Question

Which of the following best describes the "interest rate effect"?

An increase in the price level raises the interest rate and chokes off government spending.

An increase in the price level lowers the interest rate and chokes off investment and consumption spending.

An increase in the price level lowers the interest rate and chokes off government spending.

An increase in the price level raises the interest rate and chokes off investment and consumption spending.

If the marginal propensity to consume is 0.85, then a $10,000 increase in disposable income will

		increase consumption by $7,500.
		decrease consumption by $8,500.
		decrease saving by $1,500.
		increase saving by $1,500.

Answer 1

1) An increase in the price level will lead to a decline in the real money balance . as a result, the money supply curve will shift leftward. Hence, the interest rate will increase.

This will lead to a decline in the investment as both are inversely related and also due to rise in the interest rate people will want to save more and hence consumption will decline.

Hence, option D is correct.

2) C = cYd

=> change in C = c*Change in Yd

=> Change in C = $ [0.85 * 10,000]

Change in C = $ 8500 (increase)

or

an increase in saving by $ 1500 (10,000 - 8500)

Hence correct option is D

answered by: anonymous