they have to pay an interest rate. When interest rate increases, the cost of borrowings increases.

This decreases the profitability of the firms and thus, the planned investment decreases. Due to this negative relationship between interest rate and the investment, the investment curve is negatively sloped. As interest rate increases then Investment decreases. So there will be movement along the cueve and no shift in the curve.

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