Question

Notice the following model of a bond market. In each situation given, explain what happens to th bond price and yield and why. SBonds Price of bonds DBonds Quantity of Bonds a) Expected inflation decreases b) The return on bonds falls relative to other assets c) The federal government deficit decreases

Answer 1

Answer

1. Price and quantity increases

With the decrease in expected inflation, the real retuens of bonds increases, thus the demand for in will increase shifting the demand curve to the right. This increases price and quantity of bonds

SBonds DBonds

2.Price and quantity decreases

SBonds DBonds

As the return of bonds falls relative to the assets, the opportunity cost of bonds increases and bonds become less attractive. This will make people demand less of it, shifting the demand curve to the left decreasing the price and quantity.

3.Price increases, quantity decreases

$. SBonds DBonds

As government deficit decreases, indicates that the government requires less money from the public, thus the government would issue less number of bonds , reducing the supply and shifting the curve to the left decreasing the equilibirum quantity and increasing the equilbrium price.

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