Download Answers to Self Test Questions

AK Macroeconomics – Chapter 8
CHAPTER EIGHT
Answers to Self Test Questions
1.
a) total demand for money: $140
(If GDP = $800 then transactions demand = 10% x $800 = $80; and if r =
10%, asset demand is $60, so total demand = $140.)
b) 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).
3. 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.
4. A reduction in the money supply will cause interest rates to rise and this will cause a
decrease in investment and real income.
5. a) velocity of money: 10
b) P = $2.40
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(2 x 500 ÷ 100)
(120 x 10 ÷ 500)
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AK Macroeconomics – Chapter 8
Answers to Study Guide Questions
1.
2.
3.
4.
5.
False: it is determined by their nominal GDP
True
False: it is determined by the demand and supply of money
True
False: the Bank of Canada does not automatically adjust the money supply to ensure
that it always equals the demand.
6. True
7. False: it refers to the way changes in interest rates cause changes in investment and
real GDP.
8. True
9. False: refers to the number of times money changes hands in a year.
10. True
11.
12.
13.
14.
15.
36A.
a
b
a
b
c
16.
17.
18.
19.
20.
a
c
c
a
a
21.
22.
23.
24.
25.
d
d
a
a
a
26.
27.
28.
29.
30.
a
a
c
d
a
31.
32.
33.
34.
35.
d
c
c
d
e
Key Problem
a) Surplus of 20 billion. Figure 8.13 shows that at 7% interest rate, the quantity
demanded is 40. Since the money supply is 60, there is a surplus of $20.
b) 5%. This is the rate of interest that the quantity of money demanded equals the
quantity supplied. In Figure 8.13 this is where the two curves intersect.
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AK Macroeconomics – Chapter 8
c) See the following figure:
Figure 8.13 (completed)
d) 3%. This is where the new money supply curve intersects the money demand
curve in Figure 8.13 (completed).
e) Increase of $20 billion. Figure 8.14 shows that at the previous interest rate of
5%, the quantity of investment was $40. At the new interest rate of 3%, the
quantity of investment is $60. The difference is $20 billion higher.
f) See the following figure:
Figure 8.15 (completed)
150
140
AS
130
Price level
120
AD2
110
AD1
100
90
400 increased
500 by $20
600billion,
700
800 demand
900will increase
1000
Since investment
aggregate
by
$100 billion. This means graphically
that
the AD curve will shift by 2
Real
GDP
squares to the right.
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AK Macroeconomics – Chapter 8
g)
Price level of 125 and real GDP of $750. This is where the new AD curve,
AD2, intersects the AS curve.
37A.
a)
b)
77 million drams (nominal GDP is real GDP x price level (70 x 1.1 = 77)
12.1 million drams.
(the money supply must rise by the same 10% that GDP has increased: 11
million + 10% = 12.1)
38A.
V = 10.7 (nominal GDP is 873 X 108.7 ÷ 100 = 948.95 and this figure ÷ 88.4 =
10.7)
39A.
a) price level = 2;
nominal GDP = 200
b) price level = 2.4;
nominal GDP = 240
c) Since a 20% increase in the price level leads to the same percentage increase in
nominal GDP, we can conclude that there is a direct and proportional relationship
between the two.
40A. 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
41A.
a) Interest rate: 10%;
b) Interest rate: 6%;
c) Interest rate: 12%;
42A
The two major determinants of the transactions demand for money are the price
level and the real GDP of the economy (together, they make up the nominal GDP).
An increase in either will increase the transactions demand for money. (The
transactions demand is also affected by institutional factors like the efficiency of the
payments system, the use of electronic money and so on.)
43A.
Equilibrium in the money market means that the total demand for money (the total
of the transactions and asset demands) is equal to the total supply of money (as
determined by the central bank).
44A.
investment: $160.
investment: $200.
investment: $140.
a) Surplus of money of $20b (Ms = 100; Md = 80).
b) Surplus of goods and services of $30b. (At 10%, investment = $70; at GDP =
$500, savings = $100 so consumption = $400. Therefore aggregate
expenditures (C + I) = $470. So supply of goods and services of $500 exceeds
the demand of $470.)
c) GDP: $400;
interest rate: 8%.
d) GDP: $350;
interest rate: 10%.
e) Money supply: $140.
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AK Macroeconomics – Chapter 8
45A.
a)
b)
c)
d)
e)
rate of interest: 7%;
investment: $600.
decrease of 3% (from 7% to 4%).
increase by 40 (from $40 to $80).
an increase of $100B (from $80 to $180).
no
46A. a) Surplus of $20.
At 10% interest rate, Figure 8.18A shows that the quantity of money demanded
would be $80. Since the money supply is $100, the difference of $20 represents
the surplus.
b) Surplus of $30
At 10% interest, Figure 8.18B shows that investment will be $70. If GDP is
$500, Figure 8.18C shows that saving equals $100. Since there are no taxes,
then consumption must be $400. Aggregate expenditures will therefore total 70
(I) and 400 (C), equals $470. Since GDP is $500, there will be a surplus of $30
in goods and services. (This represents the difference between GDP and
aggregate expenditures.
c) Interest rate equals 8% and GDP equals $400.
Given the money demand shown in Figure 8.18A, if the money supply is set at
$100, then the equilibrium rate must be 8%. If the interest rate is 8%, then
Figure 8.18B shows that investment spending will be $80. If the product
market is in equilibrium, then saving must also be $80. To produce saving of
$80, Figure 8.18C shows that GDP must be $400.
d) Interest rate equals 10% and GDP equals $350.
Given the money demand shown in Figure 8.18A, if the money supply is set at
$80, then the equilibrium rate must be 10%. If the interest rate is 10%, then
Figure 8.18B shows that investment spending will be $70. If the product
market is in equilibrium, then saving must also be $70. To produce saving of
$70, Figure 8.18C shows that GDP must be $350.
e) Money supply of $140.
At a GDP of $500, saving equals $100. If the product market is in equilibrium
Figure 8.18C shows that investment also equals $100. For investment to be
$100, Figure 8.18B shows that the interest rate must be 4%. If the interest rate
is 4%, then Table 8.18C shows that the quantity of money demanded will be
$140. If the money market is to be in equilibrium, then the money supply must
also be $140.
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AK Macroeconomics – Chapter 8
47A. a) See the following figure:
Figure 8.19 (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 8.19 (completed)
The AD will increase by $200. (The AD curve in graph C shifts to the right by 2
squares.)
d) GDP: $700
48A. a) The transactions demand for money will increase because an increase in the price
level will increase nominal income.
b) The transactions demand for money will increase because an increase real
income will increase nominal income.
c) The transactions demand for money will increase because nominal income has
increased.
d) The transactions demand for money will increase because; nominal income has
increased.
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AK Macroeconomics – Chapter 8
49A.
To begin re-arrange the equation of exchange, to get V = P x Q
100M
Using this formula, we get:
1993: V = 15 (101.2/100 x 716/48.3); 1994: V = 14.1 (102.4/100 x 744/54.2) ;
1995: V = 14 (105.1/100 x 760/57.1); 1996: V = 13 (106.6/100 x 770/63.1);
1997: V = 11.6 (107.1/100 x 798/73.5).
50A.
$10 285. Whoever is holding the bond when it is redeemed in one year will
receive $10 800, (principal of $10 000 plus the coupon interest of $800).
Alternatively a prospective investor could invest that money ($X) at the market
rate of 5% for one year. So we ask the question: What sum of money ($X)
invested at 5% will equal $10 800 in one year? Or algebraically, $X x (1.05) =
$10 800. X therefore equals $10 800/1.05 = $10 285. So a person paying $10
285 for the bond will earn $800 in coupon interest but lose $285 on the
depreciation of the bond, totaling $515. This works out to an interest rate of
$515/$10 285 = 5%.
51A. A surplus of money would lead people to get rid of the excess by buying bonds. This
would increase the demand for bonds, so pushing up their prices, which implies a lower
interest rate. As the interest rate drops, people’s desire to hold money will increase;
this process continues to the point that at a lower interest rate people’s desire to hold
money is equal to the supply of money; in other words, until the surplus has
disappeared.
52A. An increase in the supply of money causes a surplus of money. People react by
buying bonds, causing the price of bonds to increase and the interest rate to drop. The
lower interest rate will lead to an increase in investment and in income.
The process is more direct, according to Monetarists, since the surplus of money will
lead to an increase in spending (not just on bonds) which will lead to an increase in
aggregate demand and in nominal income.
53A. $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.
54A. a)
b)
c)
d)
Keynesian view: graph A;
Monetarist view: graph B.
Keynesian view: graph B;
Monetarist view: graph A.
increase by $10. (interest rate changes by 1%).
increase by $160. (interest rate changes by 4%).
55A.
Keynesians would expect the asset demand for money to be very high.
Monetarists assume that there is no asset demand for money.
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AK Macroeconomics – Chapter 8
56A. Since economic growth means an increase in the output of real goods and services,
an increase in the money supply is needed to prevent higher interest rates (as a result
of a higher transactions demand for money) which would reduce investment and
economic growth.
57A. They do not believe that there is an asset demand because they feel that people would
not hold idle balances of cash. This is because, according to Monetarists, there are
many financial instruments available which are as safe and as liquid as cash.
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