Macro 2/2 test abt money market

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What backs the money supply?
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Terms in this set (159)
What backs the money supply?
The U.S. government's ability to keep the value of money relatively stable.

However, there is no golden standard. Money is an I.O.U (an acknowledgement of debt) issued by the government for public and private debts.
What are 6 defining characteristics of money?
Durability, portability, divisibility, uniformity, limited supply, and acceptability.

DPD ULSA.
What system would occur if we didn't use money?
Banter System: Goods and services are traded directly. There is no money exchanged.
What are the 2 problems with the banter system?
1. Before trade could occur, each trader has to have something that the other wants. This is called the double coincidence of wants.

2. Some goods can't be split. If a goat is worth 5 chickens, you can't give the trader a piece of goat for 1 chicken.
What is money?
A medium of exchange, anything generally accepted in payment for goods and services.
Is money the same as wealth or income?
No. Money is NOT wealth and money is NOT income.
What is wealth?
The value of the total collection of assets one owns.
What is income?
A flow of earnings per unit of time.
What is commodity money?
Something that performs the function of money and has intrinsic value (gold, oil, silver, cigarettes, etc).
What is fiat money?
Something that serves as money but has no other value or uses (paper money, bitcoins, digital currency).
What are the 3 functions of money?MUS! 1. Medium of exchange - Money can be easily used to buy goods and services with no complications of the barter system. 2. Unit of account - Money measures the value of all goods and services. Money acts as a measurement of value. (Ex: 1 goat = $50 = 5 chickens). 3. Store of value - Money allows you to store purchasing power for the future.What makes money effective?1. Generally accepted - buyers and sellers have agreed that it is legal tender. 2. Scarce - must not be easily reproduced. 3. Portable and dividable - must be easily transported and divided.What is the purchasing power of money?The amount of goods and services a unit of money can buy.Inflation (decreases/increases) purchasing power.Decreases.Rapid inflation (increases/decreases) acceptability.Decreases.What is liquidity?The ease with which an asset can be converted into the economy's medium of exchange. Basically, how easy it is to turn an item into cash without losing any money.What is M1?M1 is the highest liquidity. It includes: 1. Currency in circulation (our current money supply). 2. Checkable bank deposits (checking accounts) 3. Trader's checks.What is M2?M1 + the following: 1. Saving deposits. 2. Time deposits (CDs = certification of deposit) 3. Money market funds/accounts.Compare M1 to M2 in terms of Velocity Interest Store of value vs medium of exchange LiquidityM1 has higher velocity, M1 has lower interest, M1 has higher liquidity, and M1 is more of a medium of exchange than it is a store of value.What is personal finance?All of the decisions and activities of an individual or family regarding their money, including spending, saving, budgeting, etc. You might learn about checking and savings accounts, credit cards, loans, the stock market, retirement plans, and how to manage assets.What is investment and what is personal investment?Investment refers to business spending (ex: purchase of new capital). Personal investment refers to the asset management of individuals.What is the financial sector?The network of institutions that link borrowers and lenders, including banks, mutual funds, pension funds, and other financial intermediaries. Financial institutions that help people borrow, save, and regulate finances.What are assets?Anything that has monetary value (tangible or intangible) that one owns.What is a liability?The legal obligation to pay debts. Anything that is owed.What is a loan?An agreement between a lender and a borrower. Usually at a fee called the interest rate. I.E. A thing that is borrowed, especially a sum of money that is expected to be paid back with interest.A loan is an ______ for the lender and a _______ for the borrower.asset, liability.Which of the following is NOT a function of fiat money? 1) A standard of deferred payment. 2) A unit of account. 3) A source of intrinsic value. 4) A store of value. 5) A medium of exchange.3.Are credit cards money?No, credit cards are NOT money. They are short term loans with a higher-than-normal interest rate. Ex: You buy a shirt with a credit card, VISA pays the store, then you pay VISA the price of the shirt plus interest fees.What are bonds?Certificates of debt that carry a promise to buy back the bonds at a higher price. Bonds are loans or IOU's that represent debt that the government or a corporation must repay to an investor. Ex: You ask your grandmother to lend you $100 and you write this down a piece of paper: 'I owe you $100 and I will pay you back in a year plus 5% interest.' Your grandmother just bought a bond.Do bond holders have ownership stake in the company?No. The bond holder has NO OWENERSHIP of the company.Do stock holders have partial ownership?Yes.Explain stocks with an example:To get more money, you sell half your company for $50 to your brother Dirk. You put this transaction in writing: 'Dave will issue 100 shares of stock. Dirk will buy 50 shares for 50 dollars'. Dirk has just bought 50% of the business. He is allowed to make decisions and is entitled to a percent of the profit.Stockowners can earn profit in which 2 ways?Dividends and capital gain.What are dividends?Dividends are portions of a corporation's profits which are paid out to stock holders. The higher the corporate profit, thehigher the dividend.What is capital gain? (and capital loss?)Profit earned when a stockholder sells stock for more than they paid for it. Capital loss is when a stockholder sells stock at a lower price than what they paid for.What is future value?Amount to which an investment will grow after earning interest.You can determine the future value of any amount ($) if you know the _ and the _.interest rate, number of years.What is the equation for calculating future value?$X in N years = $X(1 + IR)^n ex: If the interest rate is 10% and the current value is $100, then the future value in one year is $110: $100(1 + .1) = $110What is present value?The current worth of some future amount of money.What is the equation to calculate present value?Present Value = $X / (1 + IR)^n ex: If the interest rate is 10% and the amount of money is $100 within a year, then the present value of that amount of money is $90.91: $100 / (1 + .1) This means that the future value of $90.91 when the interest rate is 10% is $100.At any given time, people demand a certain amount of liquid assets (money) for two different reasons: _ and _Transaction demand for money - people hold money for everyday interactions. Asset demand for money - people hold money since it is less risky than other assets.What is the opportunity cost of keeping money in your pocket or a checking account?The interest you could be earning from other financial assets like stocks, bonds, and real estate.What does the money demand graph look like?Y axis - Nominal interest rate (with %'s) X axis - Quantity of money Downward sloping MD MS - equilibrium line (Q under MS) (If you don't know the values where the dotted lines should be, you can put r1, r2, M1, M2)What are the 3 shifters of money demand?1. Changes in price level. 2. Changes income. 3. Changes in technology.What happens when price levels increase (inflation)?MD shifts to the right.What happens when price levels decrease?MD shifts to the left.What happens when income increases?MD shifts to the right.What happens when income decreases?MD shifts to the left.What happens when technology improves?MD shifts to the left.What happens when technology doesn't improve?MD shifts to the right.The amount of money that the public wants to hold in the form of cash (MD) will 1) be unaffected by any change in interest rates or the price level. 2) increase if interest rates increase. 3) decrease if interest rates increase. 4) increase if price level decreases. 5) decrease if price level remains constant.3) Money demand and interest rates have an inverse relationship. As money demand increases, interest rates decrease, and as money demand decreases, interest rates increase.What is money demand?How much money people want to hold in liquid form (physical, checking / savings account, accounts receivable, mutual funds, able to easily be converted without losing value).The U.S. money supply is set by the board of governors of the _, which isFED, Federal Reserve System. The FED is a nonpartisan government that sets and adjusts the money supply to adjust the economy. Created in 1913, the FED's job is to regulate banks and make sure people have faith in the financial system.What is the process of the FED adjusting the money supply to adjust the economy called?Monetary policy.What happens to interest rate, investment, and AD if the FED increases money supply?When money supply increases, there is a surplus of money that causes interest rates to fall. Interest rate goes down, you can see that when you draw the shift in the graph. If interest rate goes down, the investment will go up, and that means AD will go up (which means GDP and PL go up).What happens to interest rate, investment, and AD if the FED decreases money supply?When money supply decreases, there is a shortage of money that causes interest rates to rise. Interest rates rise, you can see that when you draw the shift in the graph. If interest rates rise, the investment will go down, and that means AD will go down (which mean GDP and PL go down).Why would the FED want to slow down the economy?To fight inflation.What is the relationship between interest rates and loans?When interest rates are high, it's more expensive to borrow money, so there are less loans. When interest rates are low, it's less expensive to borrow money, so there are more loans.What are the 3 shifters of money supply?1. Setting reserve requirements (ratios) 2. Lending money to banks and thrifts (discount rate) 3. Open market operations (buying and selling bonds)If you have a bank account, where is your money?Only a small percent of your money is held in reserve. The rest of your money has been loaned out. This is called "Fractional Reserve Banking".What is fractional reserve banking?When banks hold only a fraction of deposits on reserve to cover potential withdrawals and then loans the rest of the money out.Who sets the amount that banks must hold in reserve?The FED.What is the reserve requirement (reserve ratio)?The percent of deposits banks must hold in reserve (the percent they can't loan out).When the money supply increases, the amount of money held in bank deposits (reserves) _.increases.Banks keep some money in reserve and loans out the excess reserves. This excess reserves (these loans) eventually become _deposits for another bank that will then be able to loan out their excess reserves.There are more excess reserves when the reserve ratio is (up/down).down.There are fewer excess reserves when the reserve ratio is (up/down).up.Example of the reserve ratio:Suppose the reserve ratio in the US is 10% 1. You deposit $1000 in the bank. 2. The bank must hold $100 (required reserves). 3. Bob deposits the $900 (excess reserves). 4. Bob's bank must hold $90. It loans $810 to Jill. 5. Jill deposits $810 in her bank. The initial deposit of $1000 caused the creation of another $1710 dollars (Bob's $900 + Jill's $810).What is the money multiplier?1/RR (reserve ratio).If the reserve is .20 and the money supply increases 2 billion dollars, how much does the does the money supply increase?1/.20 = 5, 2 billion times 5 = $10 billion.If there is a recession, what should the FED do to the reserve requirement and why?Decrease the reserve ratio: 1. Banks hold less money and have more excess reserves. 2. Banks create more money by loaning out excess. 3. Money supply increases, interest rates fall, AD up.If there is inflation, what should the FED do to the reserve requirement and why?Increase the reserve ratio: 1. Banks hold more money and have fewer excess reserves. 2. Banks create less money. 3. Money supply decreases, interest rates rise, AD down.The discount rate is _The interest rate that the FED charges on loans to commercial banks. Ex: If the Bank of America needs $10 million, they borrow it from the U.S. Treasury (which the FED controls) but they must pay it back with 3% interest.To increase the money supply, the FED should _ the discount rate (Easy Money Policy).decrease.To increase the money supply, the FED should _ the discount rate (Easy Money Policy).increase.What are open market operations?When the FED buys or sells government bonds (securities). Most important and widely used monetary policy.To increase the money supply, the FED should _ government securities.Buy.To decrease the money supply, the FED should _ government securities.Sell.Buying bonds _ money supply, and selling bonds _ money supply.increases, decreases.What is the federal funds rate?The interest rate that banks charges each other for one-day loans of reserves.Who decides what interest rates banks use? Are they influenced?Banks themselves, the FED doesn't control what interest rate banks charge. However, they are influenced by the FED since the FED sets a target rate and uses open market operations to hit the target. The federal funds rate fluctuates due to market conditions, but it is heavily influenced by monetary policy (buying and selling bonds).If the reserve requirement is 25% and banks hold no excess reserves, an open market sale of $400,000 of government securities by the Federal Reserve will 1) increase the money supply by up to $1.6 million 2) decrease the money supply by up to $1.6 million 3) increase the money supply by up to $300,000 4) increase the money supply by up to $100,000 5) decrease the money supply by up to $100,0002. The key word sale lets you know that bonds are being SOLD which would DECREASE the money supply. 1/.25 = 4. 400,000 x 4 = 1.6 million.To counteract a recession, the Federal Reserve should 1) raise the reserve requirement and the discount rate 2) sell securities on the open market and raise the discount 3) sell securities on the open market and lower the discount 4) buy securities on the open market and raise the discount 5) buy securities on the open market and lower the discount5. To counteract a recession, the money supply should go up. So buy securities. Then lower the discount so that more people can buy loans and invest and AD goes up.The purchase of bonds by the Federal Reserve will have the greatest effect on real gross domestic product if which of the following situations exists in the economy? 1) The required reserve ratio is high, and the interest rate has a large effect on investment saving 2) The required reserve ratio is high, and the interest rate has a small effect on investment saving 3) The required reserve ratio is low, and the interest rate has a large effect on investment saving 4) The required reserve ratio is high, and the marginal propensity to consume is low 5) The marginal propensity to consume is high, and the interest rate has a small effect on investment saving3. Superposition. The interest rate should have a large effect, and for an even more maximized effect, the RR should be low.Bond prices and interest rates are _ related.inversely.Give an example of bond prices and interest rates being inversely related.A 30-year US treasury bond has a face value of $1000 and the interest rate is 5%. Each year, for 30 years, you will get $50. If the interest rate falls and new bonds are being issued at 3%, then people would rather have the old 5% bonds. If you like, you can sell bonds before they mature. If you sold the original 5% bond, buyers would bid up the price since they would rather have 5%.What are demand deposits?Money deposited in a commercial bank in a checking account.What are required reserves?Percent of money that banks are legally required to hold.What are excess reserves?The amount that the bank can loan out.What is a balance sheet?a record of a bank's assets, liabilities, and net worth.Are demand deposits in a bank an asset or a liability?Liability for the bank, asset to the depositor.A balance sheet is balanced whentotal assets = total liabilities.Suppose the following is true: Loans = $8000 Reserves = $500 Treasury bonds = $1500 Total assets = $10,000 Demand deposits = $5000 Owner's equity = $5000 If the bank is holding no excess reserves, how much is the required reserve ratio?.1 or 10%. If the bank is holding no excess reserves, and the reserve ratio is the percentage of your money that the bank saves, and your demand deposit is 5000, and the reserve is 500, then 500 is 10 percent of 5000.Suppose a bank's balance sheet looks as follows: Reserves: $640 Loans: $5360 Deposits: $6000 and banks are required to hold reserves equal to 10 percent of deposits. (a) How much excess reserves does the bank hold? (b) How much more can this bank lend?(a) $40. If the reserve ratio is 10%, then 10% of 6000 is 600. But there are 640 dollars in reserves, so 40 dollars are in excess. The loans have nothing to do with this. (b) $40. The bank can only lend what is in excess reserve, which is $40.Suppose a bank's balance sheet looks like this: Excess reserves: $70 Required reserves: $30 Loans: $500 Deposits: $600 (a) What is the required reserve ratio? (b) How much money can this bank still lend?(a) 5 percent. 30 is 5 percent of 600 (b) $70. The bank can only lend what is in excess reserve, which is $70.Required reserves: $10,000 Excess reserves: $5000 Loans: $85,000 Demand deposits: $100,000 Owner's equity: $0 (a) What is the reserve requirement? (b) Assume that Luis withdraws $5000 in cash from his checking account i) By how much will the bank's reserves change based on Luis's withdrawal? ii) What is the initial effect of the withdrawal on the M1 measure of money supply? Explain. iii) As a result of the withdrawal, what is the new value of excess reserves on the balance sheet of the bank based on the reserve requirement from part A? (c) Assume that the next day John withdraws from the bank an amount that exceeds the bank's excess reserves. Assuming that no loans are called in, how can the bank cover its required reserves?(a) 10% or .1 10,000 is 10 percent of 100,000. (bi) The bank's reserves decreases by $5000 [very straightforward]. (bii) The withdrawal of the money from the checking account will have no effect on the M1 measure of the money supply because it only changes the composition of M1 between cash and demand deposits. [Word it just like shown above. To better explain, no money is lost, just the form has changed and both cash and money in a checking account are forms of M1]. (biii) $500. $10,000-$5,000 = $5,000 (new RR). The ratio is 10%. 10% of 5000 is 500. [All you have to do is subtract the money withdrawn from the RR and use the ratio to find the new excess reserves]. (c) The bank can borrow from the Federal Reserve or from another bank.Assume that the next day John withdraws from the bank an amount that exceeds the bank's excess reserves. Assuming that no loans are called in, how can the bank cover its required reserves?The bank can borrow from the Federal Reserve or from another bank.Assume that a bank's balance sheet looks like the following: Required reserves: $2000 Excess reserves: $0 Customer loans: $8000 Government securities (bond): $7000 Building and fixtures: $3000 Demand deposits: $10,000 Owner's equity: $10,000 (a) What is the required reserve ratio? (b) Suppose that the Federal Reserve purchases $5000 worth of bonds from the bank. What will be the change in the dollar value immediately after the purchase? i) Excess reserves ii) Demand deposit (c) Calculate the minimum amount that the money supply can change as a result of the $5000 purchase of bonds by the Federal Reserve. (d) When the Federal Reserve purchases bonds, what will happen to the price of bonds in the open market? Explain. (e) Suppose that instead of the purchase of bonds by the Federal Reserve, an individual deposits $5000 in cash into her checking (demand deposit) account. What is the immediate effect of the cash deposit on the M1 measure of the money supply?(a) 20%. 2000 is 20% of 10,000. (bi) The excess reserves will increase by $5000. [This is because the FED purchasing a bond means that the money is given to the bank, expected to be paid later with interest. This means that the bank has an additional $5000 now which goes into their excess reserves.] (bii) There will be no change in the demand deposits. (c) $25,000. [Remember the money multiplier equation. The money will multiply by 5 times since 1/.2=5, so 5000 x 5 = 25,000]. (d) The price of bonds increases because the purchase of bonds increases the money supply which decreases the interest rate. [To answer this question, you must first know that bond price and interest rates are inversely related. So to find out what will happen to the bond price, find out what will happen to the interest rate. You know that buying bonds increases the money supply, and an increase in the money supply lowers the interest rate (visualize the graph). So the bond prices rise since the interest rate decreases]. (e) The cash deposit will not immediately change the money supply. (THIS ANSWER IS FINE SINCE IT DOESN'T SAY EXPLAIN, IF IT DID SAY EXPLAIN, YOU'D WRITE: The deposition of the money into the checking account will have no effect on the M1 measure of the money supply because it only changes the composition of M1 between cash and demand deposits.)When the FED buys bonds, where does the money go?Excess reserves.If it doesn't say explain, you don't have to _explain. But you could if you had time.Assume that the US economy is in long run equilibrium with an expected inflation rate of 6 percent and an unemployment rate of 5 percent. The nominal interest rate is 8 percent. (a) Using a correctly labeled graph with both the short-run and long-run Phillips curves and the relevant numbers room above, show the current long-run equilibrium at point A. (b) Calculate the real interest rate in the long-run equilibrium. (c) Assume now that the Federal Reserve decides to target an inflation rate of 3 percent. What open-market operation should the Federal Reserve undertake? (d) Using a correctly labeled graph of the monkey market, show how the Federal Reserve's actions you identified in part c will affect the nominal interest rate? (e) How will the interest rate change you identified in part d affect aggregate demand in the short run? Explain. (f) Assume that the Federal Reserve action is successful. What will happen to each of the following as the economy approaches a new long run equilibrium? i) The short run Phillips curve. Explain. ii) The natural rate of unemployment.(A) Label x and y axis. Draw SRPC line and LRPC line. Put 5% under the LRPC line, and 6 percent on the x axis where SRPC and LRPC intersect. Label the intersection point A. (B) 2%. [Real interest rate = Nominal interest rate - Expected inflation rate, 8-6=2]. (C) The FED should sell bonds. [Remind yourself that open market operations is buying and selling bonds. If the inflation rate is 6% and you want it to go down to 3%, then you want to decrease the money supply to decrease inflation. Selling bonds decreases the money supply.] (D) Label x and y axis. Draw MD and MS. Show MS shifting to the left. Put M1, M2, r1, r2. The nominal interest rate increases. (E) If the interest rate increases, aggregate demand in the short run will go down because higher interest rates cause investment and interest-sensitive consumption spending to decrease. Consumption and investment spending are factors that affect aggregate demand. [Say it exactly like this]. (Fi) The short run Phillips curve will shift to left because the Federal Reserve policy (selling bonds) will decrease the money supply and lower inflationary expectations. (Fii) The natural rate of unemployment will remain the same. [(NRU) is affected by changes in labor force characteristics, including productivity/technology].What does the Phillips curve look like?Downward sloping line - SRPC Y-axis: Inflation rate. X-axis: Unemployment rate. Line down the middle: LRPC, Uy (Uy is NRU, under the LRPC is the NRU, which is only shifted by productivity, meaning the LRPC is also only shifted by productivity).What is the real interest rate equation?Real interest rate = Nominal interest rate - Expected inflation rate.When you draw a shift, don't forget to label the 2nd line with the number 2.OK!When you're talking about the shifts of the Phillips Curve, remember to mention the effect of a particular policy on the _inflationary expectations.The following is the balance sheet of a bank: Reserves: $200 Loans: $1800 Demand deposits: $2000 Equity (net worth): $0 Assume that the required reserve ratio is 10 percent. (a) What is the dollar value of new loans that the bank can make? Explain. (b) Mr. Smith deposits $100 of cash in a demand deposit account in the bank. Calculate the maximum amount of new loans that the bank can now make. (c) As a result of Mr. Smith's $100 cash deposit, calculate the maximum change over time in each of the following in the banking system. i) Loans. ii) Demand deposits. (d) As a result of Mr. Smith's $100 cash deposit, calculate the maximum change over time in the money supply. (e) Provide one reason why the actual change in money supply can be smaller than the maximum change you identified in part (d).A) $0 because the required reserve is $200 since 10% of 2000 is 200. This leaves no room for excess reserves. [You must remember that loans come from excess reserves]. B) $90. [Don't add 100 to 2000, 100 is its own thing. 10 percent of 100 is 10, so the excess is 90]. Ci) $900. [There are $90 of loans. The money multiplier is 10x since 1/.1 = 10. 90 x 10 = 900]. Cii) $1000. [There are $100 dollars in demand deposits. The money multiplier is 10x since 1/.1 = 10. 100 x 10 = 1000]. D) $900. [This can be a difficult question. The answer would be $1000 if it were in the banking system. But that applies to one's personal finances, whereas LOANS affect the money supply directly. So choose the amount of money for loans when calculating the change in multiplier]. E) The money supply can be smaller than the maximum change identified when the public holds more money and/or banks hold more excess reserves.Loans come from _excess reserves.When a problem says 'calculate the maximum change over time', you need toUSING MONEY MULTIPLIER!!Explain why the money supply can be smaller than the maximum change identified:When the public holds more money and/or banks hold more excess reserves.When you want to calculate change over time within the money supply, do you rely loans or demand deposits?LOANS!Is a real interest rate of 50% good or bad?Bad for borrowers but good for lenders.What is the loanable funds market and what does it show?The private sector supply and demand of loans. It shows the effect (of the demand and supply of loans) on real interest rates.What is the relationship between quantity of loans demanded and real interest rates?Inverse. As loans demanded increases, interest rates go down. As loans demanded decreases, interest rates go up.What is the relationship between quantity of loans supplied and real interest rates?Direct. As loans supplied increases, interest rates go up. As loans supplied decreases, interest rates go down.Is loanable funds market the same as money market, and why?No because supply is not vertical.What are the 2 shifters of demand in the loanable funds market?1. Changes in perceived business opportunities. 2. Changes in government borrowing (crowding out).In general, whenever there are _ expectations about certain business opportunities, the demand for loanable funds will shift to the _, and when there are _ expectations about certain business opportunities, the demand for loanable funds will shift to the _.positive right negative left.What are the 2 shifters of supply in the loanable funds market?1. Changes in private savings behavior (money put into and taken out of banks). 2. Changes in capital flow.Capital inflows will _ the supply of loanable funds, causing it to shift to the _; capital outflows will _ the supply of loanable funds, causing it to shift to the _.increase, right, decrease, left.What is capital inflow?The amount of money entering the country.What is capital outflow?The amount of money leaving the country.An increase in savings causes the supply to shift to the _ while a decrease in savings causes the supply to shift to the _.right, left. directional relationship.What is a budget deficit?When a government spends more than what it receives in revenue.An increase in the government's budget deficit shifts the demand curve for loanable funds to the _, which leads to a _ interest rate (visualize graph).right, higher.When interest rates rise, businesses cut back on their investment spending. So a rise in government budget deficit spending tends to reduce overall investment spending. The negative effect of government budget deficits on investment spending is known as _Crowding out.What is crowding out?The negative effect of government budget deficits on investment spending.What does the loanable funds market graph look like?Y axis - real interest rates X axis - Quantity of loanable funds Upward sloping - Supply (S) Downward sloping - Demand (D) When the lines intersect you have re and qeAt re (equilibrium real interest rate), what two things equal each other?The amount that borrowers want to borrow and the amount that lenders want to lend.What would the loanable funds market graph look like if the government increased deficit spending?Label x and y axis. Label dotted line and equilibrium. Show demand shifting out to the right (D1). Label new dotted lines r1 and q1. DRAW THE ARROW.When graph making always remember to:Draw the arrow, label the curves you draw and put dotted lines for equilibrium and shifts.When an economy is at full employment, which of the following will most likely create demand pull inflation in the short run? A) An increase in the discount rate. B) An increase in personal income taxes. C) A decrease in the real rate of interest. D) A decrease in government spending. E) A decrease in the money supply.C. As opposed to the rest of choices, decreasing the interest rate will increase demand and thus inflation.What is demand-pull inflation?Period of inflation caused by increase in aggregate demand (larger or faster increase than in aggregate supply) leading to period of rising prices and output.The crowding out effect refers to the decrease in A) National output caused by higher taxes. B) Domestic production caused by increased imports. C) Private investment due to increased borrowing. D) Employment caused by higher inflation. E) Exports caused by an appreciating currency of a country.C. That's the definition.Suppose that a national government increased deficit spending on goods and services, increasing its demand for loanable funds. In the long run, this policy would most likely result in which of the following changes in this country? The answer choices are a combination of increase/decrease/no change for RIR and investment.Interest rates increase and investment decreases.The most important factor affect interest rates over time is _, which _ both the supply and demand for loanable market funds.changing expectations about future inflation, shiftsIs the true cost of borrowing the real interest rate or the nominal interest rate?The real interest rate.Assume that businesses are granted a tax credit on spending for machinery. A) Using a correctly labeled graph, show the effect of the business sector's response on real interest rate. B) Now assume that the tax rate on interest income from household savings is lowered and there is no change in the government's budget deficit. Using a second correctly labeled graph of the loanable funds market, show the effect of the household's response on the real interest rate. C) Given your answers to part B, explain what will happen to the country's production possibilities curve in the long run.A) It says real interest rate, not nominal, so that's a hint that you need to use loanable funds market not money market graphs. This is a shift in demand: Changes in perceived business opportunities. The change is positively perceived so demand shifts to the write. Draw it. B) This doesn't seem like it would be supply because it says households so you're thinking about demand. Ignore this. This is a shifter for supply: Changes in private savings behavior. Their money is being taxed less, so people are going to save more. There is a increase in savings, so supply shifts to the right. Draw it. C) The PPC will shift to the right because there is an increase in capital stock.What are the shifters of PPC?1. Change in the quantity or quality of resources (including human capital/knowledge and capital stock/economic growth. 2. Change in technology. 3. Trade.What is capital stock?Machinery and tools purchased by businesses that increase their output.Tax cuts lead people to save (more/less).more.In the short run, which of the following would occur to bond prices and interest rates if a central bank bought bonds through open market operations? The answer choices are a mix of increase/decrease for bond prices and interest rates.Bond prices fall and interest rates increase. If you buy bonds, the IR increases. IR and bond price have an inverse relationship. Bond price decreases.Suppose there is an increase in the money supply. A) Graph the change in the money supply and the resulting equilibrium interest rate. B) What happens to the quantity of money demanded when the interest rate changes? What happens to quantity of loans?A) Label Y and X axis. Draw downward sloping MD. Draw MS. Dotted lines. Show MS1 shifting right. Dotted lines. B) You can visually tell that quantity of MD increases (by the dotted lines). IR goes down so loans go up.Assume that an economy is in long-run equilibrium. Assume that consumers wish to hold less money because they use credit cards more frequently to purchase goods and services than cash. A) Draw a correctly labeled graph of the money market and show the effect of the reduced holdings of money on the equilibrium nominal interest rate in the short run. B) Based on the change in interest rate in part a, what will happen to each of the following in the short run? i) Prices of previously issued bonds ii) The price level and real income. Explain. C) With a constant money supply, based on your answer to part b(ii), will the velocity of money increase, decrease, or remain the same, or is the change intermediate? D) If the central bank wishes to reverse the change in the interest rate identified in part a, what open market operation would it use?A) Y axis (NIR), X axis (QMD), MD downward sloping, MS (Q), dotted line (re). Show MD1 shifting left (arrow). New dotted lines, R1. Why shift left? People will not demand cash if they have credit cards. B) In part A, interest rates decreased. Bond prices will increase. Price level and income will increase because interest rates are down, so investment spending increases and aggregate demand goes up. This increased spending results in inflation. C) Increase. The velocity of money is how many times a dollar has been spent within a period of time. If it is a constant supply and spending has increased, the velocity has increased. D) Sell bonds. Decrease the money supply and thus increase interest rates.For questions like, if the FED sells and if the FED buys, you need to answer by _, and you need to pay close attention to _Saying that the money supply will increase up to or decrease up to #. You also must see if you need to use increase or decrease based on the sell or buy.If the reserve requirement is 20% and banks hold no excess reserves, an open market sale of $500,000 of government securities will change the money supply by how much?The money supply will decrease $2,500,000.If it says, what will happen to the money multiplier, say increase or decrease.OK.The transaction demand for money is very closely associated with money's use as a A) standard of deferred payment B) measure of value C) medium of exchange D) standard unit of accountC, medium of exchange.When the interest rate on newly issued bonds increases, the price of existing bonds _stays the same. Interest rates issued on new bonds don't affect old bonds.AD and unemployment have a(n) _ relationship.inverse.What is the time value of money?The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. I.O.W The concept that a dollar today is worth a dollar, but a dollar in a year will be worth less than a dollar.How does interest rate affect long term economic growth?High interest rates -> low investment -> decreasing AD -> stagnant LT EG Low interest rates -> high investment -> increasing AD -> increasing LT EGAssume the bank's balance sheet looks like the following: Required reserves: $190Excess reserves: $ Loans: $810 Total Assets: $900 Checking deposits: $1900 Total Liabilities: $1900 1) What is the required reserve ratio? 2) How much will the money supply increase if they loaned out all excess reserves over time? 3) What is the total amount of money this bank can loan?1) 10% or .1 2) 8100 (810 x 10) 3) 1710 (loans + excess reserves).To find the total amount of money the bank can loan out, add up theloans and excess reserves.Assume that the economy is operating below the full employment level of real GDP with a balanced budget. A) Draw a correctly labeled graph of aggregate demand, short-run aggregate supply, and long-run aggregate supply, and show each of the following: i) current output and pirce level, labeled as Y1 and PL1 respectively ii) Full employment output labeled as Yf B) The government increases spending on goods and services by $100 billion, which is financed by borrowing. How will the increase in government spending affect each of the following: i) Cyclical unemployment ii) The natural rate of unemployment C) If the marginal propensity to consume is .75, calculate the maximum possible change in real GDP that could result from $100 billion increase in government spending. D) Using a correctly labeled graph of the loanable funds market, show the effect of the $100 billion increase in government spending on the real interest rate. E) Based on the real interest rate change in part d, what is the effect on the long-run equilibrium growth rate? Explain. F) Now assume that instead of financing the $100 billion increase in government spending by borrowing, the government increases taxes by $100 billion. With this equal increase in government spending and taxes, will the GDP increase, decrease, or remain the same? Explain.A) Draw graph, and make sure AD and AS intersect to the left of LRAS. B) Cyclical unemployment will decrease (since AD goes up) and the natural rate of unemployment remains the same. [NRU is only affect by labor changes and tech] C) $400 billion: 1/1-.75 = 4, 4 x 100 b = 400b D) Draw graph, RIR, Quantity of loanable funds, upward S downward D, Re, Q, show demand shifting to the right, r1, q1, arrow. E) In part d, RIR increases. The long run equilibrium growth rate will fall since higher interest rates slow down capital formation. F) GDP will increase because the expansionary effect of the increase in government spending outweighs the contractionary effect of the increase in taxes of the same size. The tax multiplier is smaller than the spending multiplier.What does the AD/AS graph look like?Y axis - price level X axis - real GDP AS sloping upward AD sloping downward Dotted lines (PLe) LRAS line down the middle (Yf)What is cyclical unemployment?Unemployment caused by the lack of jobs during a recession. The deviation of unemployment from its natural rate.What is the equation for MPS and MPC?MPC = change in consumption / change in income MPS = change in savings / change in income MPS + MPC = 1What is the equation for spending multiplier?1/(1-MPC) or 1/MPSFor these multiplier, MPS and MPC problems, how do we calculate the total change in GDP?Total change in GDP = multiplier x initial change in spending