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Money Demand and Supply Effects
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Maria recently received a promotion, significantly increasing her income. In response to this change, she plans to purchase a new home, which will require a loan. Based on the principles of money demand and supply, what is the most likely outcome in the money market as a result of her increased income?

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Choose the Best Answer

A

The demand for money increases, leading to higher nominal interest rates.

B

The supply of loanable funds decreases, causing nominal interest rates to fall.

C

The demand for money decreases, resulting in lower nominal interest rates.

D

The supply of loanable funds increases, leading to an increase in nominal interest rates.

Understanding the Answer

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Answer

When Maria receives a promotion and her income increases, she is likely to demand more money because she can afford to spend or invest more. This increase in her income means she may want to take out a larger loan to buy a new home, which adds more demand for money in the market. As more people like Maria seek loans and increase their spending, the overall demand for money rises. If the supply of money does not change significantly, this increased demand can lead to higher interest rates, as lenders may charge more for the loans they provide. For example, if many individuals in Maria's area are also looking to buy homes, banks may raise interest rates due to the higher demand for mortgage loans, making it more expensive for everyone to borrow money.

Detailed Explanation

When Maria earns more money, she wants to hold more cash for her new home. Other options are incorrect because Some might think that if demand increases, the supply of money decreases; This option suggests that more money means less demand, which is the opposite of what happens.

Key Concepts

Money Demand
Interest Rates
Loanable Funds Market
Topic

Money Demand and Supply Effects

Difficulty

medium level question

Cognitive Level

understand

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