Question

9. Equilibrium in the bond market

The following graph shows a bond market in equilibrium at a bond price of $5.

Use the following graph input tool to answer the questions that follow. (Note: You will not be graded on any adjustments you make to the graph.)

Suppose the bond price has changed to $2, creating a ____________( surplus / shortage ) of ______________

Graph Input Tool Bond Market Supply I Current Price 5 Quantity Supplied (Millions of bonds) Quantity Demanded (Millions of bonds) Surplus (Millions of bonds) 0 Shortage (Millions of bonds) BOND PRICE (Dollars) Demand 0 1 9 10 2 3 4 5 6 7 8 QUANTITY (Millions of bonds)

million bonds. (Hint: Enter the new price in the “Current Price” field to see the changes in quantity demanded and quantity supplied.)

Suppose that instead the bond price has changed to $8. This creates a ____________( surplus / shortage ) of ______________million bonds.

Which of the following best describes how the bond market works when there is a surplus?

A- Quantity demanded increases until the old equilibrium is reached.

B- Quantity supplied declines until the old equilibrium is reached.

C- Quantity supplied increases while quantity demanded declines until the market achieves equilibrium.

D- Quantity supplied declines while quantity demanded increases until the market achieves equilibrium.

Which of the following best describes how the bond market works when there is a shortage?

A- Quantity supplied declines until the old equilibrium is reached.

B- Quantity supplied increases whereas quantity demanded declines until the market achieves equilibrium.

C- Quantity supplied declines whereas quantity demanded increases until the market achieves equilibrium.

D- Quantity demanded increases until the old equilibrium is reached.

Answer 1

At $2: shortage of 6 millions of bonds
(As quantity demanded > quantity supplied so there is a shortage = Qd - Qs = 8 - 2 = 6)

At $8: surplus of 6 millions of bonds
(As quantity demanded < quantity supplied so there is a surplus = Qs - Qd = 8 - 2 = 6)

D- Quantity supplied declines while quantity demanded increases until the market achieves equilibrium.
(When there is a surplus, Qs > Qd. So, Qs decreases and Qd increases until equilibrium is reached.)

B- Quantity supplied increases whereas quantity demanded declines until the market achieves equilibrium.
(When there is a shortage, Qs < Qd. So, Qd decreases and Qs increases until equilibrium is reached.)