Sia
Question
Statistics
Posted 10 months ago
One of the reasons that aggregate demand (AD) is downward sloping is the interest rate effect.
Which of the following best describes the interest rate effect?
Choose 1 answer:
(A) A decrease in the price level increases real wealth
(B) An increase in the price level will lead to an increase in interest rates
(c) An increase in the price level decreases the demand for money
(D) An increase in the money supply lowers interest rates
(E) A decrease in the money supply lowers interest rates
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Answer from Sia
Posted 10 months ago
Solution by Steps
step 1
To understand the interest rate effect, we need to consider the relationship between the price level and interest rates
step 2
When the price level increases, people need more money to buy the same amount of goods and services. This leads to an increase in the demand for money
step 3
As the demand for money increases, the interest rate rises because people are willing to pay more to borrow money
step 4
Higher interest rates make borrowing more expensive, which tends to reduce spending on investment and consumption, leading to a decrease in aggregate demand
step 5
Therefore, an increase in the price level will lead to an increase in interest rates, which is the interest rate effect on aggregate demand
Answer
The correct answer that describes the interest rate effect is: An increase in the price level will lead to an increase in interest rates.
B
Key Concept
Interest Rate Effect
Explanation
The interest rate effect explains how an increase in the price level leads to higher interest rates, which in turn reduces investment and consumption, decreasing aggregate demand.
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