12 Money Supply O 10 Money Demand Co Money Supply INTEREST RATE (Percent) Money Demand N 20 40 80 100 120 MONEY (Billions of dollars) Following the price level increase, the quantity of money demanded at the initial interest rate of 6% will be GREATER OR LESS than the quantity of money supplied by the Fed at this interest rate. As a result, individuals will attempt to INCREASE OR DECREASE their money holdings. In order to do so, they will BUY OR SELL bonds and other interest-bearing assets, and bond issuers will realize that they HAVE TO OFFER HIGHER OR CAN OFFER LOWER interest rates until equilibrium is restored in the money market at an interest rate of I The following graph plots the aggregate demand curve for this economy. Show the impact of the increase in the price level by moving the point along the curve or shifting the curve. AGGREGATE DEMAND CURVE - SHIFTS ALONG THE CURVE OR SHIFTS RIGHT OR SHIFTS LEFT a Wyou need to edit. it's safer to stay in Protected View. Enable Editing Renew 180 160 Aggregate Demand 120 PRICE LEVEL Aggregate Demand 40 80 120 180 200 240 OUTPUT (Billions of dollars) The change in the interest rate found in the previous task will lead to a FALL OR RISE in residential and business spending, which will cause AN INCREASE OR A DECREASE in the quantity of output demanded in the economy. 8. Changes in the money supply The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 4% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. a WNew MS Curve Money Demand 5.0 4.5 New Equilibrium INTEREST RATE (Percent) 4.0 3.5 30 2.5 Money Supply 0.2 0.3 0.4 0.5 0.6 0.7 0.8 MONEY (Trillions of dollars) Suppose the Fed announces that it is lowering its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open-market operations to INCREASE OR DECREASE the SUPPLY OF OR DEMAND FOR money by BUYING BONDS FROM OR SELLING BONDS TO the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate and quantity of money. Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a lower interest rate will REDUCE OR INCREASE the cost of borrowing, causing residential and business investment spending to INCREASE OR DECREASE and the quantity of output demanded to INCREASE OR DECREASE at each price level. Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand. AGGREGATE DEMAND - SHIFTS RIGHT OR SHIFT LEFT OR NO CHANGE a WAggregate Demand PRICE LEVEL Aggregate Demand OUTPUT Suppose the governments of two very similar economies, economy Y and economy Z, implement a permanent tax cut of equal size. Investment spending in economy Y is more sensitive to changes in the interest rate than investment spending in economy Z. The economies are otherwise completely identical. The tax cut will have a larger impact on aggregate demand in the economy with the LOWER SENSITIVITY TO CHANGES IN HE INTEREST RATE OR HIGHER SENSITIVITY TO CHANGE IN THE INTEREST RATE. 10. Using policy to stabilize the economy The government possesses the tools necessary to influence the output level in the short run through use of monetary and fiscal policy. However, there is some debate regarding whether the government should attempt to stabilize the economy. Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply. The current tax system acts as an automatic stabilizer. Businesses make investment plans many months in advance Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses a WWhich of the following are arguments in favor of active stabilization policy by the government? Check all that apply. The current tax system acts as an automatic stabilizer. Businesses make investment plans many months in advance. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. Changes in government purchases and taxation must be passed by both houses of Congress and signed by the president. Which of the following policies are examples of automatic stabilizers? Check all that Aidde Personal income taxes The discount rate The federal funds rate