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. Under the assumptions of the model,
A) the quantity of goods and services demanded is higher at P2 than it is at P1.
B) the quantity of money is higher at Y1 than it is at Y2.
C) an increase in r from r1 to r2 is associated with a decrease in Y from Y1 to Y2.
D) All of the above are correct.

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. Under the assumptions of the model,
A) the quantity of goods and services demanded is higher at P2 than it is at P1. 
B) the quantity of money is higher at Y1 than it is at Y2. 
C) an increase in r from r1 to r2 is associated with a decrease in Y from Y1 to Y2. 
D) All of the above are correct.

Quizplus · Accepted Answer

According to the graph on the right-hand side, aggregate demand (AD) decreases from AD1 to AD2 as the interest rate (r) increases from r1 to r2 (assuming the money market is in equilibrium). This decrease in AD leads to a decrease in the quantity of goods and services demanded, which is represented by a shift from point P2 to P1 on the left-hand graph. Therefore, A is incorrect. 
In the money market, an increase in the interest rate leads to a decrease in the quantity of money demanded, which is represented by a shift from point Y1 to Y2 on the left-hand graph. Therefore, B is also incorrect. 
Finally, C is correct because it states that an increase in r leads to a decrease in Y, which is supported by the decrease in AD and the shift from point P2 to P1 on the left-hand graph.