Consider two hypothetical nations: Wahooland and Wildcat Island. Initially, thes
ID: 1215634 • Letter: C
Question
Consider two hypothetical nations: Wahooland and Wildcat Island. Initially, these nations are identical in every way. In particular, they are the same with regard to population size and age. income and wealth, and time preferences. They also have the same interest rates, saving, and investment. Suddenly, in the year 2015. the interest rate in Wahooland rises. After some investigating, economists determine that nothing has happened to the supply of loanable funds. Therefore, what are the possible reasons for the rise in interest rates in Wahooland? Given your answer to part (a), what can you say about the level of investment in Wahooland relative to that in Wildcat Island in 2015? What can you say about future income levels in Wahooland versus Wildcat Island? Often, we think of lower interest rates as always being preferable to higher interest rates. What has this question taught us about that idea? Some people have proposed an increase in retirement ages for Americans. Consider the effects of this proposed new policy. Show how the change would affect supply and demand in the market for loanable funds. How would this change affect the equilibrium interest rate and investment? In the long run, how would this affect real GDP in the United States?Explanation / Answer
3.
(a) Interest Rate of Wahooland increases due to high borrowings of money from international financial institutions and developed countries. Interest rate is generally the cost of borrowings. Apart from it the other reasons of high interest rate are inflation. The rate of inflation is directly proportional to interest rate. Higher the inflation rate, higher will be the interest rate.
(b) The investment is inversely proportional to the interest rate. So if the interest rate is high in Wahooland in 2015 than investment is low in comparison to Wildcat. The high interest rate makes the borrowing money expensive which have a negative impact on investment.
(c) The lower interest rate makes the borrowing money less expensive. It will decrease the inflation rate and increase the investment which is very much beneficial for any country.