Question

1) Draw the money market.

2) Show on the graph above what happens to money demand with the economic collapse caused by corona virus.

3) Now add to the graph what the Fed will do to MS in response.

Answer 1

1) Money supply is vertical while money demand is downward sloping.

2) Due to corona virus, people are keeping money with them rather than spending it. They have cut their extra expenditures and neither investing money in bonds / mutual funds because they know that they may need money anytime. Rise in money demand shifts the money demand curve to its right from Md to Md1 which shifts the money market equilibrium from point A to B. It raise the rate of interest.

3) Fed raise the money supply in response to it because they want money to be circulated in the market which can prevent recession. Shift in money supply to right shifts economic equilibrium from point B to C and reduce rate of interest to its initial level.