Question

1. Consider the current COVID-19 pandemic and the subsequent economic recession.

a). Are firms looking to invest or expand in this environment? Using and drawingthe supply curve for bonds, explain what happens.

b). Are individuals looking to invest or buy bonds in this environment? Assume that there are NO other assets in this economy – we are just talking about bonds. Use and draw the demand curve for bonds. Hint: Consider bond as being an asset and use the Theory of Portfolio Choice.

Answer 1

a) In these particular situations, the firm would like to invest rather than expand in business. here the reason behind this is the lack of demand. if they will expand the business then there may not be sufficient demand for the new product. so it will be better for the firms to invest their money in terms of bonds. so the bond is one of the effective measures and strategies for this type of situation. so supply of bonds in this situation is more to absorb the excess of money from the market. so the government will sell bonds and when the Fed sells bonds to the public, there is shifting the supply curve to the right. so the expected result is that the intersection of the supply and demand curve is lower price and a higher equilibrium interest rate, and the interest rate rises.

b) The individual will buy bonds in this situation, if the bond is the only option then the demand for the will increase, and that shift the demand curve to its right. so here there is a low in price and high in demand for the bonds. As the bond is only the efficient investment option so the individual will go for that with a projection of the level of risk.