Questions: A decrease in the quantity of aggregate demand resulting from the interest rate effect would be depicted as a change from point a. A to point C. b. C to point A. c. B to point C. d. B to point A.

Solution Steps

The interest rate effect explains how changes in the price level influence interest rates and, consequently, aggregate demand. A higher price level leads to increased demand for money, pushing interest rates up. Higher interest rates discourage borrowing for investment and consumption, reducing aggregate demand. Conversely, a lower price level leads to lower interest rates, stimulating investment and consumption, and increasing aggregate demand.

A decrease in the quantity of aggregate demand due to the interest rate effect implies movement _along_ a given aggregate demand curve, not a shift of the entire curve. This is because the interest rate effect is one of the factors that determine the slope of the aggregate demand curve.

Point B represents a higher price level (P2) and a higher output (Q2) than point C (P1 and Q1, respectively). Moving from B to C corresponds to a decrease in the price level, leading to lower interest rates and a decrease in the quantity of aggregate demand (as explained in step 1).

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