Answer to Question #217203 in Macroeconomics for Muhammad

Question

Discuss with help of graph (s) the general equilibrium of the economy and how
economy will reach to general equilibrium if goods market is in equilibrium but
money market is not.

Answer 1

There is disequilibrium in the period t=0. If the monetary authorities increase the supply of money the shock shifts from the initial position (Yo,io). Consequently, the money market is not in equilibrium. Starting at t=0, interest rate being above the equilibrium interest rate with goods market in equilibrium for he initial interest rate io. In the next period, interest rate decreases to i1 in the IS/LM graph as well as in the money market graph. In the following period t=2, The Y increase is translated to M^d resulting in an upward shift. the interest rate rises to i2. In period t=3, investment increases more, consequently, the same process as the previous occurs increasing interest further to i3. The process continues until a state of rest is reached at ie,Ye in the period t=n.