If the Fed decreases the money supply,causing the interest rate to rise,GDP
A)increases by the same amount as the increase in the interest rate
B)decreases by more than the increase in the interest rate because of the multiplier
C)decreases by the same amount as the decrease in investment
D)decreases by more than the decrease in investment because of the multiplier
E)decreases by less than the decrease in investment because of the multiplier

Question

Quizplus · Accepted Answer

When the Fed decreases the money supply, it causes the interest rate to rise, which makes borrowing more expensive for businesses and individuals. This decrease in investment leads to a decrease in the aggregate demand, thus causing a decrease in GDP. The decrease in GDP is greater than the decrease in investment due to the multiplier effect, which causes a ripple effect on other components of GDP such as consumption and net exports. Hence, the correct answer is (D) decreases by more than the decrease in investment because of the multiplier.

If the Fed Decreases the Money Supply,causing the Interest Rate