Suppose a country has no trade with other countries and people can borrow as much money as they want at the current interest rate.A decrease in the price level will generate
A)an increase in quantity demanded because of the real-balance effect.
B)an increase in quantity demanded because of the open-economy effect and the indirect effect.
C)an increase in quantity demanded because the real-balance effect will be stronger than the indirect effect and the open-economy effect.
D)an increase in quantity demanded because the indirect effect will be stronger than the real-balance effect.

Question

Quizplus · Accepted Answer

Since the country has no trade with other countries, there won't be any open-economy effect. Moreover, people can borrow as much money as they want at the current interest rate, so the indirect effect will also not be applicable. Therefore, the only effect that applies is the real-balance effect which states that a decrease in the price level will increase the real value of money, making people feel wealthier and thus increasing their quantity demanded. Hence, the correct answer is A.

Suppose a Country Has No Trade with Other Countries and People