Draw bond demand and supply curves. Mark clearly the graphs, the axis and equilibrium price and...

Draw bond demand and supply curves.

Mark clearly the graphs, the axis and equilibrium price and quantity.
Assume that the current inflation rate is 5%, and you expect the inflation rate to stay the same over the coming year. However, the Fed announces that it will try to combat inflation and lower it to 2% over the coming year. Illustrate in the graph what will happen to demand and supply curves after the announcement if market participants expect the Fed to succeed. Mark clearly the new equilibrium.
Explain why you shifted the demand and/or supply curve as you did above (in 1-2 sentences).
What happens to the nominal interest rate as a result of the announcement?

Solutions

Expert Solution

A. The quantity of bonds is shown on the horizontal axis and the price on vertical axis. The supply of bonds(demand for loan able funds) increase with price of bonds because the higher bonds price means a low rate of interest and thus the firms requiring funds would demand more funds and to get more funds they would supply more bonds. Thus, upward sloping supply curve for bonds.

The demand curve for bonds is downward sloping, lower prices mean more interest rate and thus, more investors would demand bonds.

The equilibrium in market is at point E, where demand and supply of bonds equate.

Rahul Sunny answered 1 year ago

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