Figure 4-2
-Employing Figure 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 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 money demand curve shifts to the right. As a result, the equilibrium moves from point G to point C. At point C, the interest rate is higher (7.5%) and the output is higher (3500). However, due to the increased money supply, investment demand increases which results in more borrowing and spending, increasing aggregate demand. This shift in aggregate demand causes economic growth, which shifts the money demand curve further to the right, leading the equilibrium to move from point C to point F. At point F, the interest rate begins to fall as the output continues to rise. The equilibrium finally settles at point D, where the interest rate is lower than the original rate (5%), and the output is higher than the initial output (4000). Therefore, we would observe the interest rate first rising to 7.5% then falling to 5%, as the economy moves from point G to C, to F and finally to D.

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