The interest rate is determined by the interaction of the demand for money and t

Question

The interest rate is determined by the interaction of the demand for money and the supply of money.

(a) Explain why the demand for money varies with the rate of interest and the level of nominal GDP.

(b) Draw a diagram of the money market and explain how the money market adjusts to bring about equilibrium. (Be sure to explain the what happens to bond prices in the process of adjustment)

(c) Explain an open market operation and using appropriate diagram explain how this open market
operation will affect the money supply and interest rates. What will be the effect on
employment, output and prices?

Explanation / Answer

money market equation

M/p = f(Y) - g(r)

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