If there is an excess demand for bonds, is the price of bonds above or below...

If there is an excess demand for bonds, is the price of bonds above or below the equilibrium price? Explain the price adjustment in equilibrium.

Expert Solution

If there is an excess demand for bonds and the supply remains constant so the price of the bonds would rise above the equilibrium price in the bond market.

Now to reach to the equilibrium price again=>

As the price of bonds rises above the equilibrium price, it leads to fall in the interest rate as interest rate and price of the bond are inversely related to each other. The fall in the interest rate would result in the rise in overall investment which thereby increases the aggregate demand. As aggregate demand increases, output also rises with the corresponding rise in transactional demand (ky) but the money supply is at a constant level, therefore speculative demand (hi) needs to fall as money supply should be equal to money demand (sum of transactional demand and speculative demand). Due to the fall in the Speculative demand, interest rate needs to rise so as to decrease the price of bond.

Rahul Sunny answered 2 years ago

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