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In: Economics

Using the principles of supply and demand, sketch an appropriate supply and demand graph, labeling all...

Using the principles of supply and demand, sketch an appropriate supply and demand graph, labeling all the lines, and use it to tell me why increasing the money supply causes interest rates to fall.

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Expert Solution

The graph above shows the money supply and money demand graph. The demand curve is downward sloping because as the interest rate raises the opportunity cost of spending also rise and people will save more, decreasing the demand for money, if the interest rate falls the money demand increase.

the money supply curve is a vertical curve because the money supply is fixed by the FEd. the money supply originally is at MS1 and the interest rate is at 10, when the money supply rises the money supply curve will shift to the right and the new curve will be at MS2 and the interest rate will be 5. With increase in the money supply people will buy more bonds and that will increase the price of the bonds and decrease the interest rate. as they are inversely related.

Rahul Sunny answered 1 year ago
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