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Question 1

Referring to liquidity preference theory, in a situation of disequilibrium in the money market, interest rates adjust to bring the market back to the equilibrium. When the interest rate is higher than the equilibrium, people prefer to put their money into investment activities because of the expected higher returns and it also becomes expensive to borrow thus public shun from borrowing.  This creates money surplus as the public holds less money than what feds supply.  Surplus in money supply puts downward pressure on interest rates, making it to adjust to the money market equilibrium. In a case where the interest rate is lower than the equilibrium level. The public prefers to hold more money due to low returns on investment. Moreover, it is also makes it cheap to borrow. This increases demand for money leading shortage in money supply. This response by the public exerts an upward pressure on interest rate, forcing it  adjust upward to the money market equilibrium level  at which the money supplied by the public equals  what is demanded.

An increase in money supply will shift the money supply curve to the right resulting in a fall in nominal interest rates.  However, it does not affect the real interest rates. The economy will therefore move to a new short  run equilibrium with high price levels and increased aggregate income.

If the interest rate is higher, people would prefer to hold less money because there are more returns if the money is held in the form of financial assets such as bonds and treasury bills. Moreover, with high interest rates, the cost of borrowing is also high, thus people refrain from borrowing reducing the money they hold.

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