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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
CHAPTER NINE
Answers to Test Your Understanding Questions
1.
a) and b)
(The total money demand curve is $80 to the right of the asset demand curve.)
c)
d)
Equuilibrium r = 8%; equilibrium quantity = $150 (Where MD and MS
intersect.)
Surplus of $10 . (The money supply of 150 is 10 more than the demand of 140)
2. See the table below:
Interest Rate
%
12
11
10
9
8
7
6
Asset Demand
Transactions
Demand
80
80
80
80
80
80
80
50
55
60
65
70
75
80
Total Demand
130
135
140
145
150
155
160
a) equilibrium interest rate: 8% (This is where the money demand of 150 is equal to
the money supply.)
b) equilibrium interest rate: 10% (This is where the money demand of 140 is equal to
the money supply.)
c) Surplus of money of $15 (At 11 percent interest, the money supply of 150 exceeds
the money demand of 135).
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
3. Whether the Bank of Canada buys bonds from chartered banks or from the public
makes no difference to the change in the commercial banks' reserves. If the
bonds are bought from the banks, there will be no change in the amount of demand
deposits and the extra reserves can all be lent out. However, if they are bought from
the public, then the amount of demand deposits at the chartered banks will increase as
the bond sellers deposit their Bank of Canada cheques. Here, the amount of excess
reserves will be slightly lower since the banks will want to keep a small fraction of
these increased deposits.
4. a) Balance sheets after the purchase of securities from the chartered banks (the
affected accounts are highlighted):
All Commercial Banks
Assets
Reserves in vaults
On deposit with the
Bank of Canada
Securities
Loans
Totals
$70
12
118
600
800
Liabilities
Deposits
800
Totals
800
Bank of Canada
Assets
Securities
Totals
Liabilities
Notes in
Circulation
Deposits of banks
Other liabilities
$ 82
82
65
12
5
82
5. As a result of the switch, the reserves and the deposits of the chartered bank will
increase by $100. Although the money supply is not immediately affected by the
switch, the bank will find itself over-reserved by 90 (increased actual reserves of 100
minus increased target reserves of 10% x 100 = 10). Loaning out these excess
reserves will result in an increase in demand deposits, which is part of the money
supply.
6. Economic growth and full-employment are compatible goals but both can come into
conflict with the goals of stable prices and a favorable balance of trade. In addition,
full-employment and stable prices are in conflict.
7. It should sell bonds.
8. If prices increase, so too will money demand, which will push up interest rates and
cause a drop in investment and real GDP. The aggregate demand curve, however,
will not shift, but the aggregate quantity demanded will decrease, i.e., the price
change causes a movement along the AD curve, not a shift in it.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
9. A reduction in the money supply will cause interest rates to rise and this will cause a
decrease in investment and real income.
10. a) velocity of money: 10
b) P = $2.40
(2 x 500 ÷ 100)
(120 x 10 ÷ 500)
Answers to Connect Study Problems
1. a) 77 million drams (nominal GDP is real GDP x price level (70 x 1.1 = 77)
b) 12.1 million drams. (The money supply must rise by the same 10% that GDP has
increased: 11 million + 10% = 12.1)
2. a) $30B (so that all three curves intersect at a GDP of 420).
b) 5% (20/400 x 100)
c) 16.67% (20/120 x 100)
3. a) price level = 2; (P = MV/Q = 40 x 5/100 = 200/100 = 2)
nominal GDP = 200 (Nominal GDP = M x V = 40 x 5 or P x Q = 2 x 100)
b) price level = 2.4; (M increases by 8 (40 x 0.2) to 48. New P = MV/Q = 48 x
5/100 = 2.4)
nominal GDP = 240 (Nominal GDP = M x V = 48 x 5 or P x Q = 2.4 x 100)
c) Since a 20% increase in the price level leads to the same percentage increase
nominal GDP, we can conclude that there is a direct and proportional relationship
between the two.
4.
2.9% interest.
Using the formula:
Rate of return (rate of interest) = coupon interest +/- change in the bond price x100
Price paid for bond
gives us: $350 - $200 x 100 = 2.9%
$5200
5. a) Pabst: 6%
b) Pabst: + 40
30 to 70)
Kokanee: 7% (The intersection of the new MS with the MD.)
(Interest rate drops from 8% to 6%. So investment increases from
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
Kokanee: + 10 (Interest rate drops from 8% to 7%. So investment increases
from 30 to 40)
c) Pabst: + 80 (40 – the answer in b) – times 2).
Kokanee: + 20 (10 – the answer in b) – times 2).
d) Pabst (Because the change in GDP is much bigger than in Kokanee.)
6.
a) Interest rate: 10%;
(Where the MS of 80 equals the MD)
investment: $160. (Reading of Graph B at an interest rate of 10%.)
b) Interest rate: 6%;
(Where the MS of 100 equals the MD)
investment: $200. (Reading of Graph B at an interest rate of 6%.)
c) See the following graph:
Figure 9.13A (Completed)
d) Interest rate: 12%;
(Where MD2 intersects MS in Figure 9.13A (Completed))
investment: $140. (reading off Figure 9.13B in the text at an interest rate of 12%)
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
7. a) See the following figure:
Figure 9.14 (Completed)
A rightward shift of 1 square of the MS curve in graph A will reduce the interest
rate by 1% and this will cause a movement along the Id curve in graph B, which
will increase investment spending by $50 (from $50 to $100).
b) investment spending: $100
c) See Figure 9.14 (Completed)
The AD will increase by $200. (The AD curve in graph C shifts to the right by 2
squares.)
d) GDP: $700 (Where AD2 intersects the AS curve)
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
8. a) See the the following tables:
Table 9.1 (Completed)
A: Central Bank of Beckland
(1)
Assets
Treasury
$190
$191
bills
Short-term
5
5
loans to
banks
Liabilities
Notes in Circulation
Government
Deposits
Deposits of
banks
$185
(1)
$185
6
6
4
5
B: Beckland's Banking System
(1)
(2)
Assets
Reserves:
In vaults
in Bank of
Beckland
Securities
8
4
8
5
8
5
30
29
29
Loans to customers
90
90
100
Liabilities
Deposits
Short-term loans
from Bank of
Beckland
Equity
120
(1)
120
(2)
130
5
5
5
7
7
7
b) no effect in the money supply
c) excess reserves of $1B
d) see Table 9.1B (completed) column (2)
e) + $10B
9. $4 / $96 X 100 X 4 (quarters) = 16.7%
$4 / $96 X 100 X 6 (2 month periods) = 25%
Thus, the rate of return has increased by 8.3% points
10. $21 200. Whoever buys the bond expects to receive a return equal to that on other
investments, i.e. $2000 over two years ($20 000 @ 5% x 2). Since the holder will
receive $3200 ($1600 x 2) in interest from the bond, that investor would be prepared to
lose $1200 on the sale of the bond, i.e. they would be prepared to pay $21 200.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
11. a) Keynesian view: graph A;
Monetarist view: graph B.
b) Keynesian view: graph B;
Monetarist view: graph A.
c) increase by $10. (interest rate changes by 1%).
d) increase by $160. (interest rate changes by 4%).
12 .
a) Beckland: interest rate ↓ by 1%
P: increases 4 points
→ (I & XN) ↑ by 20 → AD ↑ by 40 →
GDP: increases $20
Heineken: : interest rate ↓ by 2% → (I & XN) ↑ by 20 → AD ↑ by 60 →
P: increases 12 points
GDP: increases $18
Answer to Comprehensive Problem
a) See the following figure:
Figure 9.16 (completed)
b) 4%. This is where the new MS2 curve intersects the MD curve
c) Increase of $20 billion. Figure 9.17 shows that at the previous interest rate of
5%, the quantity of investment was $80. At the new interest rate of 4%, the
quantity of investment is $100. The difference is $20 billion higher.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 9
d) See the following figure:
Figure 9.17 (completed)
150
140
AS
130
Price level
120
AD2
110
AD1
100
90
400
500
600
700
800
900
1000
Real GDP
e) Price level = 125; real GDP = $750 billion. (Where AD2 intersects AS.)
f) AD must be decreased by $200 billion. (The AD curve must be shifted 4 squares to
the left so that it intersects the AS curve at a price level of 110 and a GDP level of
$600.)
g) Decrease of $40. (The change of investment is 1/5 of the change in AD.)
h) Target interest rate = 7%. (For investment to fall by $40 (2 squares), the interest rate
must increase from 5% to 7%.
i) Decrease of $20 billion. (The money supply must drop by 2 squares in order to
increase the interest rate from 5% to 7%.
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