What happens to interest rates when the price level increases?

When the price level increases, interest rates typically increase as well. This relationship stems from the interaction between aggregate demand, aggregate supply, and monetary policy. As the price level rises, consumers and businesses need more money to purchase goods and services at the higher prices. This increased demand for money can lead to higher interest rates, as lenders charge more for borrowing due to increased demand.

Additionally, central banks may respond to rising price levels by increasing interest rates to combat inflation and stabilize the economy. Higher interest rates can also reflect the cost of borrowing, which tends to rise when there is increased inflationary pressure, making it more expensive for businesses and consumers to finance loans.

Thus, the correct answer reflects the fundamental economic principle that rising prices lead to higher interest rates in order to maintain equilibrium in the money market.