Answer to Question #182935 in Macroeconomics for brian

Question

Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls. Use the IS-LM model to examine how the relative effectiveness of fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively

Answer 1

Interest rate and offline expenses. For savers, the interest rate acts as a reward for abstaining from consumption in the present at the expense of expected consumption in the future. For borrowers, the interest rate is the price of borrowed funds used by investors to buy investment goods and by households to buy consumer durables. There are many specific types of interest rates in the economy, such as interest rates paid:

banks for checking, savings, and term accounts;

on funds borrowed by the government (interest on government bonds),

business (interest on commercial securities and corporate bonds),

commercial banks to the central bank (discount rate),

households (interest on mortgages, mortgage, and consumer loans).

In economic theory, which identifies the basic, fundamental relationships and interdependencies in the economy, the differences between different types of interest rates are assumed to be insignificant and the market interest rate is understood as the average of all different rates.

The relationship between autonomous projected costs and the interest rate. Changes in the interest rate affect the following components of offline costs:

• investment costs. By borrowing money to buy investment goods, firms are trying to make a profit. Therefore, they invest in equipment and industrial structures (acquire real capital) as long as the rate of return on the additional unit of capital exceeds the cost of borrowed funds for the purchase of this additional unit, i.e. interest rate. Any increase in the interest rate reduces the efficiency of investment projects. Therefore, if the interest rate is so high (credit funds are expensive) that the expected rate of return is lower than this rate, the firm will refuse to implement such an investment project and the number of investment costs will decrease. Consequently, the relationship between the number of investment costs and the interest rate is reversed. The higher the interest rate, the less willing firms are to invest