According to liquidity-preference theory, how does an increase in the price level affect the interest rate and output demanded, respectively?
A) The interest rate increases, and output demanded increases.
B) The interest rate increases, and output demanded decreases.
C) The interest rate decreases, and output demanded increases.
D) The interest rate decreases, and output demanded decreases.

Question

Quizplus · Accepted Answer

According to liquidity-preference theory, an increase in the price level leads to an increase in the demand for money. This increases the interest rate, as people are willing to pay more to hold onto their cash. At the same time, firms and individuals decrease their demand for goods and services because they have less purchasing power due to the higher price levels. This leads to a decrease in output demanded. Therefore, an increase in the price level leads to an increase in the interest rate and a decrease in output demanded, which is represented by option B.

According to Liquidity-Preference Theory, How Does an Increase in the Price