Interest Rate and Money Supply Relationship

When demand for money increases while the supply of money remains constant, there is a shortage of money in the market. This shortage causes the 'price' of money—the interest rate—to rise. Higher interest rates are required to equilibrate the excess demand for money. This is based on the fundamental principle of supply and demand: when demand exceeds supply and supply cannot adjust, the price (interest rate) rises. Option (a) is incorrect as price levels depend on many factors. Option (c) is opposite to what occurs. Option (d) would require more money supply, not just a change in demand. The interest rate mechanism balances the supply and demand for money in the economy.

Answer: (b).