Final answer:
The quantity of money demanded decreases when nominal GDP decreases and the interest rate increases, following the principles of the quantity equation of money and the effects of government borrowing on interest rates.
"the correct option is approximately option B"
Step-by-step explanation:
In the context of monetary economics and interest rates, it is certain that the quantity of money demanded by the public will decrease when nominal GDP decreases and the interest rate increases. This situation aligns with the principles of the quantity equation of money, which suggests that if the velocity of money is constant, a change in the money supply will proportionally affect the nominal GDP. An increase in the interest rate typically discourages borrowing, reducing the money supply, and a decrease in nominal GDP implies a lower economic activity leading to reduced money demand.
Using the quantity equation of money, if we hold velocity constant, an increase in the interest rate would suggest that the cost of borrowing has gone up, leading to a decline in the investment and consumption that requires financing. This contractionary effect on the economy directly impacts the demand for money since less economic activity requires less currency for transactions. Furthermore, if nominal GDP decreases, it's a sign that the economy is shrinking, which further validates the reduced demand for money as people engage in fewer transactions.
Additionally, assuming substantial government borrowing affects private investment by increasing the demand for financial capital, it would lead to a higher equilibrium interest rate according to the graph presented, affirming the relationship between changes in government borrowing, investment levels, and interest rates. This phenomenon is known as "crowding out," where higher government demand for credit pushes up the interest rate and reduces investment spending. Therefore, an increase in the interest rate and a decrease in nominal GDP is the scenario where a decreased demand for money is most evident.