Changes in interest rates, all else held constant, cause a shift in _____. either the investment demand curve or the aggregate demand curve the investment demand curve, but not the aggregate demand curve the investment demand curve and the aggregate demand curve the aggregate demand curve, but not the investment demand curve
Question
Changes in interest rates, all else held constant, cause a shift in _____. either the investment demand curve or the aggregate demand curve the investment demand curve, but not the aggregate demand curve the investment demand curve and the aggregate demand curve the aggregate demand curve, but not the investment demand curve
Solution
Changes in interest rates, all else held constant, cause a shift in both the investment demand curve and the aggregate demand curve.
Here's why:
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Investment Demand Curve: Interest rates are a cost of borrowing. Therefore, when interest rates decrease, the cost of borrowing decreases, making it cheaper for firms to finance new investments. This increases the quantity of investment demanded at each price level, causing the investment demand curve to shift to the right. Conversely, when interest rates increase, the cost of borrowing increases, making it more expensive for firms to finance new investments. This decreases the quantity of investment demanded at each price level, causing the investment demand curve to shift to the left.
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Aggregate Demand Curve: The aggregate demand curve shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level. Investment is a component of aggregate demand. Therefore, when the investment demand curve shifts, the aggregate demand curve shifts in the same direction. For example, when the investment demand curve shifts to the right (because of a decrease in interest rates), the aggregate demand curve also shifts to the right. Conversely, when the investment demand curve shifts to the left (because of an increase in interest rates), the aggregate demand curve also shifts to the left.
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