The income effect refers to the situation when a higher nominal interest rate results from a(n)
A)decrease in income that increases the demand for money.
B)increase in income that increases the demand for money.
C)increase in the price level that increases the demand for money.
D)decrease in the price level that increases the demand for money.

Question

Quizplus · Accepted Answer

The income effect refers to the fact that an increase in the level of income raises the demand for money, as people want to hold more money to maintain their standard of living. As a result, a higher nominal interest rate is required to induce people to hold the additional money balances they demand. Therefore, an increase in income leads to an increase in the nominal interest rate, and choice (B) is the best answer.

The Income Effect Refers to the Situation When a Higher