Question

Decreases in the money supply affect the economy indirectly because A. interest rates decrease causing planned investment to increase​, which causes an increase in aggregate demand. B. people spend excess money balances and​ thus, aggregate demand increases. C. interest rates increase​, causing planned investment to decrease​, which causes a decrease in aggregate demand. D. people have insufficient money balances and thus aggregate demand decreases. E. There is no indirect effect of the money supply on the economy.

Answer 1

Answer:

The correct answer is option C.

Explanation:

A decrease in the money supply would reduce the availability of credit in the market. The money supply curve will shift to the left. This would further cause the interest rate to increase.

This increase in the interest rate would increase the cost of borrowing. As a result, the cost of borrowing will increase. This will cause the planned investment to decline.

Since investment expenditure is a component of aggregate demand, a decline in the investment will cause the aggregate demand to decrease as well.