00:01
So, problem 10 says, explain the links between the changes in the nation's money supply, the interest rate, investment spending, aggregate demand, and real gdp.
00:14
So over here, i have a graph representing the money market.
00:18
An ms0 represents money supply at level zero.
00:22
Ms1 represents money supply at level 1, ms supply, ms2 represents money supply at level 2, and i represents the interest rates and md represents money demand and q m represents the quantity of money so suppose that we are initially at ms1 and the central bank decides to decrease money supply so we move from ms1 to ms 0 so the effects of that will be an increase in the interest rates so let me just write here i 0 now what does an increase in the interest rate course? okay, firstly, before we talk about the interest rate, what happens to the quantity of money? it also decreases, right? so it decreases and the interest rate also, the interest rate increases to i zero.
01:32
Let me just clear this real quick.
01:35
So the interest rates increases and what will an increase in the interest rate cause? it will increase the cost of borrowing, all right? so investment will decrease because remember, investment is a function of income and the interest rate.
01:56
Okay.
01:58
And investment is negatively related to the interest rate.
02:03
And investment is positively related to income.
02:08
So when income increases, businesses will have more money to invest.
02:13
The investments will increase.
02:15
However, investments and interest rates are negatively related.
02:22
Because when the interest rates increases, the cost of borrowing will increase and that will decrease investment.
02:28
Okay, so that explains investment, all right? and what happens to aggregate demand? so when investment decreases, aggregate demand will also decrease because investments may be investing in the new business or investing in new machinery that's a business spending on certain goods or when a business invest in the new building that's a business spending on bricks, cement, spending on fencing perhaps so when investment decreases aggregate demand also decrease because investment is a form of expenditure on goods and services.
03:13
All right.
03:14
So when investments decreases, aggregate demand on goods and services also decreases.
03:21
When aggregate demand decreases, okay, remember how our adas graph looks.
03:26
Let me just sketch it real quick.
03:31
So the adas graph of the goods markets is like this.
03:40
Okay, so i have aggregate demand and i have aggregate gd.
03:45
Sorry and i have aggregate supply okay and on my y -axis i have prices and on my x -axis i have gdp or output okay and this is aggregate supply and this is aggregate demand okay so when aggregate demand decreases because of an increase in the interest rates so aggregate demand will look something like this now okay so initially we were at this point initially we were at a higher point of gdp or output okay but now due to a decrease in aggregate demand gdp has also decreased all right so now we are at a lower point of output so in a nutshell an increase sorry a decrease in the money supply will decrease the quantity of money in the economy.
05:12
That will increase the interest rates, and an increase in the interest rate will decrease in investment...