Question

Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C = 500 + 0.6Y. Investment (I) is given by the equation I = 2,000 – 100r, where r is the real interest rate, in percent. In addition, assume that G=0. In this case, the equilibrium real interest rate is: a. 2 percent. b. 5 percent. c. 10 percent. d. 20 percent.

Answer 1

Answer:  Option (b) 5 percent is correct.

Explanation:

Given,

GDP(Y) = 5000

Consumption (C) = 500 + 0.6Y

Investment (I) = 2000 - 100r

where, r is the equilibrium interest rate

Government expenditure (G) = 0

In a closed economy,

Y = C + I + G

5000 = 500 + 0.6Y + 2000 - 100r

5000 = 500 + 0.6 × 5000 + 2000 - 100r

100r = 5500 - 5000

r = $\frac{500}{100}$

r = 5 percent ⇒ equilibrium real interest rate