The interest-rate effect suggests that
A) a decrease in the supply of money will increase interest rates and reduce interest-sensitive consumption and investment spending.
B) an increase in the price level will increase the demand for money, reduce interest rates, and decrease consumption and investment spending.
C) an increase in the price level will increase the demand for money, increase interest rates, and decrease consumption and investment spending.
D) an increase in the price level will decrease the demand for money, reduce interest rates, and increase consumption and investment spending.

Question

Quizplus · Accepted Answer

According to the interest-rate effect, an increase in the price level will increase the demand for money because people will need more money to make purchases. This increase in demand for money will lead to an increase in interest rates because lenders can charge more when there is more demand for borrowing. Higher interest rates will decrease consumption and investment spending because borrowers will be discouraged from taking out loans when the cost of borrowing is higher. Therefore, Choice C is the correct answer.

The Interest-Rate Effect Suggests That