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ECON 2105
Homework #4
Chapters 11 – 13
You may work together on the homework, however, you must hand in your own answers.
Please type or print neatly on a separate sheet of paper. I will give no credit for
unreadable or ambiguous answers.
Part I (20 points): Matching
Match the correct definition to the word or phrase below
1. The speed with which an asset can be converted to currency
2. Currency held at a financial institutions in order to manage the demand for cash flows
3. The percentage of bank deposits a bank must keep on hand as required by the Federal
Reserve
4. Monetary policy that tends to raise interest rates
5. Monetary policy that tends to lower interest rates
6. A hypothesis that the price level is simply a function of the amount of money in
circulation
7. A situation in which expansionary monetary policy is unlikely to increase economic
activity
8. A hypothesized relationship between inflation and unemployment rates
9. A situation in which prices and unemployment rise simultaneously in an economy
10. Inflation that results from an increase in the price of inputs
A.
B.
C.
D.
E.
F.
Contractionary monetary policy
Cost-push inflation
Demand-pull inflation
Expansionary monetary policy
Liquidity
Liquidity trap
G.
H.
I.
J.
K.
Phillips curve
Quantity theory of money
Required reserve ratio
Reserves
Stagflation
Part II (25 points): True/False, Explain
State whether the following statements are true or false and explain your answer. No
points will be awarded for unsupported answers.
1. One way for the Fed to expand the money supply is to purchase government
bonds.
2. Like fiscal policy, monetary policy primarily affects aggregate demand rather
than short-run aggregate supply.
3. While inflation can cause serious problems for an economy, deflation does not
harm an economy.
4. Money doesn’t have to have any inherent value to function as a medium of
exchange.
5. If the quantity of money in an economy increases then prices must increase.
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ECON 2172
Homework #4
Chapters 11 – 13
Due: April 16, 2004
Part III (30 points): Multiple Choice
Choose the best answer for each of the following questions.
1. Fiscal policy influences the levels of income and employment by changing:
A. the money supply, credit availability, and interest rates.
B. government regulations.
C. exchange rates and tariffs.
D. taxes, transfers, and expenditures.
2. The key to understanding the money creation process is the fact that:
A. whenever banks create financial assets for themselves, they create
financial liabilities for individuals, and those financial liabilities are
considered money.
B. whenever banks create financial liabilities for themselves, they create
financial assets for individuals, and those financial assets are considered
money.
C. banks are able to print dollar bills and add these dollar bills into
circulation every time they make a loan.
D. since the money supply excludes cash but includes checking account
deposits, money is created whenever individuals deposit currency into a
checking account.
3. The financial sector is best defined as the market for the creation and exchange of:
A. Money.
B. Goods and services
C. Financial assets.
D. All assets with a money price.
4. Which of the following is not a tool available to the Federal Reserve for adjusting
interest rates?
A. A change in the required reserve ration
B. Buying or selling bonds
C. Changing the personal income tax rate
D. Changing the discount rate
5. Open market operations affect:
A. neither bond prices nor interest rates.
B. only bond prices.
C. only interest rates.
D. both bond prices and interest rates.
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ECON 2172
Homework #4
Chapters 11 – 13
Due: April 16, 2004
Part II (30 points): Multiple Choice (continued)
6. Monetary policy in the United States is controlled by:
A. Congress.
B. the president.
C. the Supreme Court.
D. the Federal Reserve Bank.
7. If the economy is in the Keynesian range, an expansionary monetary policy:
A. Increases both nominal and real income.
B. Increases real income but not nominal income.
C. Increases nominal income but not real income.
D. Increases neither nominal nor real income.
8. In the simplest of terms, the quantity theory of money says that:
A. the price level varies in response to changes in the quantity of money.
B. the quantity of output produced in an economy varies in response to
changes in the price level.
C. the velocity of money varies in response to the quantity of output
produced in an economy.
D. the price level varies in response to changes in the velocity of money.
9. Suppose the CPI rose two percentage points in 2002, 2003 and 2004 and the
economy operated at potential output in each year. Now suppose that government
announces that it will pursue much more expansionary monetary and fiscal
policies in 2001. If people form expectations rationally and if the government’s
policy announcement is credible, then expected inflation for the year 2005:
A. will not change.
B. will rise.
C. will fall.
D. could rise or fall.
10. The Phillips curve tells policy makers that if currently inflation is 6 percent and
unemployment is 4 percent, measures to reduce the inflation rate to 4 percent will
most likely result in an unemployment rate of:
A. 0 percent.
B. 2 percent.
C. 4 percent.
D. 6 percent.
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ECON 2172
Homework #4
Chapters 11 – 13
Due: April 16, 2004
Part IV (25 points): Understanding Your (Virtual) World
In Sony’s online game, “EverQuest,” players in the virtual reality can earn money by
engaging in tasks. One relatively easy task is killing rats. The rats can be traded for the
game’s currency, platinum pieces (pps for short). In this game there are artificial vendors
who will always pay one pp for a dead rat. Essentially, these vendors are like a Treasury
that dispenses money at a constant rate. Therefore, killing a rat increases the money
supply by one pp. Players can always choose to forego pps by resorting to barter with
other players.1
A.
What will happen to the value of the pps if people choose to engage in rat
killing exclusive of any other activities in the game? (You can assume that
there will be an infinite number of rats in the game. If no one makes anything
else the quantity of goods available will not grow.)
B.
If the prices of all other goods are free to fluctuate in the game, what would
you expect to happen to prices as people kill more and more rats?
C.
What will happen to the value (opportunity cost) of spending time killing rats
as prices react to the change in money supply? If you could make bows and
arrows (or any other item worth having in the virtual world) what would the
price changes do to your incentive to make bows and arrows?
D.
Imagine that you choose to enter the game as a banker (perhaps not the sexiest
of characters but if you do it right you will be very popular). Explain how you
can create money by offering your services to the other characters in the game
(Hint: in the game characters are limited in how much stuff they can carry at
any time.).
E.
Now, imagine you offer to play the game (for a fee, of course) as a minister of
platinum piece protection (i.e. you will be the Federal Reserve). How might
you change the way pps are introduced into the game to help control the
money supply?
You can read about the economy of Norrath in Edward Castronova’s paper “Virtual
Worlds: a First-Hand Account of Market and Society on the Cyberian Frontier” at
http://papers.ssrn.com/sol3/ cf_dev/AbsByAuth.cfm?per_id=277893 but I am pretty sure
you will have to be on campus to access it. If you really want to read the paper and have
troubles accessing it let me know and I will make a copy for you.
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