Question 1
Use the money demand and money supply model to show graphically and explain the effect on interest rates of the Federal Reserve's open market sale of Treasury securities.
Question 2
Use the money demand and money supply model to show the money market in equilibrium with an interest rate of 5 percent and the quantity of money of $800 billion. Suppose the Federal Reserve increases the money supply to $850 billion. At the previous equilibrium interest rate of 5 percent, will households and firms now be holding more money or less money than they want to hold, and will they be buying or selling short-term financial assets? At the new equilibrium interest rate, households and firms will desire to hold the entire $850 billion of the money supply. What causes households and firms to want to hold the additional $50 billion of the money supply?
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