Question

Explain how interest rates, output, and taxes determine the demand for capital.

Answer 1

Since the interest rate is the cost of borrowing, so when the interest rate increase, the X cost of borrowing for capital increase, so demand for capital decrease and vice-versa in case of decrease in the interest rate.

If outputs are more than the demand, it means there are excess outputs, so firm will try to produce less outputs, so in the next year, hence firm needs less capital in this year and vice-versa.

If taxes are increased, the profitability of the firms will decrease, so firm will produce less output, so demand for capital will decrease and vice-versa in case of decrease in the taxes.