Question

Using aggregate supply and demand curves drawn according to the Keynesian view, which of the following will occur if the Fed buys bonds in the open market and the economy is below full employment?a. Aggregate demand will shift to the left and unemployment rate will rise
b. Aggregate demand will shift to the right and the unemployment rate wil lfall
c. Aggregate demand will shift to the left and the price level will remain unchanged.
d. Aggregate demand will shift to the right and the price level will fall.

Answer 1

Answer:

a. Aggregate demand will shift to the left and unemployment rate will rise

Explanation:

Aggregate demand (AD) is the sum of consumer spending, government spending, investment, and net exports. The AD curve assumes that money supply is fixed. Increased money supply causes reduction in interest rates and further spending and therefore an increase in AD.  On the other hand, decreased money supply causes increase in interest rates and therefore a decrease in Aggregate Demand

Since the FED is buying Bonds it is reducing money supply and hence aggregate demand will fall causing the curve to shift to the left.

Secondly inflation and unemployment has an inverse relationship. More money in the economy is inflation and unemployment level will be low because there will be an increase in wages BUT when the FED reduces money supply by buying bonds, as a means of countering inflation, then unemployment will rise.