Using the aggregate supply and demand model, assume the economy is in equilibrium on the intermediate portion of the aggregate supply curve. A decrease in the money supply will decrease the price level and a. lower both the interest rate and real GDP. b. raise both the interest rate and real GDP. c. lower the interest rate and raise real GDP. d. raise the interest rate and lower real GDP.

The aggregate supply and demand model is a macroeconomic model that shows the relationship between the overall price level, real GDP, and the level of production within an economy. It consists of the aggregate demand (AD) curve, which represents the total demand for goods and services, and the aggregate supply (AS) curve, which represents the total supply of goods and services. The intersection between the AD and AS curves determines the equilibrium price level and real GDP in an economy.

A decrease in the money supply will cause a decrease in the price level. This is because lower money supply reduces the amount of money available for spending, translating to lower aggregate demand. To understand how this affects the interest rate and real GDP, we need to analyze the AD curve. The AD curve can be expressed as AD = C + I + G + NX, where C is consumption, I is investment, G is government spending, and NX is net exports. A decrease in the money supply will affect consumption and investment, which will shift the AD curve.

The decrease in the money supply will lead to a decrease in consumption and investment, which will shift the AD curve to the left. This is due to the fact that people will have less money to spend and, to compensate for their lower purchasing power, they will cut back on consumption and investment. Consequently, this will cause the aggregate demand to decline.

Since the economy initially is in equilibrium on the intermediate portion of the AS curve, it is sensitive to changes in the price level. Therefore, as the price level decreases, the aggregate supply will increase due to the higher level of production at a lower price. With the decline in aggregate demand, the equilibrium point will shift to a new position with a lower price level and a lower real GDP. This means the answer is between option a and option d. Now let's analyze the effect on interest rates. A decrease in the money supply usually leads to higher interest rates since there is less money circulating in the economy, making borrowing more expensive. This further reduces investment and consumption. Therefore, the correct answer is option d: the decrease in the money supply will raise the interest rate and lower real GDP.