ANSWER The real interest rate is the opportunity cost of investment. A firm that borrows funds to make an investment faces the real interest as the opportunity cost of its investment because the real interest rate determines the purchasing power—the amount of goods and services—that a firm must repay on its loan. A firm that uses its own funds to make an investment also faces the real interest rate as the opportunity cost of its investment because the firm could loan the funds to others and collect as its return the real interest rate. Because the real interest rate is the opportunity cost of investment, an increase in the real interest rate decreases the quantity of investment firms demand.
If the actual real interest rate differs from the equilibrium real interest rate, what forces drive the real interest rate to the equilibrium real interest rate?
ANSWER
ReplyDeleteThe real interest rate is the opportunity cost of investment. A firm that borrows funds to make an investment faces the real interest as the opportunity cost of its investment because the real interest rate determines the purchasing power—the amount of goods and services—that a firm must repay on its loan. A firm that uses its own funds to make an investment also faces the real interest rate as the opportunity cost of its investment because the firm could loan the funds to others and collect as its return the real interest rate. Because the real interest rate is the opportunity cost of investment, an increase in the real interest rate decreases the quantity of investment firms demand.
If the actual real interest rate differs from the equilibrium real interest rate, what forces drive the real interest rate to the equilibrium real interest rate?