Question #1 1. Assume a country’s economy is currently in recession. (c) Draw a correctly labeled...

Question #1
1. Assume a country’s economy is currently in recession.

(c) Draw a correctly labeled graph of the money market, and show
the impact of the central bank’s action of purchasing securities on the
nominal interest rate.
(e) Assume there is an increase in business confidence as a result of
the central bank’s action.
(i) What will happen to the demand for capital goods?
(ii) Draw a correctly labeled graph of the loanable funds
market, and show the effect of the change identified in part (e)(i) on
the real interest rate.
(f) Given your answer to part (e), what is the effect on potential real
output in the long run? Explain.

Solutions

Expert Solution

1. Assume a country’s economy is currently in recession.

market. This is likely to shift the money supply curve to the right and the rate of interest is likely to fall.

(e) Now with the reduction in the nominal interest rate, there is an increase in business confidence as a result

of the central bank’s action.

(i) This will increase the demand for capital goods and so investment spending would increase.

(ii) In the loanable funds market, there is an increase in the demand for loanable funds so that demand curve

shifts to the right and there is an increase in the real interest rate.

(f) In the long run, nominal interest rate would increase so that real interest rate would reach to its long run

level. There is no change in potential GDP in the long run.

Rahul Sunny answered 1 year ago

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