Which of the following statements is TRUE about the interest rate effect?
A) The interest rate effect is why the aggregate demand curve is upward sloping.
B) A lower price level lowers the interest rate, which causes businesses and consumers to increase their desired spending.
C) A higher price level lowers the interest rate, which causes business and consumers to increase their desired spending.
D) Expenditures will change as a result of a change in the real value of money balances when there is a change in the price level.

Question

Quizplus · Accepted Answer

The interest rate effect is the idea that a change in the price level will lead to a change in the interest rate, which in turn will affect spending by businesses and consumers. Specifically, a lower price level will result in a lower interest rate, which will encourage borrowing and investment and increase desired spending. Conversely, a higher price level will lead to a higher interest rate, which will discourage borrowing and investment and decrease desired spending. This relationship between the price level and the interest rate is key to understanding why the aggregate demand curve is upward sloping, as changes in the price level will lead to shifts along the curve as consumers and businesses react to changes in the interest rate. Option B correctly explains the relationship between the price level and the interest rate effect. Option A is incorrect because the interest rate effect explains why the aggregate demand curve is upward sloping, rather than being the reason for it. Option C is incorrect because a higher price level results in a higher interest rate, which will discourage spending rather than increasing it. Option D is also incorrect because the interest rate effect is related to changes in the interest rate, not changes in the real value of money balances.

Which of the Following Statements Is TRUE About the Interest