In the IS-LM model, which two variables are influenced by the interest rate?
A) supply of nominal money balances and demand for real balances
B) demand for real money balances and government purchases
C) supply of nominal money balances and investment spending
D) demand for real money balances and investment spending

Question

Quizplus · Accepted Answer

In the IS-LM model, the two variables that are influenced by the interest rate are the demand for real money balances and investment spending. As the interest rate rises, the demand for real money balances decreases, as individuals and firms are willing to hold less money when the opportunity cost of holding it (in terms of the foregone interest they could earn by investing it) is higher. At the same time, higher interest rates tend to reduce investment spending, as the cost of borrowing increases and firms are less likely to invest in new projects or expand their operations.

In the IS-LM Model, Which Two Variables Are Influenced by the Interest