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Chapter 26Monetary Policy• Key Concepts• Summary• Practice Quiz• Internet Exercises    ©2000 South-Western College Publish...
In this chapter, you will  learn to solve these   economic puzzles:Why wouldis a monetary             a Nobel Laureate    ...
What are the Three Schools of Economic Thought?       • Classical       • Keynesian       • Monetarist                   3
What is the Keynesian   View of Money?People who hold cash or checking account balances incur an opportunity cost in foreg...
According to Keynes, why would people   hold money?• Transactions demand• Precautionary demand• Speculative demand        ...
What is the Transactions Demand for Money?The stock of money people hold to pay everyday predictable expenses             ...
What is the Precautionary Demand for Money?  The stock of money   people hold to pay   unpredictable expenses             ...
What is the Speculative Demand for Money?The stock of money people hold to take advantage of expected future changes in th...
How does a change in Interest Rates affectSpeculative Demand?As the interest rate falls, the opportunity cost of holding m...
What is the Demand for   Money Curve? A curve representing the  quantity of money that  people hold at different  possible...
How do Interest  Rates affect theDemand for Money?There is an inverse relationship between the quantity of money demanded ...
What gives theDemand for Money a Downward Slope?The speculative demand for money at possible interest rates               ...
What determines Interest Rates in the Market?  The demand and supply   of money in the   loanable funds market            ...
The Demand for Money Curve16%      Interest Rate12%                                A8%                                    ...
Increase in the           quantity of money               demandedDecrease in the interest rate                       15
The Equilibrium Interest Rate16%                           MS      Interest Rate                    Surplus12%8%          ...
Bond prices fall                and the interest                   rate rises         People sell           bondsExcessmon...
Bond prices rise               and the interest                  rate falls         People buy           bondsExcessmoneys...
Why do Bond Prices Fallas Interest Rates Rise?Bond sellers have to offer higher returns (lower price) to attract potential...
Why do Bond Prices Rise as Interest Rates Fall?Bond sellers are put in a better bargaining position as interest rates fall...
How can the Fedinfluence the Equilibrium      Interest Rate? It can increase or decrease   the supply of money            ...
Increase in the Money Supply16%                        MS1   MS2       Surplus      Interest Rate12%                      ...
Decrease in the Money Supply16%                           MS2    MS1      Interest Rate                       Shortage12% ...
Decrease the                      interest rate                Money              surplus and              people buy     ...
Increase in the                       interest rate              Money shortage and               people sell bondsDecreas...
In the Keynesian Model, what do changes in the Money Supply affect?Interest rates, which in turn affect investment spendin...
Change in                 the money                   supply   Change in     Keynesian      Change inprices, real GDP, Pol...
Expansionary Monetary Policy16%                        MS1   MS2       Surplus      Interest Rate12%                      ...
Investment Demand Curve16%      Interest Rate12%                            A8%                                     B     ...
When will Businessesmake an Investment?When the investment projects for which the expected rate of profit equals or exceed...
Product Market                                                 AS      Price Level                                        ...
What is the Classical    Economic View?The economy is stable in the long-run at full employment                     32
How did the ClassicalEconomists view the  Role of Money? They believed in the equation of exchange                 33
What is theEquation of Exchange?An accounting number of times per year a dollar of the money supply is spent on final good...
What is the  Velocity of Money?The average number of times per year a dollar of the money supply is spent on final goods a...
Money      Prices      MV = PQVelocity     Quantity                        36
What is the Monetarist Theory?That changes in the money supply directly determine changes in prices, real GDP, and employm...
Change in                the quantity                 of money   Change in     Monetarist     Change inprices, real GDP, P...
What is the Quantity  Theory of Money?The theory that changes in the money supply are directly related to changes in the p...
What is the Conclusion of theQuantity Theory of Money? Any change in the money  supply must lead to a  proportional change...
Who are the Modern Monetarists?Monetarist argue that velocity is not unchanging, but is nevertheless predictable          ...
According to the Monetarist, how do we avoid Inflation   and Unemployment?   We must be sure that    the money supply is  ...
Who is   Milton Friedman?In the 1950’s and 1960’s, he was a leader in putting forth the ideas of the modern-day monetarist...
What does Milton   Friedman Advocate?The Federal Reserve should increase the money supply by a constant percentage each ye...
How do the Keynesians view the Velocity of Money?Over long periods of time, it can be unstable and unpredictable          ...
The Velocity of Money76   GDP/M154321                         Year40           50     60    70     80   90   00           ...
What is the Conclusion of the Keynesians?A change in the money supply can lead to a much larger or smaller change in GDP t...
What is the Crux of theKeynesian Argument?Because velocity is unpredictable, a constant money supply may not support full ...
What is the Conclusion ofthe Keynesian Argument?The Federal Reserve must be free to change the money supply to offset unex...
What are the main pointsof Classical Economics?                 50
• Economy tends toward a full  employment equilibrium• Prices & wages are flexible• Velocity of money is stable• Excess mo...
What are the main pointsof Keynesian Economics?                 52
• The economy is unstable at less than  full employment• Prices & wages are inflexible• Velocity of money is stable• Exces...
What are the main points  of the Monetarists?                 54
• Economy tends toward a full  employment equilibrium• Prices & wages are flexible• Velocity of money is predictable• Exce...
What is theCrowding-Out Effect?Too much government borrowing can crowd out consumers and investors from the loanable funds...
What is the KeynesianView of the Crowding-     Out Effect?The investment demand curve is rather steep (vertical), so the c...
What is the MonetaristView of the Crowding-     Out Effect?The investment demand curve is flatter (horizontal), so the cro...
Key Concepts           59
Key Concepts•   What are the Three Schools of Economic Thou•   What is the Keynesian View of Money?•   How can the Fed inf...
Key Concepts cont.•   How did the Classical Economists view the Ro•   What is the Equation of Exchange?•   What is the Vel...
Key Concepts cont.• According to the Monetarist, how do we  avoid Inflation and Unemployment?• Who is Milton Friedman?• Wh...
Summary          63
The demand for money in theKeynesian view consists of threereasons why people hold money: (1)Transactions demand is money ...
The demand for money curveshows the quantity of money peoplewish to hold at various rates ofinterest. As the interest rate...
The Demand for Money Curve16%      Interest Rate12%                                A8%                                    ...
The equilibrium interest rate isdetermined in the money market bythe intersection of the demand formoney and the supply of...
An excess quantity of moneydemanded causes households andbusinesses to increase their moneybalances by selling bonds. This...
The Equilibrium Interest Rate16%                           MS      Interest Rate                    Surplus12%8%          ...
An excess quantity of moneysupplied causes households andbusinesses to reduce their moneybalances by purchasing bonds.The ...
The Keynesian view of themonetary policy transmissionmechanism operates as follows: First,the Fed uses its policy tools to...
Monetarism is the simpler viewthat changes in monetary policydirectly change aggregate demandand thereby prices, real GDP,...
The equation of exchange is anaccounting identity that is thefoundation of monetarism. Theequation (MV = PQ) states that t...
The quantity theory of money is amonetarist argument that the velocityof money (V) and the output (Q)variables in the equa...
The monetarist solution to aninept Fed tinkering with the moneysupply and causing inflation orrecession would be to have t...
Monetarists’ and Keynesians’views on fiscal policy are alsodifferent. Keynesians believe theaggregate supply curve isrelat...
Chapter 26 Quiz   ©2000 South-Western College Publishing                                            77
1. Keynes gave which of the following as a motive  for people holding money?   a. Transactions demand.   b. Speculative de...
2. A decrease in the interest rate, other things  being equal, causes a (an)   a. upward movement along the demand curve  ...
3. Assume the demand for money curve is  stationary and the Fed increases the money  supply. The result is that people   a...
Expansionary Monetary Policy16%                        MS1   MS2       Surplus      Interest Rate12%                      ...
4. Assume the demand for money curve is fixed  and the Fed decreases the money supply. The  result is a temporary   a. exc...
Decrease in the Money Supply16%                           MS2    MS1      Interest Rate                       Shortage12% ...
5. Assume the demand for money curve is  fixed and the Fed increases the money  supply. The result is that the price of  b...
6. Using the aggregate supply and demand model,  assume the economy is in equilibrium on the  intermediate portion of the ...
7. Based on the equation of exchange, the  money supply in the economy is calculated as   a. M = V/PQ.   b. M = V(PQ).   c...
8. The V in the equation of exchange  represents the   a. variation in the GDP.   b. variation in the CPI.   c. variation ...
9. Which of the following is not an issue in the  Keynesian-monetarist debate?   a. The importance of monetary vs. fiscal ...
10. Keynesians reject the influence of monetary  policy on the economy. One argument  supporting this Keynesian view is th...
Expansionary Monetary Policy8%                         MS1    MS2     Interest Rate6%                         E1          ...
11. Starting from an equilibrium at E 1 in Exhibit  12, a rightward shift of the money supply curve  from MS1 to MS2 would...
12. Beginning from an equilibrium at E2 in  Exhibit 12, a decrease in the money supply  from $600 billion to $400 billion ...
Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises           ...
END      94
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Transcript of " 12 monetary policy"

  1. 1. Chapter 26Monetary Policy• Key Concepts• Summary• Practice Quiz• Internet Exercises ©2000 South-Western College Publishing 1
  2. 2. In this chapter, you will learn to solve these economic puzzles:Why wouldis a monetary a Nobel Laureate What people wish to Why do economist suggest replacing policy transmission thehold money balances? an Federal Reserve with mechanism? intelligent horse? 2
  3. 3. What are the Three Schools of Economic Thought? • Classical • Keynesian • Monetarist 3
  4. 4. What is the Keynesian View of Money?People who hold cash or checking account balances incur an opportunity cost in foregone interest or profits 4
  5. 5. According to Keynes, why would people hold money?• Transactions demand• Precautionary demand• Speculative demand 5
  6. 6. What is the Transactions Demand for Money?The stock of money people hold to pay everyday predictable expenses 6
  7. 7. What is the Precautionary Demand for Money? The stock of money people hold to pay unpredictable expenses 7
  8. 8. What is the Speculative Demand for Money?The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmoney financial assets 8
  9. 9. How does a change in Interest Rates affectSpeculative Demand?As the interest rate falls, the opportunity cost of holding money falls, and people increase their speculative balances 9
  10. 10. What is the Demand for Money Curve? A curve representing the quantity of money that people hold at different possible interest rates, ceteris paribus 10
  11. 11. How do Interest Rates affect theDemand for Money?There is an inverse relationship between the quantity of money demanded and the interest rate 11
  12. 12. What gives theDemand for Money a Downward Slope?The speculative demand for money at possible interest rates 12
  13. 13. What determines Interest Rates in the Market? The demand and supply of money in the loanable funds market 13
  14. 14. The Demand for Money Curve16% Interest Rate12% A8% B4% Billions of dollars MD 500 1,000 1,500 2,000 14
  15. 15. Increase in the quantity of money demandedDecrease in the interest rate 15
  16. 16. The Equilibrium Interest Rate16% MS Interest Rate Surplus12%8% E Shortage4% MD Billions of dollars 500 1,000 1,500 2,000 16
  17. 17. Bond prices fall and the interest rate rises People sell bondsExcessmoneydemand 17
  18. 18. Bond prices rise and the interest rate falls People buy bondsExcessmoneysupply 18
  19. 19. Why do Bond Prices Fallas Interest Rates Rise?Bond sellers have to offer higher returns (lower price) to attract potential bond buyers, or else they will go elsewhere to get higher interest returns 19
  20. 20. Why do Bond Prices Rise as Interest Rates Fall?Bond sellers are put in a better bargaining position as interest rates fall (higher price); potential buyers cannot go elsewhere to get higher interest returns so easily 20
  21. 21. How can the Fedinfluence the Equilibrium Interest Rate? It can increase or decrease the supply of money 21
  22. 22. Increase in the Money Supply16% MS1 MS2 Surplus Interest Rate12% E1 E28% MD4% Billions of dollars 500 1,000 1,500 2,000 22
  23. 23. Decrease in the Money Supply16% MS2 MS1 Interest Rate Shortage12% E28% E1 MD4% Billions of dollars 500 1,000 1,500 2,000 23
  24. 24. Decrease the interest rate Money surplus and people buy bondsIncrease inthe money supply 24
  25. 25. Increase in the interest rate Money shortage and people sell bondsDecrease inthe money supply 25
  26. 26. In the Keynesian Model, what do changes in the Money Supply affect?Interest rates, which in turn affect investment spending, aggregate demand, and real GDP, employment, and prices 26
  27. 27. Change in the money supply Change in Keynesian Change inprices, real GDP, Policy interest & employment rates Change in the aggregate Change in demand curve investment 27
  28. 28. Expansionary Monetary Policy16% MS1 MS2 Surplus Interest Rate12% E1 E28% MD4% Billions of dollars 500 1,000 1,500 2,000 28
  29. 29. Investment Demand Curve16% Interest Rate12% A8% B I4% Billions of dollars 1,000 1,500 29
  30. 30. When will Businessesmake an Investment?When the investment projects for which the expected rate of profit equals or exceeds the interest rate 30
  31. 31. Product Market AS Price Level E2155 E1150 AD2 Full Employment AD1 Billions of dollars 6.0 6.1 31
  32. 32. What is the Classical Economic View?The economy is stable in the long-run at full employment 32
  33. 33. How did the ClassicalEconomists view the Role of Money? They believed in the equation of exchange 33
  34. 34. What is theEquation of Exchange?An accounting number of times per year a dollar of the money supply is spent on final goods and services 34
  35. 35. What is the Velocity of Money?The average number of times per year a dollar of the money supply is spent on final goods and services 35
  36. 36. Money Prices MV = PQVelocity Quantity 36
  37. 37. What is the Monetarist Theory?That changes in the money supply directly determine changes in prices, real GDP, and employment 37
  38. 38. Change in the quantity of money Change in Monetarist Change inprices, real GDP, Policy the money & employment supply Change in the aggregate demand curve 38
  39. 39. What is the Quantity Theory of Money?The theory that changes in the money supply are directly related to changes in the price level 39
  40. 40. What is the Conclusion of theQuantity Theory of Money? Any change in the money supply must lead to a proportional change in the price level 40
  41. 41. Who are the Modern Monetarists?Monetarist argue that velocity is not unchanging, but is nevertheless predictable 41
  42. 42. According to the Monetarist, how do we avoid Inflation and Unemployment? We must be sure that the money supply is at the proper level 42
  43. 43. Who is Milton Friedman?In the 1950’s and 1960’s, he was a leader in putting forth the ideas of the modern-day monetarists 43
  44. 44. What does Milton Friedman Advocate?The Federal Reserve should increase the money supply by a constant percentage each year to enhance full employment and stable prices 44
  45. 45. How do the Keynesians view the Velocity of Money?Over long periods of time, it can be unstable and unpredictable 45
  46. 46. The Velocity of Money76 GDP/M154321 Year40 50 60 70 80 90 00 46
  47. 47. What is the Conclusion of the Keynesians?A change in the money supply can lead to a much larger or smaller change in GDP than the monetarists would predict 47
  48. 48. What is the Crux of theKeynesian Argument?Because velocity is unpredictable, a constant money supply may not support full employment and stable prices 48
  49. 49. What is the Conclusion ofthe Keynesian Argument?The Federal Reserve must be free to change the money supply to offset unexpected changes in the velocity of money 49
  50. 50. What are the main pointsof Classical Economics? 50
  51. 51. • Economy tends toward a full employment equilibrium• Prices & wages are flexible• Velocity of money is stable• Excess money causes inflation• Short-run price & wage adjustments cause unemployment• Monetary policy can change aggregate demand & prices• Fiscal policies are not necessary 51
  52. 52. What are the main pointsof Keynesian Economics? 52
  53. 53. • The economy is unstable at less than full employment• Prices & wages are inflexible• Velocity of money is stable• Excess demand causes inflation• Inadequate demand causes unemployment• Monetary policy can change interest rates and level of GDP• Fiscal policies may be necessary 53
  54. 54. What are the main points of the Monetarists? 54
  55. 55. • Economy tends toward a full employment equilibrium• Prices & wages are flexible• Velocity of money is predictable• Excess money causes inflation• Short-run price & wage adjustments cause unemployment• Monetary policy can change aggregate demand & prices• Fiscal policies are not necessary 55
  56. 56. What is theCrowding-Out Effect?Too much government borrowing can crowd out consumers and investors from the loanable funds market 56
  57. 57. What is the KeynesianView of the Crowding- Out Effect?The investment demand curve is rather steep (vertical), so the crowding- out effect is insignificant 57
  58. 58. What is the MonetaristView of the Crowding- Out Effect?The investment demand curve is flatter (horizontal), so the crowding-out effect is significant 58
  59. 59. Key Concepts 59
  60. 60. Key Concepts• What are the Three Schools of Economic Thou• What is the Keynesian View of Money?• How can the Fed influence the Equilibrium Int• In the Keynesian Model, what do changes in th• What is the Classical Economic View? 60
  61. 61. Key Concepts cont.• How did the Classical Economists view the Ro• What is the Equation of Exchange?• What is the Velocity of Money?• What is the Quantity Theory of Money?• What is the Conclusion of the Quantity Theor• Who are the Modern Monetarists? 61
  62. 62. Key Concepts cont.• According to the Monetarist, how do we avoid Inflation and Unemployment?• Who is Milton Friedman?• What does Milton Friedman Advocate?• What is Classical Economists?• What is Keynesian Economists?• What is Monetarism? 62
  63. 63. Summary 63
  64. 64. The demand for money in theKeynesian view consists of threereasons why people hold money: (1)Transactions demand is money heldto pay for everyday predictableexpenses. (2) Precautionary demandis money held to pay unpredictableexpenses. (3) Speculative demand ismoney held to take advantage ofprice changes in nonmoney assets. 64
  65. 65. The demand for money curveshows the quantity of money peoplewish to hold at various rates ofinterest. As the interest rate rises, thequantity of money demanded is lessthan when the interest rate is lower. 65
  66. 66. The Demand for Money Curve16% Interest Rate12% A8% B4% Billions of dollars MD 500 1,000 1,500 2,000 66
  67. 67. The equilibrium interest rate isdetermined in the money market bythe intersection of the demand formoney and the supply of moneycurves. The money supply (M1),which is determined by the Fed, isrepresented by a vertical line. 67
  68. 68. An excess quantity of moneydemanded causes households andbusinesses to increase their moneybalances by selling bonds. Thiscauses the price of bonds to fall,thus driving up the interest rate. 68
  69. 69. The Equilibrium Interest Rate16% MS Interest Rate Surplus12%8% E Shortage4% MD Billions of dollars 500 1,000 1,500 2,000 69
  70. 70. An excess quantity of moneysupplied causes households andbusinesses to reduce their moneybalances by purchasing bonds.The effect is to cause the price ofbonds to rise, and, thereby, therate of interest falls. 70
  71. 71. The Keynesian view of themonetary policy transmissionmechanism operates as follows: First,the Fed uses its policy tools to changethe money supply. Second, changes inthe money supply change theequilibrium interest rate, which affectsinvestment spending. Finally, a changein investment changes aggregatedemand and determines the level ofprices, real GDP, and employment. 71
  72. 72. Monetarism is the simpler viewthat changes in monetary policydirectly change aggregate demandand thereby prices, real GDP, andemployment. Thus, monetaristsfocus on the money supply, ratherthan on the rate of interest. 72
  73. 73. The equation of exchange is anaccounting identity that is thefoundation of monetarism. Theequation (MV = PQ) states that themoney supply multiplied by thevelocity of money is equal to theprice level multiplied by real output.The velocity of money is the numberof times each dollar is spent during ayear. Keynesians view velocity asvolatile but monetarists disagree. 73
  74. 74. The quantity theory of money is amonetarist argument that the velocityof money (V) and the output (Q)variables in the equation of exchangeare relatively constant. Given thisassumption, changes in the moneysupply yield proportionate changes inthe price level. 74
  75. 75. The monetarist solution to aninept Fed tinkering with the moneysupply and causing inflation orrecession would be to have the Fedsimply pick a rate of growth in themoney supply that is consistent withreal GDP growth and stick to it. 75
  76. 76. Monetarists’ and Keynesians’views on fiscal policy are alsodifferent. Keynesians believe theaggregate supply curve isrelatively flat, and monetaristsview it as relatively vertical.Because the crowding out effect islarge, monetarists assert that fiscalpolicy is ineffective. Keynesiansargue that crowding out is smalland that fiscal policy is effective. 76
  77. 77. Chapter 26 Quiz ©2000 South-Western College Publishing 77
  78. 78. 1. Keynes gave which of the following as a motive for people holding money? a. Transactions demand. b. Speculative demand. c. Precautionary demand. d. All of the above. D. These are the three motives for holding currency and checkable deposits (M1) rather than stocks, bonds, or other nonmoney forms of wealth. 78
  79. 79. 2. A decrease in the interest rate, other things being equal, causes a (an) a. upward movement along the demand curve for money. b. downward movement along the demand curve for money. c. rightward shift of the demand curve for money. d. leftward shift of the demand curve for money.B. At a lower interest rate, money is demanded because the opportunity cost of holding money is lower. 79
  80. 80. 3. Assume the demand for money curve is stationary and the Fed increases the money supply. The result is that people a. increase the supply of bonds, thus driving up the interest rate. b. increase the supply of bonds, thus driving down the interest rate. c. increase the demand for bonds, thus driving up the interest rate. d. increase the demand for bonds, thus driving down the interest rate. D. 80
  81. 81. Expansionary Monetary Policy16% MS1 MS2 Surplus Interest Rate12% E1 E28% MD4% Billions of dollars 500 1,000 1,500 2,000 81
  82. 82. 4. Assume the demand for money curve is fixed and the Fed decreases the money supply. The result is a temporary a. excess quantity of money demanded. b. excess quantity of money supplied. c. increase in the price of bonds. d. increase in the demand for bonds. A. 82
  83. 83. Decrease in the Money Supply16% MS2 MS1 Interest Rate Shortage12% E28% E1 MD4% Billions of dollars 500 1,000 1,500 2,000 83
  84. 84. 5. Assume the demand for money curve is fixed and the Fed increases the money supply. The result is that the price of bonds a. rises. b. remains unchanged. c. falls. d. none of the above.A. The result is an excess beyond the amount people wish to hold and they buy bonds which drives the price of bonds upward. 84
  85. 85. 6. Using the aggregate supply and demand model, assume the economy is in equilibrium on the intermediate portion of the aggregate supply curve. A decrease in the money supply will decrease the price level and a. lower both the interest rate and the real GDP. b. raise both the interest rate and real GDP. c. lower the interest rate and raise real GDP. d. raise the interest rate and lower real GDP. D. The decrease in money supply increases the interest rate which decreases investment. Since investment is a component of aggregate demand, the aggregate demand curve shifts leftward and real GDP declines. 85
  86. 86. 7. Based on the equation of exchange, the money supply in the economy is calculated as a. M = V/PQ. b. M = V(PQ). c. MV = PQ. d. M = PQ - V. C. The equation of exchange is MV = PQ rewritten, M = PQ/V 86
  87. 87. 8. The V in the equation of exchange represents the a. variation in the GDP. b. variation in the CPI. c. variation in real GDP. d. average number of times per year a dollar is spent on final goods and services.D. In the equation of exchange, GDP is defined as PQ and the CPI is an index to measure the price level (P). 87
  88. 88. 9. Which of the following is not an issue in the Keynesian-monetarist debate? a. The importance of monetary vs. fiscal policy. b. The importance of a change in the money supply. c. The importance of a crowding-out effect. d. All of the above are part of the debate. D. Monetarists believe the effects of monetary policy are more powerful than fiscal policy. They view the shape of the investment demand curve as less steep, so the crowding- out effect is significant. Keynesians disagree. 88
  89. 89. 10. Keynesians reject the influence of monetary policy on the economy. One argument supporting this Keynesian view is that the a. money demand curve is horizontal at any interest rate. b. aggregate demand curve is nearly flat. c. investment demand curve is nearly vertical. d. money demand curve is vertical. C. If the investment demand curve is nearly vertical, changes in money supply and resulting changes in interest rate have little effect on investment and aggregate demand. 89
  90. 90. Expansionary Monetary Policy8% MS1 MS2 Interest Rate6% E1 E24% MD2% Billions of dollars 200 400 600 800 90
  91. 91. 11. Starting from an equilibrium at E 1 in Exhibit 12, a rightward shift of the money supply curve from MS1 to MS2 would cause an excess a. demand for money, leading people to sell bonds. b. supply of money, leading people to buy bonds. c. supply of money, leading people to sell bonds. d. demand for money, leading people to buy bonds.B. An excess quantity of money supplied causes people to buy bonds. The greater demand for bonds causes the price of bonds to increase and the interest rate to decrease. 91
  92. 92. 12. Beginning from an equilibrium at E2 in Exhibit 12, a decrease in the money supply from $600 billion to $400 billion causes people to a. sell bonds and drive the price of bonds down. b. buy bonds and drive the price of bonds up. c. buy bonds and drive the price of bonds down. d. sell bonds and drive the price of bonds up. A. An excess quantity of money demanded causes people to sell. The greater supply of bonds on the market causes the price of bonds to decrease and the interest rate to increase. 92
  93. 93. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 93
  94. 94. END 94
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