Use the following to answer question 3.

Exhibit: Saving, Investment, and the Interest Rate 2

(Exhibit: Saving, Investment, and the Interest Rate 2) The economy begins in equilibrium at Point E, representing the real interest rate,
𝑟
1
, at which saving,
𝑆
1
, equals desired investment,
𝐼
1
. What will be the new equilibrium combination of real interest rate, saving, and investment if there is a technological innovation that increases the demand for investment goods?

Question

Use the following to answer question 3.

Exhibit: Saving, Investment, and the Interest Rate 2

(Exhibit: Saving, Investment, and the Interest Rate 2) The economy begins in equilibrium at Point E, representing the real interest rate, 
𝑟
1
 , at which saving, 
𝑆
1
 , equals desired investment, 
𝐼
1
 . What will be the new equilibrium combination of real interest rate, saving, and investment if there is a technological innovation that increases the demand for investment goods?

BlackTom AI · Accepted Answer

To approach this question, we start by understanding what a shift in investment demand does in the savings–investment framework.

Option A: Point A. This point would correspond to a lower real interest rate and a smaller or unchanged level of investment relative to the initial equilibrium. If the investment demand curve shifts to the right (due to a technological innovation increasing demand for investment goods), we would not expect the new equilibrium to move to a lower interest rate or a clearly reduced investment. Therefore Point A is inconsistent with the direction of the shift.

Option B: Point B. This point is at a higher interest rate than the initial equilibrium but sits on the vertical axis corresponding to a higher saving level than S1, yet it does not reflect the new equilibrium where the investment demand has increased. The shift in I demand should move the intersection to a new point where saving and investment lines intersect at a higher level of investment and (usually) a higher interest rate; however, Point B may not capture the full simultaneity of higher I and higher S in the new equilibrium.

Option C: Point C. This point lies at a lower r (interest rate) and a much lower saving level, implying a contraction in investment demand rather than an expansion. Since the scenario describes an increase in demand for investment goods, a move to lower r and lower saving is inconsistent with the mechanism of investment-demand shifting right. Therefore C is incorrect.

Option D: Point D. When investment demand increases, the I2 curve shifts to the right of I1. The new intersection with the saving curve occurs at a higher real interest rate and a higher level of saving and investment than the initial equilibrium E. Point D is positioned where I2 intersects the saving schedule, reflecting an increased r and increased S and I relative to E. This aligns with the standard result: an outward shift in investment demand raises both the real interest rate and the quantity of saving and investment in the new equilibrium.

In summary, the rightward shift of the investment demand curve due to the technological innovation raises the equilibrium interest rate and moves the economy to a higher saving and investment point, which corresponds to Point D. The other points correspond to scenarios inconsistent with an outward shift of investment demand (lower r or lower S and I) or misalignment with the direction of the shift.

BU.220.610.51.FA25 M2 Practice Quiz

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