How would a rise in interest rates cause a fall in AD (include investment)?
Currently a 3rd year BSc Economics student at City, University of London.
Interest rates can be defined in the following two ways. Interest rates are the cost of borrowing for an economic agent (i.e the price of making an investment). Also interest rates are the benefit of saving(that is the payment made to an agent for putting money into a bank account). When interest rates rise, the cost of borrowing also rises, meaning that an economic agent will pay a higher price for an investment. Due to the law of demand, this will reduce the demand for investing and the level of investment in an economy will fall. Since the national income identity is given by C+I+G+X-M, when investment falls ceteris paribus the level of aggregate demand in an economy falls.
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