Chapter 4R, Problem 7MCQ

To determine

To determine the effect of a decrease in aggregate price level due to the interest rate effect.

Explanation of Solution

When the aggregate price level falls, it leads to a fall in interest rates as well. Due to a fall in interest rate, the cost of borrowing capital will decline, leading to an increase in investment spending. Therefore, investment spending will rise due to the interest rate effect of a fall in the price level. Thus, option (b) is correct.

As it is well known that investment spending is a part of the aggregate demand, an increase in investment spending will lead to a rise in the aggregate demand. Therefore, due to the interest rate effect, the aggregate demand will rise. Thus, option ( e) is correct.

The purchasing power of money holding depends on the price level and not on the interest rate. Hence, the purchasing power of money holding does not get affected due to the interest rate effect. Option (a) is not the correct choice.

Finally, the interest rate effect cannot impact the interest rate, Hence, option ( c) is not the correct choice.

Economics Concept Introduction

Interest rate effect leads to a decrease in the aggregate price level as a decrease in interest rate will increase both consumption and investment spending in the economy and hence, the aggregate demand.