on the right vertical axis increasesas we go down the axis. Only increases in the variables are shown. The effect of decreases in the variables on the change in supply wouldbe the opposite of those indicated in the remaining columns.Bs2Bs1B←(increases)↑P(increases )↑iBs2Bs1B←(increases)↑P(increases )↑iBs2Bs1B←(increases)↑P(increases )↑i
Expected Profitability of Investment Opportunities.The more profitable plant andequipment investments that a firm expects it can make, the more willing it will be toborrow in order to finance these investments. When the economy is growing rapidly,as in a business cycle expansion, investment opportunities that are expected to beprofitable abound, and the quantity of bonds supplied at any given bond price andinterest rate will increase (see Figure 4).Therefore, in a business cycle expansion, thesupply of bonds increases, and the supply curve shifts to the right. Likewise, in arecession, when there are far fewer expected profitable investment opportunities,the supply of bonds falls, and the supply curve shifts to the left.Expected Inflation.As we saw in Chapter 4, the real cost of borrowing is more accu-rately measured by the real interest rate, which equals the (nominal) interest rateminus the expected inflation rate. For a given interest rate, when expected inflationincreases, the real cost of borrowing falls; hence the quantity of bonds suppliedincreases at any given bond price and interest rate. An increase in expected inflationcauses the supply of bonds to increase and the supply curve to shift to the right(seeFigure 4).Government Activities.The activities of the government can influence the supply ofbonds in several ways. The U.S. Treasury issues bonds to finance government deficits,the gap between the government’s expenditures and its revenues. When these deficitsare large, the Treasury sells more bonds, and the quantity of bonds supplied at eachbond price and interest rate increases. Higher government deficits increase the sup-ply of bonds and shift the supply curve to the right(see Figure 4). On the other hand,98P A R T I IFinancial MarketsF I G U R E 4Shift in theSupply Curve for BondsWhen the supply of bondsincreases, the supply curve shiftsto the right. (Note: Pand iincrease in opposite directions. Pon the left vertical axis increasesas we go up the axis, while ionthe right vertical axis increasesas we go down the axis.)F7508008509009501,000100200300400500600700Quantity of Bonds, B($ billions)0.05.311.117.625.033.0Price of Bonds, P($)(Pincreases )Interest Rate, i (%)(iincreases )↑ ↑IHCGFIHCGBs1Bs2.requests/cpi/cpiai.txtContains historical informationabout inflation.
government surpluses, as occurred in the late 1990s, decrease the supply of bondsand shift the supply curve to the left.