Suppose a country has no trade with other countries and people can borrow as many funds as they want at the current interest rate. An increase in the price level will generate
A) a decrease in total planned real expenditures because of the real-balance effect.
B) a decrease in total planned real expenditures because of the open-economy effect and the indirect effect.
C) a decrease in total planned real expenditures because the real-balance effect will be stronger than the indirect effect and the open-economy effect.
D) a decrease in total planned real expenditures because the indirect effect will be stronger than the real-balance effect.

Question

Quizplus · Accepted Answer

In a closed economy with no external trade, an increase in the price level will only affect the real-balance effect, which will decrease the total planned real expenditures. The real-balance effect is the decrease in the purchasing power of money holdings due to an increase in the price level, which reduces consumers' real wealth and decreases their willingness to spend. Therefore, Choice A is the correct answer. Choices B, C and D are incorrect because they involve the open-economy effect and the indirect effect, which are not applicable in a closed economy with no external trade.

Suppose a Country Has No Trade with Other Countries and People