According to the intertemporal substitution effect, when the price level increases, the interest rate
A) is not affected.
B) rises and the quantity of real GDP demanded decreases.
C) rises and the quantity of real GDP demanded increases.
D) falls and the quantity of real GDP demanded decreases.

Question

Quizplus · Accepted Answer

According to the intertemporal substitution effect, when the price level increases, the purchasing power of money decreases. This leads to an increase in the interest rate because people require higher returns to save their money rather than spending it immediately. As a result, the quantity of real GDP demanded decreases since the higher interest rate discourages investment and consumption. Option A is incorrect because the interest rate does increase as explained above. Option C is incorrect because the intertemporal substitution effect suggests that consumption and investment fall due to higher interest rates. Option D is incorrect because the intertemporal substitution effect results in a higher interest rate and a decrease in the quantity of real GDP demanded.

According to the Intertemporal Substitution Effect, When the Price Level