Assume the following graph for money supply and money demand. Explain the adjustment process that would take place in this money market if the interest rate is 12 percent. Make sure that your answer includes a discussion of what happens to money balances and bond prices.

Question

Quizplus · Accepted Answer

The Answer is If the interest rate is 12 percent then the quantity of money in circulation will exceed the amount that households will want to hold. This excess supply of money will cause the interest rate to drop as people try to shift their funds into interest bearing bonds. The increased demand for bonds will bid their price up; i.e., the interest rate will drop.

Assume the Following Graph for Money Supply and Money Demand