2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called...

Extracted text: 2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money. 12 Money Supply 10 Money Demand Money Supply MD1 2 MD2 10 20 30 40 50 60 MONEY (Billions of dollars) INTEREST RATE (Percent)


Extracted text: After the decrease in the price level, the quantity of money demanded at the initial interest rate of 6% will be less than the quantity of money supplied by the Fed at this interest rate. People will try to decrease their money holdings. In order to do so, people will buy bonds and other interest-bearing assets, and bond issuers will find that they can offer lower interest rates until the money market reaches its new equilibrium at an interest rate of 4% The following graph shows the economy's aggregate demand curve. Show the impact of the decrease in the price level by moving the point along the curve or shifting the curve. 180 150 Aggregate Demand 120 90 60 Aggregate Demand 30 20 40 60 80 100 120 OUTPUT (Billions of dollars) The change in the interest rate that you found previously will cause residential and business investment spending to rise , leading to an increase in the quantity of output demanded in the economy. PRICE LEVEL