   Chapter 16, Problem 2PA

Chapter
Section
Textbook Problem

The Federal Reserve expands the money supply by 5 percent.a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate.b. Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run.c. When the economy makes the transition from its short-run equilibrium to its new long-run equilibrium, what will happen to the price level?d. How will this change in the price level affect the demand for money and the equilibrium interest rate?e. Is this analysis consistent with the proposition that money has real effects in the short run but is neutral in the long run?

Subpart (a):

To determine

Impact of expansionary policy on the interest rate and the aggregate demand and supply model.

Explanation

Figure 1 illustrates the impact of increasing money supply on equilibrium position.

Figure 1 illustrates the impact of the expansionary policy on the interest rate. The horizontal axis in figure 1 represents the quantity of money demanded and supplied, and the vertical axis denotes the interest rate. By the theory of liquidity preference, an increase in the money supply shifts the money–supply curve to the right causing the equilibrium interest rate to decline as shown in Figure 1...

Subpart (b):

To determine

Impact of expansionary policy on the interest rate and the aggregate demand and supply model.

Subpart (c):

To determine

Impact of expansionary policy on the interest rate and the aggregate demand and supply model.

Subpart (d):

To determine

Impact of expansionary policy on the interest rate and the aggregate demand and supply model.

Subpart (e):

To determine

Impact of expansionary policy on the interest rate and the aggregate demand and supply model.

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