An indirect effect of an increase in the price level works through
A) people substituting out of domestic goods and into foreign goods as exchange rates rise.
B) changes in trade balances as domestic goods become more expensive, causing interest rates to move in the opposite direction from the change in the exchange rate.
C) interest rates as people save more as the higher prices make their money balances less attractive.
D) interest rates as people borrow to maintain their money balances, bidding up interest rates and reducing total planned real expenditures.

Question

Quizplus · Accepted Answer

An increase in the price level reduces the purchasing power of individuals, causing them to borrow more to maintain their current level of spending. This bidding up of interest rates reduces total planned real expenditures, causing a decrease in aggregate demand and a decrease in output.

An Indirect Effect of an Increase in the Price Level