Question

Suppose that changes in bank regulations reduce the availability of credit cards so that people need to hold more cash. Show how this event affects the demand for money. Demand Supply Value of Money (1/P) Quantity of Money Demand Supply If the Fed does not respond to this event, the price level will . True or False: If the Fed wants to keep the price level stable, it should keep the money supply unchanged. True False

Answer 1

Solution and Explanation:

(a) If people need to hold more cash, the demand for money increases, shifting money demand curve rightward, leading to higher interest rate.

(b) If Fed does not respond, the price level will decrease (since higher the demand for money will increase interest rate, causing investment demand to fall, lowering aggregate demand and shifting AD curve leftward which lowers price level).

(c) TRUE  - Increase in the money supply will decrease interest rate, keeping price level unchanged.