As the price level falls, the cost of borrowing money will rise, causing the quantity of output demanded to rise. This phenomenon is known as the interest rate effect.
What is interest rate effect?
The shift in borrowing and spending habits following an interest rate modification is known as the interest rate effect. The interest rate effect affects aggregate demand in following ways.
(i) Borrowing money gets more "expensive" when interest rates increase. When interest rates rise, consumer spending and capital investment decline since they would normally be funded by borrowed money. As a result, aggregate demand declines.
(ii) The reverse occurs when interest rates decrease. At reasonable rates, both individuals and businesses can borrow money. The aggregate demand rises as a result of the investment of this borrowed money in capital and consumer spending.
For example, when interest on house loan is decreased from 7% to 6% by a bank, the demand for house loan among customers will increase because now they would be owing lesser money to the bank. So borrowing of money will increase.
To know more about interest rate effect, check out:
brainly.com/question/25379255
#SPJ4
