Question

Consider the money market in equilibrium. An increase in the price level causes

I. Ms/P to shift left

II. Md/P to shift left

		Only I is true
		Only II is true
		Both I and II are true
		Neither I nor II is true

Answer 1

When price level increase in the economy, then real money supply decreases (Ms/P), therefore money supply curve shifts leftward, as a result interest rate increase. Therefore when interest rate increases, then the investment become more expensive, so investment by the firms decreases, so production of goods and services decreases. AD curve shifts leftward, so quantity of real GDP decreases.

Hence it can be said that with the increase in the price level, Ms/P shift to the left. But it will not shift Md/P to the left.

It means only I is true.

Hence option first is the correct answer.