Assume that money market is initially in equilibrium and that the money supply is then increased.
Explain the adjustments towards a new equilibrium interest rate. Will bond prices be higher or lower at the new
equilibrium rate of interest? What effects would you expect the interest rate change to have on the levels of
output, employment and prices? What if the money supply is reduced? Why there is a need for the Federal
Reserve System to control the money supply?
Sample Solution
