If the interest rate is decreased in an economy, it will
Answer & explanation
Answer: (c) increase the investment expenditure in the economy
A lower interest rate cuts the cost of borrowing. Firms then find it cheaper to buy machines and build capacity, so investment expenditure rises. The same fall in the cost of funds also tends to raise consumption, which is the opposite of what option (a) says.
- ✗ (a) A lower interest rate cuts the cost of loans for consumer purchases and lowers the reward for saving. Consumption demand therefore tends to rise, not fall.
- ✗ (b) Tax collection depends on tax rates and on incomes and output. An interest-rate cut does not directly raise it. Any effect would come only indirectly, through changes in output.
- ✓ (c) Producers' investment decisions, such as whether to buy a new machine, depend largely on the market rate of interest. When the rate falls, borrowing for investment becomes cheaper and investment expenditure goes up.
- ✗ (d) A lower interest rate reduces the return on deposits and other savings. That discourages saving and encourages spending, so it does not increase total savings.
Remember · Lower interest rates mean cheaper credit. That raises investment and consumption demand, which is the interest-rate channel of monetary policy. Higher rates do the reverse.
📘 Read it in NCERT: Class 12 Introductory Macroeconomics, Ch 4 (practise this chapter)
Sources
- NCERT Class 12 · Introductory Macroeconomics, Chapter 4 “Investment decisions by producers, such as whether to buy a new machine, depend, to a large extent, on the market rate of interest.”
- RBI Bulletin – Monetary policy transmission (interest rate channel) ↗ “expansionary monetary policy, for instance, leads to a lowering of the cost of loanable funds, which, in turn, raises investment and consumption demand and eventually both output and prices.”
Question: UPSC Civil Services (Preliminary) 2014, General Studies Paper I. Explanation: Minimalist IAS, checked 25 Oct 2026 (how we verify). ·
