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Inflation Rates Edged Down in April

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The government’s main tool to combat inflation rests with the Fed, which can raise interest rates. Higher lending costs tend to cool the economy by weighing on business and consumer spending, and eventually lead to lower prices overall.—washingtonpost.com

Answer the following questions to check your understanding of the story.

How do higher interest rates influence business investment and consumer spending?

Higher interest rates _______ the opportunity cost of borrowing, which ____________ consumer spending and business investment.

When the real interest rate rises, does the opportunity cost of borrowing rise, or does it fall? Do consumers and businesses borrow more or less? Why? Do consumer spending and business investment increase or decrease?

The real interest rate is the opportunity cost of borrowing to buy consumer goods and capital equipment. So higher interest rates raise the opportunity cost of borrowing, which decreases consumer spending and business investment.

In the AS-AD model, how do higher interest rates change aggregate supply and aggregate demand?

In the AS-AD model, higher interest rates ______________ short-run aggregate supply and _____________ aggregate demand.

What factors influence short-run aggregate supply? Are any of these factors influenced by higher interest rates? What are the components of aggregate demand? Are any of these components influenced by higher interest rates?

Higher interest rates decrease consumption expenditure and investment, which are components of aggregate demand. Short-run aggregate supply changes when potential GDP changes or when the money prices of factors of production change, but none of these events that influence short-run aggregate supply are influenced by higher interest rates.

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