Final answer:
Increases in the price level increase the quantity of money needed for transactions and also increase the opportunity cost of holding money. The correct option is that price increases do the latter by prompting individuals and businesses to seek higher returns on their money due to higher interest rates.
The correct answer is option b. increase the quantity of money needed for buying and selling.
Step-by-step explanation:
Increases in the price level increase the quantity of money needed for buying and selling because each unit of currency now purchases less than it did before the increase. This leads to the need for more currency to carry out the same transactions. Moreover, higher price levels increase the opportunity cost of holding money, as holding onto cash, rather than investing it, means forgoing the higher returns that could be earned elsewhere due to higher interest rates in an inflationary environment.
According to the quantity theory of money and general macroeconomic principles, an increase in the money supply typically decreases interest rates and increases aggregate demand, leading to higher price levels. Conversely, contractionary monetary policy, such as increasing reserve requirements or conducting open market operations to reduce the money supply, raises interest rates, reducing borrowing and aggregate demand, which, in turn, tends to lower price levels.