Final answer:
The increasingly digital society would decrease the demand for money, leading to a lower equilibrium nominal interest rate. Action by the central bank to reduce the money supply can restore the initial interest rate. If the real interest rate increases, it indicates a decrease in the price level.
Step-by-step explanation:
(a) In a fully labeled money market graph, the x-axis represents the quantity of money, and the y-axis represents the nominal interest rate. The demand for money curve (MD) slopes downward, indicating that at lower interest rates, the quantity of money demanded is higher. The supply of money curve (MS) is vertical, showing that it is set by central bank policy and not affected by the interest rate. An increasingly digital society that conducts fewer market transactions will decrease the demand for money. This is represented by a leftward shift of the MD curve, leading to a lower equilibrium nominal interest rate.
(b) When the nominal interest rate decreases, the price of previously issued bonds generally increases because the fixed payment they provide becomes more valuable compared to the new lower interest rate bonds available on the market.
(c) To restore the original equilibrium interest rate, a new graph would show a leftward shift in the money supply curve (MS) to counteract the decreased demand for money. The MS curve would have to shift to where the new MD curve intersects with the old interest rate level.
(d) The money supply could shift as indicated in part (c) through central bank actions such as open market operations, changing reserve requirements, or adjusting the discount rate.
(e) If the original equilibrium nominal interest rate is restored and the real interest rate is greater, it implies that the price level has decreased. This is because the real interest rate is adjusted for inflation, which means that if inflation were higher, the real interest rate would be lower.