5. Explain why the supply curve in the classical theory of interest rates has a positive slope. Why does the demand curve in the classical theory have a negative slope?
Answer: The supply curve in the Classical theory of interest rates has a positive slope because the so-called substitution effect mandates that "higher interest rates increase the attractiveness of saving relative to consumption spending, encouraging more individuals to substitute current consumption (and future consumption) for some quantity of current saving." The demand curve in the Classical theory has a negative slope partly because "at lower rates of interest, more investment projects become economically viable and firms require more funds to finance a longer list of projects."