a year. The current, or market, rate of interest is determined primarily by the relation betweenthe supply of money and demands of borrowers (see Supply and Demand). When the supplyof money available for investment increases faster than the requirements of borrowers,interest rates tend to fall. Conversely, interest rates generally rise when the demand for investment fund grows faster than the available supply of funds to meet that demand.Business executives will not borrow money at an interest rate that exceeds the return theyexpect the use of the money to yield. '' Paul A. Samulelson & William D. Nordhus
Sixteen edition, Tata Mc Graw Hill Publishing Company Limited, New Dlhi, P.469''.It is the price of credit. But unlike other prices in the economy, the rate of interest is really aratio or two quantities: the money cost borrowing divided by the amount of money actually borrowed, usually expressed on an annual percentage basis. The cost of borrowing money,measured in rupee per year per rupee borrowed, is the interest rate.
When we examine how money affects economic activity, we will focus on the interest rate,which is often called "The price of money". Interest is rent paid for the use of money. In other words, people must pay for opportunity to borrow money. Financial institutions, as financialintermediaries, collect borrow money. Financial institutions, as financial intermediaries,collect money from savers in the form o deposit and provide that for business sector in theform of loan. These institutions pay the interest to the depositors for the money borrowedfrom them and charge interest from the borrower for money lend to them. As any price isdetermined theoretically, by the interplay of demand and supply in a market economy, the price of money- the interest rate- plays a vital role in the allocation of resources and in thedecision making of consumers and businesses. For example, an increase in the interest rate provides additional incentives to individuals and others to postpone current consumption(Save) and thereby free resources for investment. Interest rates send price signals to borrowers, lenders, and savers. Higher interests rates generally bring forth a greater volume of savings and stimulate the lending of fund i.e.
Lower rate of interest, onthe other hand, tends to reduce the volume of borrowing and capital investment, and lower rates stimulate borrowing and investment spending.
Investment is the function of interestrate. The quality and flow of investment determines the income in the economy. Therefore,