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UW-Madison ECON 102 - Practice Questions 8

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Econ 102 Fall 2004 Practice Questions 8Readings: Chapter 11, 12, 13, 14, and 15Chapter 11 and 121. The distinction between M1 and M2 is based ona. portability—the ease with which an asset can be moved.b. divisibility—the ease with which an asset can be used to make smaller payments.c. liquidity—the ease with which an asset can be converted into cash.d. storability—how long an asset will retain its value.2. When a banker accepts a deposit of $1,000 in cash and puts $200 aside as required reserves and then makes a loan of $800 to a new borrower, this set of transactionsa. decreases the money supply by $1,000.b. decreases the money supply by $200.c. increases the money supply by $200.d. increases the money supply by $800.3. If the Federal Open Market Committee decides to expand the money supply, then it willa. raise the discount rate to member banks.b. issue directions to purchase government securities, thus putting more reserves in member banks.c. issue directions to sell government securities, thus taking reserves from member banks.d. order new Federal Reserve notes delivered to member banks.14. The Fed conducts an open market purchase of Treasury bills of $10 million. If the requiredreserve ratio is .10, what change in the money supply can be expected using the demand deposit multiplier?a. $100 millionb. $10 millionc. –$10 milliond. –$100 million5. How are Treasury bond prices affected when the interest rate falls?a. The purchaser of the bond needs to spend less money to obtain a given number of dollars of interest per year, so the price of the bond must decrease. b. The purchaser of the bond needs to spend more money to obtain a given number of dollars of interest per year, so the price of the bond must increase.c. The purchaser of the bond needs to spend more money to obtain a given number of dollars of interest per year, so the price of the bond must decrease.d. The purchaser of the bond needs to spend less money to obtain a given number of dollars of interest per year, so the price of the bond must increase.6. Assume the required reserve ratio is 10 percent and the FOMC orders an open market sale of $50 million in government securities from member banks. If the demand deposit multiplier is assumed, then the money supply willa. increase by $500 million.b. increase by $100 million.c. decrease by $100 million.d. decrease by $500 million.7. If the Fed wants to reduce banks’ reserves, it cana. buy securities in the open market.b. lower the reserve ratio.c. lower the federal funds rate.d. raise the discount rate.28. If the Fed raises the discount rate, what will be the effect on the money supply?a. It will decrease the money supply.b. It will increase the money supply.c. No change in the money supply.d. Not enough data to give an answer.9. Assume that the banking system has $200 billion in reserves. There are no excess reservesin the system. If the reserve requirement is decreased from 10 percent to 8 percent, what will happen to the level of excess reserves in the system?a. There will be a deficiency of $40 billion in reserves.b. There will be a deficiency of $20 billion in reserves.c. There will be $20 billion in excess reserves.d. There will be $40 billion in excess reserves.10. The Federal Reserve System has purchased $10 million in government securities from banks, paying for them with increases in banks’ reserves. Describe the changes in the balancesheets of the commercial banks and the Federal Reserve System, respectively. 11. Assume that the required reserve ratio is 10 percent. After the transaction in question 10 is completed, what happens to actual reserves, required reserves, and excess reserves? Assume that the transaction in question 10 is the only transaction/adjustment that has occurred.12. In question 11, compute the total change in the money supply using the demand deposit multiplier. 13. Suppose the demand for money is given by Md = 750 – 50rwhere Md is the quantity of money demanded (in billions of dollars) and r is the interest ratein percentage points. The supply of money is set at $400 billion.a. At an interest rate 12%, is the quantity of money demanded greater than the quantity ofmoney supplied? Compute the excess demand/supply in the money market, if any.3Also, compute the excess demand/supply in the bond market, if any. What will happento the bond price and the interest rate?b. Compute the equilibrium interest rate. 14. The demand for money is Md = 650 – 50rwhere Md is the quantity of money demanded (in billions of dollars) and r is the interest rate in percentage points. The supply of money is set at $250 billion. Suppose that all demand deposits are held in commercial banks, and that all commercial banks are subject to fractional reserve requirements where the required reserve ratio (RRR) is 50%..a. Compute the equilibrium interest rate.b. Suppose the Fed wants the interest rate to be 4% and so it tries to change the money supply by intervening in the open market. What amount of bonds should the Fed sell or buy?415. Suppose the demand for money is given by Md = 750 – 50rwhere Md is the quantity of money demanded (in billions of dollars) and r is the interest rate in percentage points. The supply of money is set at $350 billion. The aggregate expenditure (AE) in billions of dollars is given by AE = .5Y + 2,250a. Compute the equilibrium interest rate in the money market and the equilibrium real GDP.b. The Fed has decided to increase the money supply by $100 billion. For the time being, we suppose the spending in the economy is never sensitive to the change in the interest rate. Compute the equilibrium interest rate and the real GDP in this case.c. Now, let us suppose that every 1 percent point decrease in the real interest rate stimulates the spending in the economy by 500 billion dollars. However, the quantity ofmoney demanded is never affected by the change in the real GDP. Compute the equilibrium real GDP given the change in part (b). [Hint: think carefully about how you need to modify the equation(s) you need.]d. Finally, we suppose that every 1,000 billion dollars increase in the real GDP creates an additional money demand by 25 billion dollars. Find the equilibrium interest rate given the level of real GDP you found in part (c). 16. Now let us go back to the original example in question 15. That is, we are now given the equilibrium interest rate and the equilibrium real GDP computed in the question 15. a. a. Suppose the


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UW-Madison ECON 102 - Practice Questions 8

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