Shift the appropriate curve on the graph to show the impact of an increase in th

Question

Shift the appropriate curve on the graph to show the impact of an increase in the overall price level on the market for money. After the increase in the price level, the quantity of money demanded at the initial interest rate of 9% will be than the quantity of money supplied by the Fed at this interest rate. People will try to their money holdings. In order to do so, people will bonds and other interest-bearing assets, and bond issuers will find that they interest rates until the money market reaches its new equilibrium at an interest rate of The following graph shows the economy's aggregate demand curve.

Explanation / Answer

After the increase in the price level, the quantity of money demanded at the initial interest rate of 9% will be more than the quantity of money supplied by the central bank at this interest rate. People will try to hold their money holdings. In order to do so, people will sell bonds and other interest-bearing assets, and bond issuers will find that they increase the interest rates until the money market reaches the new equilibrium at an interest rate of 12%.

Below is the graph showing the money market:

The reason behind this is that as there is excess demand of money at the initial interest rate, people become indifferent between either holding money or buying interest bearing assets. So, they start selling bonds because of low interest earnings from bonds. It will create excess supply in the bond market. The price level in bond market starts falling and the interest rate will rise until the new money market interest rate is achieved.

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