Final answer:
Under contractionary monetary policy, a fall in the money supply leads to higher interest rates, reduced investment and consumption, and a short-run decrease in GDP. In the financial market, a rise in the supply of money and loanable funds leads to a decline in interest rates and an increase in loans made and received.
Step-by-step explanation:
The question relates to the effects of monetary policy, specifically contractionary monetary policy, in the context of monetarist theory. When a central bank enacts contractionary monetary policy, it decreases the supply of money and credit in the economy. According to monetarist assumptions, a decrease in the money supply will first lead to increased interest rates. Over time, this slows borrowing for investment and consumption, shifting aggregate demand to the left. This results in a short-run decrease in the real GDP and a lower price level. Eventually, in the long run, it is expected to stabilize the economy at a new, albeit lower, level of real GDP with reduced price inflation.
Answering the first student's question, which concerns the sequence of points showing the consequences of a fall in the money supply, the sequence under monetarist assumptions would be: a-e-b. Initially at point 'a', if the money supply falls, in the short run (e), interest rates would rise leading to a decrease in investment and consumption. In the long run, the economy would move to 'b', with lower prices and real GDP at a new equilibrium.
Regarding changes in the financial market, a rise in supply of money and loanable funds, represented by option 'C', will lead to a decline in interest rates, facilitating more borrowing, and thus an increase in the quantity of loans made and received. Conversely, a fall in supply would lead to higher interest rates and less borrowing, which aligns with the effects described in contractionary monetary policy.