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Macroeconomic problem - Essay Example

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Date Macroeconomics Section I a) The equilibrium interest rate is determined where the money demand is equal to the money supply. It is the point of intersection of the money demand curve and the money supply curve. At this point, the economy will be at stability as there is neither excess demand nor excess supply of money in the economy…
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Macroeconomic problem
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Macroeconomic problem

Download file to see previous pages... The amount of money supplied by the government fixed by Fed hence making it perfectly inelastic. b) In our situation, the equilibrium interest rate will be 5.8% as this is the point of intersection of the supply curve and the money demand curve. C) When the economy is at full employment, an increase in money supply will not result in an increase in the output. In this case, the increased money supplied will result in increased level of inflation. The excess money pumped in the economy will chase the same quantity of goods and services thereby making their prices to inflate. Normally, the increases in the money supply is intended to stimulate economic growth by reducing the level of interest rates (Floyd 58). In the case of full employment, all the resources are already utilized and the increased money supplied will not achieve the intended purpose of increasing production level. Besides, the increased inflation will make the local currency unstable and discourage foreign investors from holding the local currency. This can adversely affect the investment levels and increase the economic problems. Fed decision to increase money supply can be propelled by several factors. First, an increase in money supply can be aimed at increasing the level of expenditure in the economy. By increasing the level of money supply, the government will increase the amount of wealth held by individuals. This makes them increase their expenditure to stimulate economic growth. Money spent in both consumption and investment will increase because of the increase in the disposable income (Floyd 63). Individuals will as well increase the proportion of their investments in bonds, as they will use the excess money to buy bonds and shares in the capital markets. Secondly, Fed can decide to increase the money supply to stimulate investments. An increase in money supply will result in a fall in the nominal interest rates, which will further result in the fall in the real interest rates. Due to the fall in interest rates, the cost of borrowings will be reduced. Potential investors will therefore be encouraged to borrow and acquire capital necessary in pursuing their investment plans. Consequently, the increased investments will increase the level of employment because of the increased economic activities. Sometimes, the government through Fed can decide to increase the level of money supply to cause an increase the price levels by a desirable margin. According to the quantity theory of money, price levels depend directly on the money supply. In the long-run therefore, an increase in money supply will result in an increase in the price level by equal proportion. Fed can have this objective during the period of recession or depression when the level of economic activities is low to stimulate economic activities and increase the quantity of purchases. In addition, a decrease in the interest rates will increase the demand of the local currency hence cause depreciation in the currency. This is because in an open economy, interest rates parity must always be preserved. This will cause the currency to fall with a further expectation that it will fall faster in the future. The depreciation in the local currency will make the cost of local goods cheaper and attractive thereby causing a surge in both the foreign and local demand (Floyd ...Download file to see next pagesRead More
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