According to the liquidity-preference theory, how does an increase in the price level affect the interest rate?
A) It increases the money demand and the interest rate.
B) It lowers the money demand and the interest rate.
C) It increases the money demand and lowers the interest rate.
D) It lowers the money demand and increases the interest rate.

Question

Quizplus · Accepted Answer

According to the liquidity-preference theory, an increase in the price level increases the demand for money. As people hold more money, they have less money available to lend, which increases the interest rate to compensate for the decreased supply of loanable funds. Therefore, an increase in the price level leads to an increase in money demand and the interest rate (choice A).

According to the Liquidity-Preference Theory, How Does an Increase in the Price