Question

3. Using the money supply (M1) model developed in class, explain the likely effects on the money supply of the following. Be sure your answer indicates what changes in the model. (4 points each)

a. the U.S. Treasury sells new U.S. bonds at auction and does not spend the proceeds

b. more stores are willing to accept debit or credit cards for transactions

c. banks start paying a higher interest rate on checkable deposits

Answer 1

a.When US treasury sells bonds at auction
and doesn't spend the proceeds, the money supply decreases resulting in a leftward shift in the money supply curve as a result quantity of money in the economy decreases and the interest rate rises.

b. As more stores start accepting card payments the demand for money will fall.
In case of cash money people often hold more money than required as a buffer for emergencies. So when the economy starts to become a cashless economy the demand for money will fall , money demand curve shifts left and interest rate will decrease even though quantity of money in the economy remains unchanged as does the money supply curve.

c. As banks start to pay a higher amount of interest on checkable deposits which are like demand deposits and have a very high liquidity, the demand for money in the economy will fall as the money demand curve shifts to the left and the market rate of interest falls while the quantity of money in the economy remains same along with money supply curve.