An increase in financial frictions results in ________.
A)a movement to the left along the AD curve
B)a leftward shift of the MP curve
C)a decrease in output and increase in inflation
D)a leftward shift of the IS curve

Question

Quizplus · Accepted Answer

An increase in financial frictions - such as higher borrowing costs, tighter credit conditions, or greater risk aversion among lenders - makes it more difficult and costly for households and firms to obtain financing, which reduces their willingness and ability to spend and invest. This leads to a leftward shift of the IS curve, as shown in the IS-MP model, where the equilibrium level of output and interest rate both decrease. The other options are incorrect or incomplete.

An Increase in Financial Frictions Results in ________