Whitman CollegeEcon 407Exam 1October 7, 1999Write all answers in your blue book. Show all of your work.1. (a) (5pts) In "Of the Origin and Use of Money" Adam Smith describes the characteristics of a society that cause people to use money. What are these characteristics?(b) (5pts) In "Money and the Mechanism of Exchange" W. S. Jevons describes four functions that money serves. What are these four functions? Which of Jevon's four is the defining role of money?(c) (5pts) In "On the Origin of Money" Karl Menger asks why "economic man is ready toaccept a certain kind of commodity, even if he does not need it, or if his need of it is already supplied, in exchange for all the goods he has brought to market." How does Menger explain the origin of people's willingness to accept money?2. (10pts) Consider the class experiment from September 7th, in which students took the roles of producers of one of three goods, and could trade for the good they wished to consume. How could an observer of this experiment determine whether any of the experimental goods was serving as money? Explain, with reference to a definition of money.3. (5pts) What items are included in the Federal Reserve's definition of the monetary aggregate M1? Approximately how big is M1 currently?4. (25pts) In "Deflating the Case for Zero Inflation" Rao Aiyagari states that his "review of the available relevant economic theory and evidence demonstrates that the case for ashift to the proposed policy of zero inflation is, at best, weak." Describe the theory and evidence that Aiyagari cites to support this conclusion.For questions 5-7, consider the yield curve for U.S. Treasury debt given on the next page.5. (5pts) What was the price on October 4, 1999 of a 10 year Treasury bond with a face value of $10,000 and no intermediate payments?6. (15pts) Suppose that the Pure Expectations Theory assumptions hold. If everyone believes that the expected annual real interest rate on a one-year T-bill will be 3.2% for each of the next four years, then what are expected annual inflation rates for each of the next three years? That is, what is the expected inflation rate for the twelve month period starting in October of 1999, the expected inflation rate for the twelve month period starting in October of 2000, and the expected inflation rate for the twelve month period starting in October of 2001?7. (2pts) (a) State the assumptions of the Liquidity Premium theory.For parts (b) and (c) suppose that the Liquidity Premium assumptions hold and that theliquidity premia are given in the table below.(b) (8pts) Forecast the annual nominal interest rate on a three-year Treasury note offered for sale two years from now.(c) (15pts) If everyone believes that the expected annual real interest rate on a one-year T-bill will be 3.2% for each of the next four years, then what are expected annual inflation rates for each of the next three years?Term to maturity Liquidity premium (in percent per year)3 months 01 year 0.25 (i.e. 1/4 of a percent per year)2 years 0.753 years 0.804 years 0.855 years