With money demand remaining unchanged, an increase in money supply creates a surplus of money at prevailing interest rate in turn the more money is available in the economy. As a result interest rate will fall as there is surplus availability of money in the economy. Similarly when money supply decreases there occurs a shortage of money in the economy to meet the demand and as a result interest rate will increase.

With money supply remaining unchanged, an increase in money demand will raise the cost of borrowing and as a result rate of interest will increase. Similarly when money demand decreases, cost of borrowing will fall as there is no demand for money as before and as a result rate of interest will fall. increase in money supply shifts the MS curve rightward to MS. At new equilibrium e’ interest rate decreases to I.

This happens because when money supply increases quantity demanded for money is less than quantity supplied. To combat the excess supply interest rate decreases so that people demand less bonds and more money. Increase in money demand shifts the MD curve rightward to MD’. At new equilibrium e’ interest rate is higher at I. This happens because when money demand increases there is excess demand and to combat the excess demand interest rate increases that encourages people to hold more bonds and less money.

Reply to at least 2 of your classmates. Be constructive and professional in your responses.

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