Question

I know the answer, (D) but I do not understand why price below the equilibrium if...

I know the answer, (D) but I do not understand why price below the equilibrium if there is an excess of demand. Explain, please.

When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and price will ________.

A) above; rise

B) above; fall

C) below; fall

D) below; rise

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Homework Answers

Answer #1

Option D.

  • When the price of a bond is below the equilibrium price, there is an excess demand for bonds and the price will rise.
  • As the prices of a bond falls below the equilibrium price level and if the expected return from the bond rises, then the investor's become more interested in that bond as they can increase their investments and hence this will lead to an increase in the quantity demanded. This creates an excess demand in the bond market.
  • With greater demand the suppliers of bonds in the bond market decrease the supply of bonds and increase the prices of those bonds to earn more profits.
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