Figure 34-2. On the left-hand graph, MS represents the supply of money and MD represents the demand for money; on the right-hand graph, AD represents aggregate demand. The usual quantities are measured along the axes of both graphs.

-Refer to Figure 34-2. Assume the money market is always in equilibrium, and suppose r1 = 0.08; r2 = 0.12; Y1 = 13,000; Y2 = 10,000; P1 = 1.0; and P2 = 1.2. Which of the following statements is correct? When P = P2,
A) investment is lower than it is when P = P1.
B) nominal output is higher than it is when P = P1.
C) the expected rate of inflation is higher than it is when P = P1.
D) the velocity of money is higher than it is when P = P1.

Question

Figure 34-2. On the left-hand graph, MS represents the supply of money and MD represents the demand for money; on the right-hand graph, AD represents aggregate demand. The usual quantities are measured along the axes of both graphs.
 
-Refer to Figure 34-2. Assume the money market is always in equilibrium, and suppose r1 = 0.08; r2 = 0.12; Y1 = 13,000; Y2 = 10,000; P1 = 1.0; and P2 = 1.2. Which of the following statements is correct? When P = P2,
A) investment is lower than it is when P = P1. 
B) nominal output is higher than it is when P = P1. 
C) the expected rate of inflation is higher than it is when P = P1. 
D) the velocity of money is higher than it is when P = P1.

Quizplus · Accepted Answer

When P = P2, the price level is higher, leading to a higher interest rate (r2 = 0.12) compared to when P = P1 (r1 = 0.08). Higher interest rates generally lead to lower investment.