Question

In: Economics

Drawing proper diagram, explain the followings: (a) The effect of expected inflation on the demand for...

Drawing proper diagram, explain the followings:

(a) The effect of expected inflation on the demand for bonds.

(b) The effect of expected inflation on the supply of bonds.

(c) Explain how expected inflation affects the interest rate.

Solutions

Expert Solution

above diagram show the effect of inflation on both demand and supply

(a) higher inflation expectations fall demand for bonds because at this time bond price increases and due to increase in bond price the interest rate falls as shown in the graph if only demand shifts due to inflation bond price increase

b) higher inflation expectations rise supply for bonds because at this time bond price increases and due to increase in bond price the interest rate falls so no one wants to hold the bond and tries to sell as soon as possible as shown in the graph if only supply shifts due to inflation bond price increase

c) due to inflation in the economy demands of bond falls and supply of bond rises this results in increase in the price of bond and fall in intrest rate as there is an inverse relationship between both bond price and inflation rate

for any query please comment and please upvote

Rahul Sunny answered 9 months ago
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