Chapter 28, Problem 2FRQ

To determine

To draw: A labeled graph of the money market illustrating the equilibrium.

Explanation of Solution

Calculation:

  

Graph 1

In this graph, E represents the equilibrium point where aggregate supply is equal to aggregate demand. At interest rate, rE equilibrium can be achieved. If the interest rate is decreased to rL, then money demand will be increased and equilibrium cannot be attained.

The government needs to control the money supply by using open market operation tools. Either the money supply can be increased or the interest rate can be increased to attain equilibrium.

Economics Concept Introduction

Money Market: The money market is the place where the trading of short-term financial instruments takes place. The short-term financial instrument includes commercial papers, T-bills, interbank loans, mutual funds, etc.