The Economic Significance of Interest rates?

Question

The Economic Significance of Interest rates?

Answer 1

Interest rates are the premium that lenders charge borrowers for the privilege of using their money.  It is mostly calculated based on the risk that the borrower will be unable to pay the loan (default risk) or that the investment will be unprofitable (market risk).  

Here is the main economic significance:  Opportunity cost.  If you have a project that could make 8% returns, but you don't have $10,000 to cover it, then you would need to borrow money.  Lets say you come to me, and i have $10,000 but my best project only returns 3%.  Well, I can lend you the money at 5%, then I make more money than I would have on my own project, and you have the $10,000 to pursue your 8% project, which will make you money with enough to pay me back.  

Put shortly, interest entices lenders to lend money to projects that will make them money, and allows the money to be (theoretically) put to the best use.

Answer 2

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