Question

An increase in the money supply curve would most likely result in which of the following situations?

Select one:

a. No effect on the real interest rate

b. An increase in the real interest rate

c. A decrease in the quantity of money available

d. A decrease in the real interest rate

Answer 1

The effects of increase in money supply would be seen in the IS-LM framework.

LM CURVE represents the money supply in the economy and is upward sloping

An increase in money supply would shift the LM curve to right. This would increase the real gdp or output. But the interest rate reduces due to the shift. So there is a decrease in the interest rate.

The reason is that when the LM CURVE shifts to right, there is excess supply of money which would reduce the interest rate. So r falls. A falls in the real interest rate would increase the demand for investment, which would lead to an increase in the output or Y.

So answer is option D) a decrease in real interest rate

(You can comment for doubts)