Question

When the money supply decreases, other things being equal,

A. real interest rates fall and investment spending rises
B. real interest rates fall and investment spending falls
C. real interest rates rise and investment spending falls
D. None of the above

Answer 1

Answer: The answer is C

Explanation: The supply of money is the total amount of money in circulation in a country at a given period of time. The supply of money includes the total bank deposit.

The bank rate is the rate of interest Central Bank charges commercial banks and other financial institutions for lending or borrowing from them and discounting their bill. When their is an increase in bank rate, it will increase interest rate charged by bank on borrowing from the bank. This will discourage commercial bank from lending to people, it will also discourage businessmen and women from borrowing from the commercial bank to invest in the economy.

Therefore, investment spending will fall as a result of increase in interest rate.

Answer 2

C. real interest rates rise and investment spending falls

Step-by-step explanation:

Due to the decrease in the money supply, keeping other things remain constant. The investment spending falls and due to the shortage of money, the real interest rate is rise so that it will become expensive for the customer to take out the loan.

Hence, it shows a direct relationship between the change in money supply and the investment spending while in respect of real interest rate it shows an inverse relationship between the change in money supply and real interest rate.

Hence, all other options are wrong except C.