2123 15s PS2

Topics: Monetary policy, Money supply, Macroeconomics Pages: 5 (1394 words) Published: March 19, 2015
ECON 2123: Macroeconomics

Problem Set 2

Instructor: Yao Li

Problem Set 2
Macroeconomics, ECON 2123
(Instructor: Yao LI; TA: Astor FOK)

-----------------------------------------------------------------------------------------------------------------------------------[Pay attention to the deadline announced via LMES system] 100 marks total

Part I: Multiple Choice Questions. Choose the best answer. (10 marks, 2 marks each) 1. The money demand curve will shift to the left when which of the following occurs? a. a reduction in the interest rate


an increase in the interest rate


an open market sale of bonds by the central bank


an increase in income


none of the above

2. At the current interest rate, suppose the supply of money is less than the demand for money. Given this information, we know that:
a. the price of bonds will tend increase.
b. the price of bonds will tend to fall.
c. production equals demand.
d. the goods market is also in equilibrium.
e. the supply of bonds also equals the demand for bonds.
3. The LM curve shifts down (or, equivalently, to the right) when which of the following occurs? a. an increase in taxes.
b. an increase in output.
c. an open market sale of bonds by the central bank.
d. an increase in consumer confidence.
e. none of the above.
4. Suppose policy makers decide to reduce taxes. This fiscal policy action will cause which of the following to occur?
a. the LM curve shifts and the economy moves along the IS curve. b. the IS curve shifts and the economy moves along the LM curve. c. both the IS and LM curves shift.
d. neither the IS nor the LM curve shifts.
e. output will change causing a change in money demand and a shift of the LM curve. 1

ECON 2123: Macroeconomics

Problem Set 2

Instructor: Yao Li

5. For this question, assume that investment spending depends only on the interest rate and no longer depends on output. Given this information, a reduction in the money supply a. will cause investment to decrease.

b. will cause investment to increase.
c. may cause investment to increase or to decrease.
d. will have no effect on output.
e. will cause a reduction in output and have no effect on the interest rate.

Part II: Financial Markets (Chapter 4) (35 marks)
1. Given the following conditions: (all units are trillions of US $) (13 marks) Money Demand: Md = $Y (0.2 – i)
Nominal Income: $Y = 2000
Money Supply: Ms = 300
(a) Find Md for i = 10% and i = 5%. (2 marks)
(b) What is the relationship between i and Md. (2 mark)
(c) Graph Ms and Md and calculate the equilibrium i. (3 marks) (d) Now decreases Ms from 300 to 250. What happens to money market equilibrium? (solve & graph ) (4 marks)
(e) Describe how the central bank can increase/decrease interest rate i. (2 marks) 2. Consider a bond that promises to pay $100 in one year. (7 marks) (a)

What is the interest rate on the bond if its price today is $75? $85? $95? (3 marks)


What is the relation between the price of the bond and the interest rate? (2 mark)


If the interest rate is 8%, what is the price of the bond today? (2 mark)

3. ATMs and Credit Cards (10 marks)
This problem examines the effect of the introduction of ATMs and credit cards on money demand. For simplicity, let’s examine a person’s demand for money over a period of four days. Suppose that before ATMs and credit cards, this person goes to the bank once at the beginning of each four-day period and withdraws from her saving account all the money she needs for four days. Assume that she spends $4 per day.


How much does this person withdraw each time she goes to the bank? Compute this person’s money holdings for days 1 through 4 (in the morning, before she spends any of the money she withdraws). (2 marks)


What is the amount of money this person holds, on average? (1 mark) Suppose now that with the advent of ATMs, this person withdraws money once every two days....
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