UPSC Prelims 2013 question on Money Demand Interest Rate

Analysis

According to the official UPSC Answer Key for Prelims 2013 General Studies Paper, the correct option is “an increase in the rate of interest”.

When money supply remains unchanged and demand for money increases, the price of money rises. This price of money is reflected in the rate of interest.

1. A fall in the level of prices — Incorrect

A fall in prices is not the immediate result of higher demand for money when money supply remains fixed.

Price level depends more directly on aggregate demand, aggregate supply and inflationary conditions.

This is not the defining effect in the money market.

2. An increase in the rate of interest — Correct

Interest rate is the price paid for borrowing or holding money.

When demand for money rises but supply remains the same, people compete for limited funds.

As a result, the rate of interest rises to restore money market equilibrium.

3. A decrease in the rate of interest — Incorrect

A decrease in interest rate occurs when money supply increases or demand for money falls.

Here, demand for money is increasing while supply remains unchanged.

So, the interest rate will rise, not fall.

4. An increase in the level of income and employment — Incorrect

Higher interest rates make borrowing costlier for firms and consumers.

This may reduce investment and spending.

Therefore, it does not directly lead to higher income and employment.