Which of the following is most likely to occur when interest rates increase in an economy?

• A. The supply of money will increase
• B. Consumer borrowing will increase
• C. Investment spending by firms will decrease
• D. Aggregate demand will rise

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the relationship between interest rates and economic behavior. Interest rates represent the cost of borrowing money. When interest rates increase, borrowing becomes more expensive.
2. Step 2: Analyze the effect on consumer borrowing. Since borrowing costs are higher, consumers are less likely to take out loans for consumption, so consumer borrowing tends to decrease, not increase.
3. Step 3: Consider the impact on investment spending by firms. Firms often finance investment projects through borrowing. Higher interest rates increase the cost of financing, which typically leads to a reduction in investment spending.
4. Step 4: Examine the supply of money. The supply of money is usually controlled by the central bank and is not directly increased by higher interest rates; in fact, higher rates often result from tighter monetary policy, which can reduce money supply growth.
5. Step 5: Look at aggregate demand. Since investment spending is a component of aggregate demand, a decrease in investment due to higher interest rates tends to reduce aggregate demand rather than increase it.