Question

question 3 (1 point)
imagine an economy where real national income (y) increases significantly while the real money supply (m^s) remains constant. which of the following outcomes is most likely?

increased income → higher money demand → higher interest rates → money market equilibrium.

increased income → higher money demand → lower interest rates → money market equilibrium.

increased income → unchanged money demand → unchanged interest rates → money market equilibrium.

increased income → reduced money demand → lower interest rates → money market equilibrium.

Explanation:

1. Recall the relationship between income, money demand, and interest rates in the money market: As real national income (\(Y\)) increases, people need more money for transactions (higher money demand, \(M^D\)).
2. With a constant real money supply (\(M^S\)), to restore equilibrium in the money market (where \(M^D = M^S\)), interest rates must rise. Higher interest rates make holding money less attractive, reducing money demand until it equals the fixed supply.
3. Analyze each option:

• First option: Increased income leads to higher money demand. To balance with constant supply, interest rates rise, reaching equilibrium. This matches the theory.
• Second option: Higher money demand should increase, not decrease, interest rates. Eliminate.
• Third option: Income increase should increase money demand (more transactions), so "unchanged money demand" is incorrect. Eliminate.
• Fourth option: Income increase increases, not reduces, money demand. Eliminate.

Answer:

A. Increased income → higher money demand → higher interest rates → money market equilibrium.