Final answer:
In a two-asset economy, the quantity of money people want to hold is affected by factors like interest rates, bond prices, and monetary policy. Expansionary policies increase money supply, reduce interest rates, and stimulate investment and net exports. Conversely, contractionary policies reduce money supply, increase interest rates, and may lead to decreased investment and consumption.
Step-by-step explanation:
In a two-asset economy with money and T-bills, the quantity of money that people will want to hold, other things being equal, can be expected to be influenced by a variety of factors that affect the money demand curve. To carry out an expansionary monetary policy, the Federal Reserve (Fed) may opt to buy bonds, which increases the money supply. This action, according to Panel (b), shifts the demand curve for bonds and results in a decrease in interest rates as bond prices rise. Lower interest rates, in turn, stimulate investment and reduce the demand for the domestic currency, leading to a depreciation in the exchange rate. This effect encourages a surge in net exports, contributing to a rightward shift in the aggregate demand curve as indicated by a movement from AD to AD2 in Panel (a).
Conversely, an increase in government spending shifts the aggregate demand (AD) curve to the right, positively affecting income and price levels (point 8). On the other hand, a reduction in the money supply results in a leftward shift of the AD curve, signifying lower income and price levels, as banks have less money to lend and therefore interest rates are driven up (point 9). These shifts in the AD curve demonstrate the correlation between monetary policy, investment, consumption, and international trade balances.
Similarly, Figure 4.5 illustrates how the equilibrium in the market for borrowing money is achieved when the demand for borrowing financial capital meets the supply for lending financial capital. Interest rates act as the price in this market, balancing the quantity supplied with the quantity demanded. Shifts in interest rates above or below equilibrium levels result in adjustments to the quantities supplied and demanded, showcasing the delicate balance of financial markets.