## 2. The Theory of Liquidity Preference and the Downward-Sloping Aggregate Demand CurveThe following graph illustrates the money market in a hypothetical economy. The central bank in this economy is referred to as the Fed. Assume that the Fed fixes the quantity of money supplied.Suppose the price level decreases from 90 to 75.**Task:** Shift the appropriate curve on the graph to demonstrate the impact of a decrease in the overall price level on the market for money.### Graph Explanation:- **Axes:** - The vertical axis represents the Interest Rate (Percent), ranging from 0 to 12%. - The horizontal axis represents the Money (Billions of dollars), ranging from 0 to 60 billion dollars.- **Curves:** - **Money Supply:** Represented by a vertical orange line at 30 billion dollars, indicating a fixed money supply. - **Money Demand (MD1):** The initial blue downward-sloping line, labeled as MD1. - **Money Demand (MD2):** The shifted blue downward-sloping line, labeled as MD2, to reflect the impact of the decreased price level.The shift from MD1 to MD2 signifies a change in money demand due to the decrease in the overall price level from 90 to 75. After the decrease in the price level, the quantity of money demanded at the initial interest rate of 6% will be **less** than the quantity of money supplied by the Fed at this interest rate. People will try to **decrease** their money holdings. In order to do so, people will **buy** bonds and other interest-bearing assets, and bond issuers will find that they **can offer lower** interest rates until the money market reaches its new equilibrium at an interest rate of **4%**.The following graph shows the economy's aggregate demand curve.**Show the impact of the decrease in the price level by moving the point along the curve or shifting the curve.****Graph Explanation:**1. **Axes**: The vertical axis represents the price level, ranging from 0 to 180. The horizontal axis represents output, measured in billions of dollars, ranging from 0 to 120.2. **Aggregate Demand Curve**: The blue line represents the aggregate demand curve, which is downward sloping. This indicates that as the price level decreases, the quantity of output demanded increases.3. **Points**: A black dot on the curve illustrates a specific quantity of output demanded at a particular price level. A downwards arrow suggests a movement to a new point along the curve due to a decrease in the price level.4. **Dashed Lines**: Blue dashed lines indicate the change in position along the curve from a higher price level to a lower one, showing increased output.The change in the interest rate that you found previously will cause residential and business investment spending to **rise**, leading to **an increase** in the quantity of output demanded in the economy.

Money demand refers to the quantity of money that individuals and firms are willing to hold for transactions and speculative purposes at various interest rates.Money supply refers to the total amount of money available in an economy, including physical currency (coins and paper money) and various types of deposits.The price level in the economy decreases from 90 to 75.When the price level in the economy decreases then households reduce their demand for money.This reduction in demand for money shifts the demand curve for money to the left.Following is the required figure After the fall in the price level, the quantity of money demanded at the initial interest rate of 6% will be less than the quantity of money supplied by the Fed at this interest rate. People will try to reduce their money holdings. In order to do so, people will buy bonds and other interest-bearing assets, and bond issuers will find that they can offer less interest rates until the money market reaches its new equilibrium at an interest rate of 4%.After figure 2 The change in the interest rate that you found previously will cause residential and business investment spending to rise, leading to an increase in the quantity of output demanded in the economy

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2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes he quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money.

2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes he quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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