Question

1. In our model from chapter 4, the supply of bonds to domestic and private sectors equals the demand for bonds, i.e.
   1. Plot this graphic, label the axis and explain why the supply of bonds to domestic and private sectors is a vertical line.
   2. Use this graphic to show and explain what happens to the interest rate if the central bank decides to reduce their holding of Domestic government Bonds .
   3. Can you say what happens, under this scenario, to the demand for foreign bonds, i.e. the demand for bonds issued by foreign governments.
   4. Show in the Monetary market the effect of the decision the central bank took. Explain in words why the curve(s) shift.
   5. Now use the Foreign exchange market graphic to explain what happens to the Exchange rate.
   6. If the central bank from the foreign economy wants to keep the exchange rate at the level at the value it was before the domestic central bank decided to reduce What policy must this central bank implement? Please explain and show this in a graphic.
2. What determined movements of gold between countries under the gold standard, and why? Under the gold standard "rules of the game" would such movements be likely to continue until a country's gold stock was depleted? Why or why not?
3. Consider the case of a gold-standard economy.
4. What effect would you expect an increase in the price of gold to have on the level of domestic real GDP, and why?
5. What effect would you expect the change in real GDP to have on net exports?
6. What is the net effect of the increase in the price of gold and the change in real GDP on net exports, and why?

Answer 1

For a, b, c and d answer- please refer to the images.

d) The effect of central bank in monetary market:

d.1) Money supply increase in the economy as central bank issues lesser bonds.

d.2) It will lead to inflation as money supply will be more than money demand since central banks issues lesser bonds.

e) Central bank should take policies will will decrease the money supply in the hands of the people. It should offer more options for investments in the domestic market.

Movements of the gold market depends upon the whole economy. When the economy develops, the demand for gold generally rise.

Increase in the price of gold will lead to rise in level of domestic real GDP as demand for gold is considered as a growth factor of the economy.

Increase Net exports will lead to rise in real GDP as net exports is an component of GDP.

Net effect on net exports= change in real GDP + increase in the price of gold(because of rise in demand for gold)