Macroeconomics Policy Restraints

Question

Assume the economy is starting at point B in the graph below.

Graph Image Link: https://ibb.co/yNZtLyZ

Which point demonstrates the effects on investment of:

a) an interest rate cut? From B to _?

b) an interest rate cut accompanied by decreased sales expectations? From B to _?

Answer 1

The graph shows investment demand falling from I1 to I2. Point B is in the middle of the initial investment demand curve, I1.

a) An interest rate cut will be a movement along the investment curve to point C because at lower interest rates, more investment projects become feasible since the borrowing costs are lower, so investment demand increases along the initial investment demand curve.

b) If the cut in interest rates is accompanied by a decrease in expected sales, the decrease in expected sales will shift the investment demand curve to the left, while the cut in interest rates will increase investment demand. The combined effect is to move the market to point F.