Answer to Question #219733 in Macroeconomics for shyam kishor kumar

Question

Illustrate, graphically, the determination of interest rate in the classical system. Explain what 

happens where there is a drop in autonomous investment demand. Does it reduce the overall 

demand in the economy?

5

Answer 1

Rate of interest is determined by the supply of and demand for savings. As the offered rate of interest rises, volume of saving forthcoming also rises. The supply curve of savings, thus, slopes from left upward to the right as shown below

b. When autonomous investment demand drops it discourages borrowing by the business due to high interest rate. It is also likely to cause a drop in technology. A decline in autonomous demand will indicate an increase in capital prices. It also implies an increase in capital assets.

If the business firm expects an improving economy in the future then they are likely to increase autonomous investment. Therefore a drop in autonomous investment demand reduces the overall demand in the economy.