CA Foundation · Business Economics · Money Market
In the standard money market model with a downward-sloping money demand curve and a vertical money supply curve (set by the central bank), what happens when the interest rate is above the equilibrium rate?
When the interest rate is above equilibrium, money supply exceeds money demand. Households and firms holding surplus cash buy bonds, which raises bond prices and pushes the interest rate down until money demand equals the fixed money supply at the equilibrium rate.
- ASupply of money exceeds demand for money, and people buy bonds, which pushes the interest rate downCorrect
- BDemand for money exceeds supply of money, and people sell bonds, which pushes the interest rate up
- CSupply of money exceeds demand for money, and people sell bonds, which pushes the interest rate up
- DDemand for money exceeds supply of money, and people buy bonds, which pushes the interest rate down
Explanation
Above the equilibrium rate, people want to hold less money than is available, so money supply exceeds money demand. The excess money is used to buy bonds, raising bond prices and lowering the interest rate until the market clears. Options suggesting bond selling describe the opposite case, a rate below equilibrium.
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