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suppose the money supply is $14 trillion, and the fed sells bonds on the open market...

suppose the money supply is $14 trillion, and the fed sells bonds on the open market in sufficient quantities to decrease the money supply by $500 billion. what impact will this have on the interest rate, investment spending, real GDP, and the price level? draw graphs to illustrate your points, and describe them and the points thereon thoroughly.

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Answer #1

Decrease in money supply shifts the LM curve leftward to LM'. New equilibrium reaches at e' where equilibrium real interest rate is higher at i' and real gdp gdp decreases to Y'.

Increase in interest rate decreases the investment spending as interest rate is the cost of investment. Lower investment spending leads to decrease in aggregate demand and AD shifts leftward to AD'. New equilibrium reaches at e' where price level increases to P' and real gdp decreases to Y'.

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