Question

Answer the question on the basis of the following information. Assume that if the interest rate that businesses must pay to borrow funds were 20 percent, it would be unprofitable for businesses to invest in new machinery and equipment, so investment would be zero. But if the interest rate were 16 percent, businesses would find it profitable to invest $10 billion. If the interest rate were 12 percent, $20 billion would be invested. Assume that total investment continues to increase by $10 billion for each successive 4 percentage point decline in the interest rate. Refer to the information. Which of the following is an accurate verbal statement of the described relationship?a. There is no regular or dependable relationship between business investment and the interest rate. b. The amount of business investment is unaffected by changes in the interest rate. c. Investment spending by businesses varies inversely with the interest rate. d. Investment spending by businesses varies directly with the interest rate.

Answer 1

Answer:

c. Investment spending by businesses varies inversely with the interest rate.

Explanation:

The relationship described in the question is known as inverse or negative relationship.

An inverse relationship occurs when two variables move in the opposite direction. That is, as variable A increase, variable B decreases. Conversely, as variable A decreases, variable B increases.  This different from a positive relationship which occurs when two variables move in the same direction. That is, as variable A increase, variable B too increases. Conversely, as variable A decreases, variable B also decreases.

From the question, a continuous increase in total investment by $10 billion as the interest rate falls successively by 4 percentage point is an example of an inverse or negative relationship. From this, it can also be inferred that total investment will continue to fall by $10 billion as the interest rate rises successfully by 4 percentage point.

Therefore, the verbal statement that "investment spending by businesses varies inversely with the interest rate" is an accurate description of the relationship between the investment and the interest rate.

All the best.