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 decline in interest rates occurs with a fall in demand (option b) and a rise in supply (option c) in the financial market.

Step by step solution

Understand the relationship between demand and interest rates

When the demand for money increases, people and businesses are willing to pay higher interest rates to obtain funds. This increase in demand leads to an increase in interest rates. On the other hand, when the demand for money decreases, people and businesses are not as willing to pay high-interest rates. This decrease in demand leads to a decline in interest rates.

Understand the relationship between supply and interest rates

When the supply of money increases, there is more money available in the market, leading to lower interest rates as institutions do not need to compete as much for funds. Conversely, when the supply of money decreases, there is less money available, and institutions will need to compete more for funds, leading to an increase in interest rates.

Evaluate the given options

a. A rise in demand: This would lead to an increase in interest rates as institutions compete more for funds. b. A fall in demand: This would lead to a decline in interest rates, as there is less competition for funds. c. A rise in supply: This would lead to a decline in interest rates, as there is more money available in the market and less competition for funds. d. A fall in supply: This would lead to an increase in interest rates as there is less money available and more competition for funds.

Select the correct answer

Based on the analysis above, the correct answer is a combination of options b and c, as both a fall in demand and a rise in supply lead to a decline in interest rates.

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