Which of the following correctly describes the interest-rate effect?
A) If the price level decreases, consumer purchasing power decreases, the demand for credit rises, interest rates rise, debt-financed borrowing decreases, and real GDP demanded falls.
B) If the price level decreases, consumer purchasing power increases, the demand for credit rises, interest rates rise, debt-financed borrowing decreases, and real GDP demanded falls.
C) If the price level decreases, consumer purchasing power increases, the demand for credit falls, interest rates rise, debt-financed borrowing decreases, and real GDP demanded falls.
D) If the price level decreases, consumer purchasing power increases, the demand for credit falls, interest rates fall, debt-financed borrowing increases, and real GDP demanded increases.

Question

Quizplus · Accepted Answer

The interest-rate effect suggests that a lower price level increases consumer purchasing power, which reduces the demand for credit, leading to lower interest rates. This, in turn, encourages more debt-financed borrowing, increasing the quantity of real GDP demanded.

Which of the Following Correctly Describes the Interest-Rate Effect