Qn.

ID: 1271070
Solution

a) Buying bonds on the open market implies that Fed increases money supply which
leads to a decrease in the interest rate

Interest
rate
MS MS‘

MD

Quantity of money

b) In this case people need to hold less cash so their demand for money decreases
which leads to a decrease in the interest rate

Interest
rate
MS

MD
MD‘

Quantity of money

c) Reduction in reserve requirements implies an increase in money supply and

decreases the interest rate ( the same graph as in a) )
d) In this case demand for money increases which leads to an increase in the interest
rate .

Interest
rate
MS

MD‘
MD

Quantity of money

e) Expansion of aggregate demand raises level of income the economy which leads to an
increase in the demand for money . Thus interest rate increases
 P LAS
AD
AD‘
AS

Y* Y

MS

MD‘
MD

Quantity of money

f) Shift of the aggregate supply to the left decreases the level of income in the economy
and leads to a decrease in the demand for money. Thus interest rate decreases.