Question

3) (10 points total) You have the following expressions for bond demand and bond supply respectively: BD: P 200-3Q B: P 50 +2Q a) (2 points) Solve for the equilibrium quantity and price in this bond market (please show work) b) (4 points for correct and completely labeled diagram) Draw a demand and supply diagram and locate this initial point as point A. Now conditions change.... bond demand remains the same but bond supply changes and is now: BS: P- 30 +.2Q c) (2 points) Name and explain two reasons why bond supply could change like this. d) (2 points) Solve for the new equilibrium quantity and price in the bond market and label as point B. What has happened to interest rates as a result of this change in bond supply?

Answer 1

c) Increase in expected inflation - will cause the supply of bonds to increase and shift to the right .  Inflation erodes the value of the dollar, so over time, the value of debt decreases over time . If businesses and government believe inflation will become higher in future , they will borrow more funds at present by issuing bonds .

Also bonds are issued to implement contractionary policy or to reduce money supply in the economy . This is a measure to curb inflation .