Chapter 13 review answers PDF

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Money and Banking

Chapter 13 quiz

NAME ______________________________________

1. Use the figures in the table below to answer the following questions. Small time deposits Large time deposits Saving deposits, including money-market deposit accounts Money-market mutual funds Checkable deposits Currency

$ Billions 1,250 1,300 1,620 905 836 325

(a) What is the value of M1? (b) What is the value of M2? (c) What is the value of M3?

2. List three major points that gives money its value.

3. The total demand for money is equal to the transactions demand plus the asset demand for money. (a) Assume that each dollar held for transactions purposes is spent on the average five times per year to buy final goods and services. If the nominal GDP is $5000 billion ($5 trillion), what is the transaction demand? (b) The table below shows the asset demand at certain rates of interest. Using your answer to part (a), complete the table to show the total demand for money at various rates of interest. Interest rate (in %) 10 8 6 4

Asset demand (billions) $ 40 80 120 160

Total demand (billions) $_____ _____ _____ _____

(c) If the money supply is $1080 billion, what will be the equilibrium rate of interest? (d) If the money supply rises, will the equilibrium rate of interest rise or fall? (e) If GDP rises, will the equilibrium rate of interest rise or fall?

Chapter 13

4. Use the graph below to answer the following questions. Dt is the transactions demand for money, Dm is the total demand for money, and Sm is the supply of money.

(a) What is the transactions demand for money in this market?

(b) What is the asset demand for money if the interest rate is 4%?

(c) If the money market is in equilibrium at 6%, describe the change that must occur for the equilibrium rate to change to 4%.

(d) If the money market is in equilibrium at 6% and the money supply has increased to Sm3, by how much has total demand for money changed?

5. Use the table below for the next set of questions. Column 1 shows the interest rate, column 2 shows the demand for money, and columns 3–5 show the supply of money. All quantities are in millions ($). (1) Interest rate

(2) Dm

(3) Sm1

10% 8 6 4 2

$1,500 1,800 2,200 2,500 2,800

$2,200 2,200 2,200 2,200 2,200

(4) Sm2

(5) Sm3

$2,500 $1,800 2,500 1,800 2,500 1,800 2,500 1,800 2,500 1,800

Money and Banking

(a) Given the demand for money, what will the equilibrium interest rate be for each of the different supply of money schedules?

(b) Assume the economy was in equilibrium at Dm and Sm1. If the FED decides to change the money supply to Sm2 and the interest rate stays the same, how much of a shortage or surplus in the money supply will there be? Describe what will happen in the money market and the bond market to eliminate the surplus or shortage and restore a new equilibrium interest rate.

(c) Assume the economy was in equilibrium at Dm and Sm1. If the FED decides to change the money supply to Sm3 and the interest rate stays the same, how much of a shortage or surplus in the money supply will there be? Describe what will happen in this money market and the bond market to eliminate the surplus or shortage of money and restore a new equilibrium interest rate.

7. Answer the next two questions using the following information: The price of a bond with no expiration date is $1000 and its fixed annual interest payment is $50; bond annual rate of interest is 5%. (a) If the price of this bond decreases by $250 to $750, what will its effective interest rate be for the new buyer? (b) If the price of this bond increases to $1200, what will its effective interest rate be for the new buyer?

8. Suppose that a bond having no expiration date has a face value of $10,000 and pays a fixed amount of interest of $1000 annually. Compute and enter in the spaces provided either the effective interest rate which a bond buyer could receive at the new price or the bond price required to receive the interest rate shown. Bond price $ 8,000 ______ 10,000 12,000 ______

Interest rate (%) ______ 11.1 ______ ______ 6.67

Answers to Review 3. Interest rate Asset demand (in %) 10 8 6

Total demand (billions) $ 40 80 120

(billions) $1,040 1,080 1,120

Chapter 13

4

160

1,160

(a) $5000 billion / 5 = $1000 billion (b) See table above. (c) Where money supply is equal to total demand at 8%. (d) If the money supply increases, the rate will fall. (e) The rate will rise because transactions demand, hence total demand, will rise and intersect supply at a new higher rate of interest. [text: E pp. 251-254; MA pp. 251-254] 4. Use the graph below to answer the following questions. Dt is the transactions demand for money, Dm is the total demand for money, and Sm is the supply of money.

(a) What is the transactions demand for money in this market? (b) What is the asset demand for money if the interest rate is 4%? (c) If the money market is in equilibrium at 6%, describe the change that must occur for the equilibrium rate to change to 4%. (d) If the money market is in equilibrium at 6% and the money supply has increased to Sm3, by how much has total demand for money changed? (a) $125 (b) $325 – 125 = $200 (c) On the above graph, the money supply must increase to 325. Although not indicated on the diagram, a decrease in demand could achieve the same effect assuming the supply remained at 250, demand would have to shift leftward until it intersected supply at 250 and 4%. (d) [text: E pp. 251-254; MA pp. 251-254] 5. Use the table below for the next set of questions. Column 1 shows the interest rate, column 2 shows the demand for money, and columns 3–5 show the supply of money. All quantities are in millions ($). (1) Interest rate

(2) Dm

(3) Sm1

10% 8 6 4

$1,500 1,800 2,200 2,500

$2,200 2,200 2,200 2,200

(4) Sm2

(5) Sm3

$2,500 $1,800 2,500 1,800 2,500 1,800 2,500 1,800

Money and Banking

2

2,800

2,200

2,500

1,800

(a) Given the demand for money, what will the equilibrium interest rate be for each of the different supply of money schedules? (b) Assume the economy was in equilibrium at Dm and Sm1. If the FED decides to change the money supply to Sm2 and the interest rate stays the same, how much of a shortage or surplus in the money supply will there be? Describe what will happen in the money market and the bond market to eliminate the surplus or shortage and restore a new equilibrium interest rate. (c) Assume the economy was in equilibrium at Dm and Sm1. If the FED decides to change the money supply to Sm3 and the interest rate stays the same, how much of a shortage or surplus in the money supply will there be? Describe what will happen in this money market and the bond market to eliminate the surplus or shortage of money and restore a new equilibrium interest rate. (a) Dm and Sm1: 6%; Dm and Sm2: 4%; Dm and Sm3: 8%. (b) There will be a surplus of $300 million. People will now try to get rid of money by buying more bonds. The collective attempt to buy bonds increases the demand for bonds relative to the supply and drives up their price. Bond prices will rise and interest rates will fall until a new higher equilibrium interest rate is established at 8%. (c) There will be a shortage of $300 million. People will attempt to make up for this shortage by selling some of the financial assets they own such as bonds. The collective attempt to sell bonds increases their supply relative to the demand and drives down their price. Bond prices will fall and interest rates will rise until a new higher equilibrium interest rate is established at 8%. [text: E pp. 253-254; MA pp. 253-254] 6. Suppose that a bond having no expiration date has a face value of $10,000 and pays a fixed amount of interest of $1000 annually. Compute and enter in the spaces provided either the effective interest rate which a bond buyer could receive at the new price or the bond price (rounded to the nearest $1000) required to receive the interest rate shown. Bond price $ 8,000 ______ 10,000 12,000 ______

Bond price $ 8,000 9,000 10,000 12,000 15,000

Interest rate (%) ______ 11.1 ______ ______ 6.67

Interest rate (%) 12.5 11.1 10.0 8.3 6.67

[text: E pp. 253-254; MA pp. 253-254]...