1 Explain the relationship between interest rates and unempl

1. Explain the relationship between interest rates and unemployment. How do changes in the interest rate affect the level of unemployment in the economy? (10 points)

Solution

Many companies and organisations have to borrow funds at some interest rate in order to finance their business.These companies create and provide employment opportunities to various people in the economy.Decision of how much to invest in business by companies depend on how much they can borrow from market.Investment function is negatively related to interest rates.So if interest rate on borrowing in the economy is high,organisations prefer to borrow and invest less in business depending on profit and cost considerations,so they may not be able to fully expand the business, hence leading to decrease in the creation of employment opportunities in the economy.

Similarly,when interest rates are low, companies can borrow more .Since borrowing will be less costly at low interest rates, they can borrow more which leads to expansion of their business and hence decrease in unemployment.