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Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383

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BuyFindarrow_forward

Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383
Textbook Problem

Draw both the money market and bond market in equilibrium. Next, explain, and show diagrammatically, what happens to the interest rate and the price of bonds as a result of the Fed’s decreasing the money supply.

To determine

The relation between the bond price and the interest rate.

Explanation

The inverse relation between the bond price and its interest rate is shown in the figure below:

According to the diagram, initially, the money market is in equilibrium at ‘a’ with the bond price PB1 and the interest rate of 5 percent.  When the Fed increases the money supply, the supply curve shifts to the left from S1 to S2 shown in Panel (a)...

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