The following diagrams show the determination of monetary equilibrium and the demand for investment. The economy begins
Question:
The following diagrams show the determination of monetary equilibrium and the demand for investment. The economy begins with money supply \(M_{S}\), money demand \(M_{D}\), and investment demand \(I^{D}\). The interest rate is \(i_{0}\) and desired investment is \(I_{0}\).
a. Beginning at the initial equilibrium, suppose the Bank of Canada increases the money supply. What happens in the money market, and what happens to desired investment expenditure?
b. Beginning in the initial equilibrium, suppose there is a reduction in the demand for money (caused, perhaps, by bonds becoming more attractive to firms and households). What happens in the money market, and what happens to desired investment expenditure?
c. Explain why an increase in money supply can have the same effects on desired investment expenditure as a reduction in money demand.
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