N23

2. Continue to the last question.

a) Select a point to the right of the LM curve. Label this point A. Is the bond market in equilibrium at this point? Explain. Show this point on the bond market diagram. Explain.

b) Suppose now the Fed wishes to increase the supply of bonds in the economy. Carefully explain how it would do so. Does the wealth of the economy increase, decrease, or remain constant? Explain.

c) What, if anything, happens to the LM curve as a result of the Fed's actions?

3. Suppose, instead, that during the current crisis companies do not wish to borrow regardless of the interest rate. In particular, assume that if the investment is not sensitive to the interest rate.

a) Show the effect of this event on the equilibrium interest rate and income using the IS-LM diagram. Explain.

b) Now, suppose that the Central bank pursues an expansionary monetary policy. Show the effect on the diagram. Explain.