Question

3. (a) Use a diagram of the demand and supply of money to depict the impact of (i) the Fed selling bonds on the open market; (ii) the Fed lowering the reserve requirement. What is the effect of these monetary policies on the price level in the economy? Draw a separate diagram for each case. 4. What is the effect on the U.S. aggregate demand in each of the following events? Which component of AD is affected? a. Business owners are optimistic about the health of the economy. b. Consumers expect the job market to weaken in the next few months. c. The stock market has reached new record-high levels of value. d. An economic boom occurs in Canada. 5. Explain why the long-run aggregate supply curve is vertical while the short-run aggregate supply curve is upward-sloping.

Answer 1

3)a)i) Fed selling bonds in open market. Selling bonds would mean that public would buy those bonds, which would reduce the money in the economy. hence the money supply would reduce, shifting the LM curve to left. This would mean that if the money supply has reduced, people would have less to spend which would shift the AD or aggregate demand curve to left . This would reduce the price level given everything else constant.

interest rate -LM - - - - LMI Yoy

ii) Reducing the reserve requirement would mean that the banks could lend more. This would increase the money supply shifting the LM curve to right and now since the people would have more money, the AD curve would shift to right, increasing the price level.

-LM - - - LMI YY TV, Y Y 8:12

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