Suppose that expenditure is very responsive to interest rates, so even a small change in interest rates has a substantial effect on investment. In this case, a fall in the price level that results in a small drop in interest rates will:
A) not increase output, resulting in a vertical AD function.
B) increase output only slightly, resulting in a steep AD function.
C) increase output modestly, resulting in a horizontal AD function.
D) increase output sharply, resulting in a low slope in the AD function.

Question

Quizplus · Accepted Answer

If expenditure is very responsive to interest rates, a small drop in interest rates will lead to a substantial increase in investment and hence a sharp increase in output. This scenario describes a situation where the aggregate demand (AD) function would have a low slope, indicating a high sensitivity of output to changes in the price level.

Suppose That Expenditure Is Very Responsive to Interest Rates, So