According to liquidity preference theory,an increase in the price level causes the interest rate to
A)increase, which makes output demanded increase.
B)increase, which makes output demanded decrease.
C)decrease, which makes output demanded increase.
D)decrease, which makes output demanded decrease.

Question

Quizplus · Accepted Answer

Liquidity preference theory states that people prefer to hold money in liquid form (cash or deposits) rather than in illiquid assets. An increase in the price level will lead to an increase in the demand for money as people need more money to make the same purchases. This increased demand for money will push up the interest rate. As interest rates increase, the cost of borrowing increases and investment decreases, which leads to a decrease in aggregate demand and output. Therefore, an increase in the price level causes the interest rates to increase, which makes output demanded decrease.

According to Liquidity Preference Theory,an Increase in the Price Level