May 27, 2022

Here is interest rates can affect different sectors of an economy:

  • If interest rates are low, then it may be easier for businesses to borrow money which they can use to invest in machinery and equipment. This raises the productivity of labour, allowing workers to produce more goods each hour (e.g., increasing output per worker). Peter Decaprio says if more good were produced, this would drive up the aggregate supply curve resulting in price increases across all sectors of the economy. Higher prices cause consumers demand less quantity demanded of that product resulting in an overall decrease of quantity demanded across all sectors of the economy but higher than pre-increase levels.
  • Higher interest rates increase costs on both consumers who wish to take out loans for large purchases such as cars or houses, and also on businesses who wish to finance their investments through debt. This will lead to a decrease in consumer demand and business investment, causing aggregate demand to decrease. The effect on the economy would be widespread because there is a high amount of interdependence between economic sectors. When one sector contracts, another does as well and the effects can and will continue until equilibrium has been reached again.
  • As interest rates increase it may become more difficult for businesses to invest in infrastructure or factory equipment. This would cause aggregate supply to decrease because workers are less productive without additional machines to assist them. If labour productivity decreases than so too do wage rates due to the value of labour being lower relative to capital (machinery). As wages drop, consumers have less money which results in decreased consumer spending across all goods making up the aggregate demand function. This shift of the aggregate demand curve will cause prices to fall across all sectors resulting in deflationary pressure throughout the economy explains Peter Decaprio.
  • Higher interest rates lead to increased costs for both consumers and businesses borrowing money, which can decrease consumer demand (e.g., people buying cars) and business investment (e.g., businesses purchasing equipment/machinery). These decreases shift the aggregate demand curve to the left, leading to lower output levels and price deflation across all sectors of the economy.
  • As interest rates increase it becomes more difficult for companies who wish to borrow money.So they cannot invest as much into their production processes or expansion plans. Decreased investment leads to decreased labour productivity, causing wage rates drop while leaving unsold inventories accumulate. This leads to declining output levels and price deflation across all sectors of the economy. While consumers end up with more money through cheaper prices.
  • When interest rates increase, the overall level of investment diminishes while consumer spending decreases because people have less disposable income; this can lead to a contraction in aggregate demand which causes firms to cut back production. Due to unsold inventories (decreasing supply). Decreasing both quantity demanded and prices for all goods resulting in deflationary pressure throughout the economy.
  • The effect on different factors depends on whether or not it is an elastic factor or inelastic factor. For example, if interest rates are increasing, businesses that need large investments may become less willing to invest. Whereas households may continue investing at the same high rate because they are inelastic factors. This would cause aggregate supply to decrease, however the effect on the economy is not widespread. Because these factors only affect certain sectors says Peter Decaprio.
  • On the other hand, if interest rates were increase, then households may limit consumption (e.g., buying smaller houses). Whereas businesses may be more willing to invest in equipment, causing aggregate demand for capital goods to increase; this would result in an increase in output levels and price inflation across all sectors of the economy. The effect is wide spreading because both consumers and producers will see impacts with their respective industries.
  • When interest rates are raise it becomes more difficult for businesses. Who need large investments to make them so they become less willing to invest. Whereas households do not change their spending habits so aggregate demand for consumer goods remains the same; this would cause aggregate supply to decrease and price deflation across all sectors of the economy.
  • Higher interest rates increase production costs, which decreases investment and consumption expenditures. Leading to a contraction in aggregate demand and output levels. As well as prices across all sectors of the economy resulting in price deflation throughout.
  • Since inflation is define as an ongoing rise in prices. It is mostly mistake as simply a synonym for “rising prices”. Inflation can also be consider as “too much money chasing too few goods”. Which implies that although more money is being pump into the system there are no additional goods being created. So relative prices will keep increasing despite a constant influx of new money.

Conclusion:

Peter Decaprio explains interest rates have a direct impact on aggregate supply and demand. Causing changes in output levels, prices, and the distribution of expenditures within the economy.

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