1 Chapter 20 Practice Quiz Tutorial Monetary Policy ©2004 South-Western

2 1. Keynes gave which of the following as a motive for people holding money? a. Transactions demand. b. Speculative demand. c. Precautionary demand. d. All of the above. D. These are the three motives for holding currency and checkable deposits (M1) rather than stocks, bonds, or other nonmoney forms of wealth.

3 2. A decrease in the interest rate, other things being equal, causes a (an) a. upward movement along the demand curve for money. b. downward movement along the demand curve for money. c. rightward shift of the demand curve for money. d. leftward shift of the demand curve for money. B. At a lower interest rate, money is demanded because the opportunity cost of holding money is lower.

4 3. Assume the demand for money curve is stationary and the Fed increases the money supply. The result is that people a. increase the supply of bonds, thus driving up the interest rate. b. increase the supply of bonds, thus driving down the interest rate. c. increase the demand for bonds, thus driving up the interest rate. d. increase the demand for bonds, thus driving down the interest rate. D.

5 16% 12% 8% 4% 5002,000 E1E1 Expansionary Monetary Policy MD MS 1 Surplus 1,000 MS 2 E2E2 1,500 Interest Rate Billions of dollars

6 4. Assume the demand for money curve is fixed and the Fed decreases the money supply. The result is a temporary a. excess quantity of money demanded. b. excess quantity of money supplied. c. increase in the price of bonds. d. increase in the demand for bonds. A.

7 16% 12% 8% 4% 5002,000 E1E1 Decrease in the Money Supply MS 1 1,000 MS 2 E2E2 1,500 Shortage Interest Rate Billions of dollars MD

8 5. Assume the demand for money curve is fixed and the Fed increases the money supply. The result is that the price of bonds a. rises. b. remains unchanged. c. falls. d. none of the above. A. The result is an excess beyond the amount people wish to hold and they buy bonds which drives the price of bonds upward.

9 6. Using the aggregate supply and demand model, assume the economy is in equilibrium on the intermediate portion of the aggregate supply curve. A decrease in the money supply will decrease the price level and a. lower the interest rate and the real GDP. b. raise both the interest rate and real GDP. c. lower the interest rate and raise real GDP. d. raise the interest rate and lower real GDP. D. The decrease in money supply increases the interest rate which decreases investment. Since investment is a component of aggregate demand, the aggregate demand curve shifts leftward and real GDP declines.

10 7. Based on the equation of exchange, the money supply in the economy is calculated as a. M = V/PQ. b. M = V(PQ). c. MV = PQ. d. M = PQ - V. C. The equation of exchange is MV = PQ rewritten, M = PQ/V

11 8. The V in the equation of exchange represents the a. variation in the GDP. b. variation in the CPI. c. variation in real GDP. d. average number of times per year a dollar is spent on final goods and services. D. In the equation of exchange, GDP is defined as PQ and the CPI is an index to measure the price level (P).

12 9. Which of the following is not an issue in the Keynesian-monetarist debate? a. The importance of monetary vs. fiscal policy. b. The importance of a change in the money supply. c. The importance of a crowding-out effect. d. All of the above are part of the debate. D. Monetarists believe the effects of monetary policy are more powerful than fiscal policy. They view the shape of the investment demand curve as less steep, so the crowding- out effect is significant. Keynesians disagree.

Keynesians reject the influence of monetary policy on the economy. One argument supporting this Keynesian view is that the a. money demand curve is horizontal at any interest rate. b. aggregate demand curve is nearly flat. c. investment demand curve is nearly vertical. d. money demand curve is vertical. C. If the investment demand curve is nearly vertical, changes in money supply and resulting changes in interest rate have little effect on investment and aggregate demand.

14 16% 12% 8% 4% 5002,000 E1E1 MD MS 1 Surplus 1,000 MS 2 E2E2 1,500 Interest Rate Billions of dollars Exhibit Expansionary Monetary Policy

Starting from an equilibrium at E 1 in Exhibit 20-13, a rightward shift of the money supply curve from MS 1 to MS 2 would cause an excess a. demand for money, leading people to sell bonds. b. supply of money, leading people to buy bonds. c. supply of money, leading people to sell bonds. d. demand for money, leading people to buy bonds. B. An excess quantity of money supplied causes people to buy bonds. The greater demand for bonds causes the price of bonds to increase and the interest rate to decrease.

Beginning from an equilibrium at E 2 in Exhibit 20-13, a decrease in the money supply from $600 billion to $400 billion causes people to a. sell bonds and drive the price of bonds down. b. buy bonds and drive the price of bonds up. c. buy bonds and drive the price of bonds down. d. sell bonds and drive the price of bonds up. A. An excess quantity of money demanded causes people to sell bonds. The greater supply of bonds on the market causes the price of bonds to decrease and the interest rate to increase.

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