Interest Rates
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a) Explain what effect a rise in interest rates might have on the level of total expenditure.
b) Discuss what policies apart from interest rates changes a government might use to control inflation.
Total expenditure can be defined as the total demand for all domestically produced final goods and services in an economy over a period of time and consists of the sum of demand of households, firms, the government and the foreign purchases of domestically produced goods. In the other words, it consists of consumption, investment, government expenditure and net exports expenditure. Interest rate can be defined as the price paid for the use of borrowed money and it has impacts on all the components of total expenditure with the exception of government which is interest inelastic. An increase in interest rates is brought about by a reduction in the money supply.
Consumption is disposable income that households spend on consumer goods to satisfy their current wants while savings is disposable income which is not spent. A rise in interest rates will cause the cost of borrowing to increase. Consumers will not be encouraged to borrow and hence consumption on consumer durables falls. An increase in interest rates, on the other hand, will cause the returns from saving to increase and hence, the people are induced to save more and again, consumption falls...