1a. If there are high interest rates now, and if we want to buy the computer on credit,
then buying the computer now would cost us more than if we bought the computer
sometime later in the future when interest rates are lower, so we pay the same for the
principal but less interest expense for us. If interest rates are high, investment spending
is expected to go down, as there would be more interest expense to pay if, for example,
companies took out loans for a new office building or expensive equipment.
1b. If we expect the economy to go into a recession for example, we will probably want
to hold our money, and not buy the computer as the value of goods and services would
plummet in a recession. However, if we expect higher inflation in the economy, then we
would want to rush to buy that computer because otherwise the computer would cost
more, and borrowers win out when there are high interest rates and high inflation, if the
computer is bought now.
2a.
2b. Over the last 3 years, the Federal Reserve has been raising interest rates in an
effort to cut down on inflation and spending as a whole, and the nominal interest rate
has been rising because banks borrow from the Federal Reserve. The 2 interest rates
have a direct relationship, if the federal funds rate increases, then the bank prime loan
rate will also increase and if the federal funds rate decreases, then the bank prime loan
rate will also decrease because the banks borrow from the Fed.
2c. The interest rate has roughly stayed the same or has slightly increased because the
Federal Reserve wants to secure this rate of inflation for the economy to stabilize.
2d. The cost of borrowing has increased in the last 3 years, as individuals and firms
would have to pay a higher interest expense over loans used for investment spending
than 3 years ago.
3a.
P
SRA
S
P1
A
D
Y1
GDP
3b. Gas and energy prices rise all around the world, increasing commodity prices. Shifts
SRAS left and caused a recession.
A hurricane wrecks thousands of acres of farmland, increasing commodity prices. Shifts
SRAS left and caused a recession.
A housing market crisis emerges, leading to a decrease in consumer spending. Shifts
AD left and caused a recession.
SRAS
2
P
SRAS1
P2
P1
A
D
3c.
Y2
Y1
GDP
A hurricane wrecks thousands of acres of farmland, the SRAS curve shifts left because
the economy is no longer producing at its total potential GDP. The price level also
increases as the cost of produce rises because of the lack of quantity, and the economy
is not at full employment, as some farmers may have lost their way of life because of
the hurricane.