The table shows a private closed economy. All figures are in billions of dollars. Refer to the table above. An increase in the real interest rate from 2% to 6% will:
A) Decrease the equilibrium level of GDP by $200 billion
B) Decrease the equilibrium level of GDP by $300 billion
C) Decrease the equilibrium level of GDP by $400 billion
D) Increase the equilibrium level of GDP by $400 billion

Question

The table shows a private closed economy. All figures are in billions of dollars.  Refer to the table above. An increase in the real interest rate from 2% to 6% will:
A) Decrease the equilibrium level of GDP by $200 billion 
B) Decrease the equilibrium level of GDP by $300 billion 
C) Decrease the equilibrium level of GDP by $400 billion 
D) Increase the equilibrium level of GDP by $400 billion

Quizplus · Accepted Answer

An increase in the real interest rate will reduce investment spending, as it becomes more expensive for firms to borrow funds for investment purposes. This decrease in investment will shift the aggregate demand curve to the left, lowering the equilibrium level of GDP. From the table, we can see that a $100 billion decrease in investment spending reduces GDP by $400 billion, so a $300 billion decrease in investment (due to the interest rate increase) will reduce GDP by $1,200 billion (3 x $400 billion). Therefore, the correct answer is C, which represents a $400 billion decrease in GDP due to the interest rate increase.

The Table Shows a Private Closed Economy