The investments (I) have a negative relationship with interest rate (r) $$ I = e-f \cdot r. $$

So $e$ can be interpreted as a minimum level of investments while $f$ can be interpreted as how much the interest rate (r) affects the investments (I) negatively.

I don't understand why an increment in interest rate (r) implies a negative effect on the investments (I).

I thought that my investments would become more valuable if the interest rate increases, so from my point of view, people would be more interested in investing if the interest rate increases.

I guess I have misunderstood something.

  • $\begingroup$ More context is needed. What is $I$? Demand for investments? Equilibrium investments? Also, are you talking about the static relationship or the intertemporal relationship? Such kind of information should be included in your question to narrow it down fruitfully. $\endgroup$ – Alecos Papadopoulos Dec 14 '15 at 23:17
  • $\begingroup$ Agree, your description is pretty ambiguous. But, it helps to turn it around: a decrease in investment causes interest rate to rise to re-establish equilibrium. That squares with basic supply and demand as falling supply of investment yields rising price. Its important not to misinterpret an equilibrium condition as an individual agent's choice function--in this models individuals still want to invest more at higher rates. $\endgroup$ – Matthew Dec 15 '15 at 0:52

The investment I earns income in the future. This income can be compared to the risk free rate of interest in the market to determine whether the income earned on I exceeds the opportunity cost of investing in I.

When interest rates rise, it is more worthwhile for an investor to purchase risk free bonds rather than invest in I. This decreases the demand for I, hence its price decreases.

  • $\begingroup$ I still don't understand the inverse relationship between interest rate n investment $\endgroup$ – Beverly Jul 22 '17 at 17:35

Investment in economics refers to investment in capital goods generally by firms. When Interest rates are higher cost of borrowing for investor increases, hence she invest lower. Thus the negative slope.


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