Chapter 4: Problem 7

Which of the following changes in the financial market will lead to a decline in interest rates: a. a rise in demand b. a fall in demand c. a rise in supply d. a fall in supply

Short Answer

Expert verified

A fall in demand (b) and a rise in supply (c) lead to a decline in interest rates in the financial market.

Step by step solution

Understand the concepts of supply and demand in the financial market

In the financial market, supply refers to the amount of funds available for borrowing, which mainly comes from financial institutions, like banks. Demand refers to the requests for borrowing money by businesses, households, and governments. Interest rates are determined by the interaction of supply and demand for funds.

Analyze the impact of a rise in demand

If demand for borrowing increases (a rise in demand) while the supply remains constant, there will be more competition among borrowers to secure funds. This competition will drive up the price of borrowing money, in other words, interest rates will increase. So a rise in demand won't lead to a decline in interest rates.

Analyze the impact of a fall in demand

If the demand for borrowing decreases (a fall in demand) while the supply remains constant, there will be less competition among borrowers, and more funds available for borrowing. Consequently, the price of borrowing money (interest rates) will decrease. Hence, a fall in demand leads to a decline in interest rates.

Analyze the impact of a rise in supply

If there is an increase in the supply of funds for borrowing (a rise in supply) while the demand remains constant, there will be more funds readily available for borrowers. This availability will result in a decreased price for borrowing money (interest rates), as lenders would be competing to provide loans. So, a rise in supply leads to a decline in interest rates.

Analyze the impact of a fall in supply

If the supply of funds for borrowing decreases (a fall in supply) while the demand remains constant, there will be fewer funds available for borrowing. This scarcity will result in an increased price of borrowing money (interest rates), as borrowers would compete to secure limited funds. Therefore, a fall in supply won't lead to a decline in interest rates. #Conclusion# Based on the analysis, a fall in demand (b) and a rise in supply (c) lead to a decline in interest rates in the financial market.