Question

An increased interest rate will cause residential and business investment spending to______, leading to______in the quantity of output demanded in the economy.

A. decrease; decrease

B. decrease; increase

C. increase; decrease

D. increase; increase

Answer 1

Option A

An increase in interest rate means the rise in the borrowing cost. A higher borrowing cost discourages the investment by the business sector because that pushes the required return higher. Similarly, individuals or households also view a higher borrowing cost as a strain on the income because of higher interest payment and they reduce the borrowing.

The overall effect is a decrease in the investment by the households and businesses in the economy. A lower demand from the households means a decrease in output in the economy.