Question

(f) With the aid of a well labelled diagram, carefully explain the impact on the

money market if there was a discovery of gold that fuels inflation. (5 marks

Answer 1

Money market model is a graphical representation of money demand and supply in the economy.

As stated in the question, if a gold is discovered, this means more of money will be supplied in the economy as money is printed in exchange of gold and money is backed by gold.

As a result, money supply curve will shift to the right causing an increase in quantity of money and a fall in interest rate which will lead to inflation.

The graph above is a money market model which contains MD curve and MS curve. Due to discovery of gold, the money supply curve shifts rightwards to $MS'$ as a result of which the quantity of money supplied is increased from $Q$ to $Q'$ and fall in interest rate from $I$ to $I'$ .

As a result of fall in interest rate, inflation in the economy will rise.