An increase in credit card fees causes people to use credit cards less often for

Question

An increase in credit card fees causes people to use credit cards less often for transactions and demand more money.
(a) Using a correctly labeled graph of the money market, show how the nominal interest rate will be affected.
(b) Given the interest rate change in part (a), what will happen to bond prices in the short run?
(c) Given the interest rate change in part (a), what will happen to the price level in the short run? Explain.
(d) Identify an open-market operation the Federal Reserve could use to keep the nominal interest rate constant at the level that existed before the drop in credit card fees. Explain.

Explanation / Answer

(a) Using the LM graph (with interest rate as the y axis and money supply as x axis), as demand of money increase (money demand curve shift rightward), using the traditional LM graph (where money supply is exogenous), money supply is constant but interest rate will rise. (b) price of bond is inversely related to interest rate so as interest rate rise, price of bond will fall. (c) Using the aggregate demand-aggregate supply graph, as increase in interest rate increases, investment will fall and aggregate demand will fall as well. Leftward shift in aggregate demand curve will lower the general price level and output. (d) first of all the question in (a) mentions increase in credit card fees and not drop in credit card fees so I will assume you mistype question (d) and follow question (a) scenario. To prevent rise in interest rate, fed needs to increase money supply. To do so in open market operation, fed needs to buy bonds (and sell money, inversely). Money supply will increase and interest rate (as well as general price level and output) will remain the same before the change. Hope this helps.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.