Chapter 4R, Problem 6MCQ

To determine

To determine the effect of wealth effect as it increases the aggregate price level.

Explanation of Solution

Explanation for the correct option:

Due to the wealth effect, as the aggregate price level rise which decreases both the consumption as well as investment spending will subsequently decrease the aggregate demand.

Explanation for incorrect options:

Due to the wealth effect, people have more money, and the price level increases. This does decrease the purchasing power.

Due to the wealth effect, an increase in the price level will not decrease the interest rate but rather increases the interest rate as IS curve shifts to the right.

Due to the wealth effect, an increase in the price level will not decrease the interest rate, but rather increases the interest rate and decreases the investment spending as IS curve shifts to the right.

Due to the wealth effect, nominal wages do not decrease.

Thus, option ‘e’ is the correct option.

Economics Concept Introduction

Due to the wealth effect, people having more money at their disposal will demand more goods and services. This leads to an increase in prices and the overall price level in the economy rises.