Question

State whether the following statement is True, False, or Uncertain. Be sure to explain your answer.

In the basic market-clearing model, a permanent parallel upward shift in the production function causes aggregate output to increase, the interest rate to rise, and the real demand for money to fall.

Answer 1

In the basic market clearing model, an upward shift in the production function represents an increase in output.

This increase in output also raises the income levels, which will cause the demand for money to rise.

This increased demand for money will raise the interest rates, assuming that money supply remains constant.

Hence, the given statement is false.

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Another way to verify this result is: the increase in productivity causes the AS curve to shift to the right. This causes output to rise.

This causes a drop in the price level. This causes an increase in C and I, and the demand for money.

This causes a rise in the interest rates, assuming money supply is constant.