note1 - So the interest rate will fall The interest rate...

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Refer to diagram 4 – Equilibrium in the Money Market. At an interest rate of r1 there is an excess supply of money equal to the distance ab Wealth holders would prefer to hold bonds rather than money because the interest rate r1 is above the equilibrium interest rate re. Equilibrium is restored as follows: Bondholders prefer to hold bonds rather than money at r1 Therefore, they purchase bonds This causes the price of bonds to rise Remember the price of bonds is equal to the present value of bonds There is an inverse relation between the price of bonds and the interest rate
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Unformatted text preview: So the interest rate will fall The interest rate will continue to fall until equilibrium is restored at re Diagraph 5: An Increase in the Money Supply When the money supply increases from MS0 to MS1 this creates an excess supply of money at re, the excess supply of money is equal to the distance “cd” The interest rate has to fall from re to r1, in order for equilibrium to be restored in the money market. A lower interest rate will persuade wealth holders to hold these excess money balances....
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