Digital Society and Market Transactions: Impact on Money Market Equilibrium

For each prompt below, carefully and thoroughly follow the directions. For the graphs, be certain to accurately label all axes, curves, and equilibria points. Use arrows to indicate the direction of any shifts.

Assume that an increasingly digital society decreases their market transactions as they spend more time on non-market online activities.

(a) Draw a fully labeled money market, showing the impact of the change on the equilibrium nominal interest rate.

Overall, the demand for money would decrease due to the shift towards non-market online activities in an increasingly digital society. This would lead to a lower equilibrium nominal interest rate in the money market.

(b) Based on the change in part (a), what will happen to the price of previously issued bonds? Explain.

When the nominal interest rate decreases, the price of previously issued bonds generally increases. This is because the fixed payments provided by these bonds become more valuable compared to new bonds available at the lower interest rate.

(c) On a new graph, illustrate the change in the money supply that would be required to restore the original equilibrium interest rate.

To restore the original equilibrium interest rate after the decrease caused by the digital society's impact, the money supply curve would need to shift leftward. This adjustment would counteract the decreased demand for money and bring the market back to its initial equilibrium.

(d) What could shift the money supply in the way indicated in part (c)?

The money supply could be shifted leftward as indicated in part (c) through central bank actions. These actions may include open market operations, changes in reserve requirements, or adjustments to the discount rate.

(e) Assume that the original equilibrium nominal interest rate is restored. If the real interest rate turns out to be greater, does that mean the price level has increased or decreased? Explain.

When the original equilibrium nominal interest rate is restored, and the real interest rate is greater, it suggests that the price level has decreased. This is because the real interest rate takes inflation into account, so a higher real interest rate would indicate a lower price level.

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.

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.