Effects of higher interest rate on households and firm behavior.

Question

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Answer 1

Question

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

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Students have asked these similar questions

Suppose there is an increase in the interest rate in the financial markets. What effect will this have on income? Use a diagram to support your answer.

The interest rate is determined by... a) Financial markets and do not affect the market for goods and services b) Markets for goods and services and do not affect financial markets c) Financial markets and affect investment (I) so that it will affect the market for goods and services d) The market for goods and services and affects investment (I) so that it will affect the financial market

Suppose that Intel is considering building a new chip-making factory a. Assuming that Intel needs to borrow money in the bond market, why would an increase in interest rates affect Intel’s decision about whether to build the factory? b. If Intel has enough of its own funds to finance the new factory without borrowing, would an increase in interest rates still affect Intel’s decision about whether to build the factory? Explain!

Answer 2

Question

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Question

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Question

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

Answer 6

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Answer 7

Chapter 30, Problem 1.1P

Sub part (a):

To determine

Effects of higher interest rate on households and firm behavior.

Answer 8

Sub part (a):

Expert Solution

Explanation of Solution

If the Federal Reserve System rises the interest rates, then the borrowing of items become more costly. Therefore, households will reduce the purchase of durable goods such as auto mobiles and houses. So when the rate of interest rises, consumers spending on durable goods reduce.

In the case of firms, when the rate of interest rises, cost of capital becomes higher. Therefore firms will reduce the spending on investment. So when the rate of interest rises, investment will reduce.

Answer 9

Sub part (a):

Expert Solution

Answer 10

Sub part (a):

Expert Solution

Answer 11

Expert Solution

Answer 12

Economics Concept Introduction

Concept introduction:

Rate of interest: The rate of interest: The rate of interest refers to that percentage at which the money is borrowed or is taken as a loan. The amount to be paid as interest is calculated on this given percentage.

Answer 13

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Answer 14

Sub part (b):

To determine

Effects of higher interest rate on bonds.

Answer 15

Sub part (b):

Expert Solution

Explanation of Solution

When the rate of interest rises by the Federal Reserve, it will fall the existing values of fixed rate bonds. Because, in the case of fixed rate bonds, if the holder paying 7% for the next 10 years is become simply worth less if the potential buyers can now earn 8% by buying a new bond. That’s why, the higher interest rate would decrease the value of existing fixed rate bonds held by the public.

Answer 16

Sub part (b):

Expert Solution

Answer 17

Sub part (b):

Expert Solution

Answer 18

Expert Solution

Answer 19

Economics Concept Introduction

Concept introduction:

Bonds: Bond refers to the securities, which are traded in the public to raise the capital when needed. It is an investment with a fixed income, where an investor gives money to an entity or individual for a specified period of time at a fixed rate.

Answer 20

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.

Economics Concept Introduction

Concept introduction:

Wealth effect: Wealth effect refers to the effect of a change in the price that has on the wealth of the individual.

Answer 21

Sub part (c):

To determine

Wealth effect of higher interest rate on consumption.

Answer 22

Sub part (c):

Expert Solution

Explanation of Solution

Figure 1 illustrates the changes in aggregative demand curve and aggregative supply curve due to the wealth effect of higher interest rate on consumption.

Principles of Economics (12th Edition), Chapter 30, Problem 1.1P

In figure-1, vertical axis shows the output and the horizontal axis shows the price level. When the consumption falls the AD curve will shift from AD to AD1. As a result, price level falls and the quantity reduces from Y0 to Y1.

When the rate of interest rises, the cost of borrowing become higher. And also, the investment rate reduces because of the higher rate of capitals. These factors will reduce the wealth of an economy. When wealth reduces, consumers will spend less and they become worse off. In short, higher interest rate will reduce the spending of consumers. Therefore, the aggregative demand curve will shift the left wards. This is higher than the direct effect on investment.