Figure 4-2

-Employing Figure 4-2 above,the money market is initially in equilibrium at point G and after the economy moves to equilibrium,the Federal Reserve increases the money supply by 500.We would observe

Question

Figure 4-2
 
-Employing Figure 4-2 above,the money market is initially in equilibrium at point G and after the economy moves to equilibrium,the Federal Reserve increases the money supply by 500.We would observe

Quizplus · Accepted Answer

When the Federal Reserve increases the money supply by 500, the LM curve shifts down and to the right (from LM1 to LM2), leading to a decrease in the interest rate and an increase in output. Initially, the interest rate increases to 7.5% (point C), as the IS curve shifts left due to a decrease in investment spending (caused by higher interest rates). However, as output increases, the demand for money also increases, shifting the LM curve back up. The interest rate eventually falls to 5% (point D), and output increases to Y2 = 4000. Therefore, choice (B) is the correct answer.

Figure 4-2 -Employing Figure 4-2 Above,the Money Market Is Initially in Equilibrium