When the supply and demand for money are expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the price level

Question

a. shifts money demand to the right and increases the interest rate.
b. shifts money demand to the left and increases the interest rate.
c. shifts money demand to the right and decreases the interest rate.
d. shifts money demand to the left and decreases the interest rate.
e. none of the above.

Answer 1

The correct answer is a. shifts money demand to the right and increases the interest rate.

Here's the reasoning:

When the price level increases, consumers need more money to buy the same amount of goods and services. This leads to an increase in the demand for money (the desire to hold cash or liquid assets). In the money market graph where the interest rate is on the vertical axis and the quantity of money is on the horizontal axis, an increase in money demand is represented as a shift of the money demand curve to the right.

As the money demand curve shifts to the right, assuming the supply of money is unchanged, this leads to a higher interest rate at the new equilibrium point where the quantity of money demanded equals the quantity of money supplied. Therefore, the interest rate increases as a result.