Question 1

Interest rates and the price of old or existing bonds are

Accepted Answer

When interest rates rise, the value of existing bonds decreases because new bonds are issued at higher interest rates, making the existing lower-rate bonds less attractive to investors. This lowering of demand causes the price of existing bonds to decrease. As such, interest rates and the price of existing bonds are inversely related.

Question 2

Suppose that a rules-based monetary policy proposal specifies that the money supply will grow 5 percent each year. If velocity grows 2 percent this year and Real GDP grows 2 percent, the price level will __________ by __________ percent.

Accepted Answer

According to the Quantity Theory of Money (MV = PY), where M is the money supply, V is the velocity of money, P is the price level, and Y is the real GDP, if the money supply (M) grows by 5%, velocity (V) grows by 2%, and Real GDP (Y) grows by 2%, the price level (P) must adjust to maintain the equality. The total nominal GDP growth (MV) is 7% (5% from M and 2% from V), and with Real GDP (Y) growing by 2%, the difference (7% - 2% = 5%) must be attributed to the price level (P) increasing. However, the correct calculation for the price level increase should be 5%, not 3%. This indicates a mistake in the explanation regarding the percentage increase in the price level. The correct interpretation of the Quantity Theory of Money in this scenario would suggest that the price level should indeed rise, but the precise percentage increase provided in the options does not accurately reflect the correct application of the theory based on the given percentages for money supply, velocity, and Real GDP growth.

Question 3

The SRAS curve is upward sloping, there is a liquidity trap, and investment spending is sensitive to changes in the interest rate. According to the monetarist transmission mechanism, if the money supply increases the AD curve __________ and the price level __________.

Accepted Answer

With an upward sloping SRAS curve, an increase in the money supply will lead to a shift in the AD curve to the right, resulting in an increase in both the output level and the price level. Additionally, the presence of a liquidity trap implies that interest rate changes will have minimal effects on investment spending, so the monetarist transmission mechanism emphasizes changes in the money supply as the primary determinant of changes in the AD curve.

Question 4

If you believe the economy is self-regulating, you are more likely to be a(an) __________ than a(an) __________.

Accepted Answer

The belief that the economy is self-regulating is consistent with a nonactivist approach, which argues that government intervention can often do more harm than good. On the other hand, an activist approach advocates for government intervention to stabilize and steer the economy. The other answer choices are less relevant to the belief in self-regulation.

Question 5

Investment spending is insensitive to changes in the interest rate and the SRAS curve is upward sloping. According to a monetarist, an increase in the money supply will __________ Real GDP. According to a Keynesian, an increase in the money supply will __________ Real GDP.

Accepted Answer

Monetarists believe that changes in the money supply have a direct effect on inflation and real GDP in the short run, hence an increase in the money supply will raise Real GDP. Keynesians, however, argue that in the presence of liquidity traps or when investment spending is insensitive to changes in the interest rate, an increase in the money supply may not change Real GDP because the extra liquidity does not translate into increased spending or investment.

Question 6

The Keynesian link between the money market and the goods and services market is __________. Changes in the money market must affect the __________ market before the goods and services market is affected.

Accepted Answer

The Keynesian theory posits an indirect link between the money market and the goods and services market, where changes in the money market first impact the investment goods market. This is because changes in interest rates, which are part of the money market dynamics, influence investment decisions, thereby affecting the overall demand for goods and services.

Question 7

Last year, Danielle bought a bond for $10,000 that promises to pay $350 a year. This year, a person who buys a bond for $10,000 receives $325 a year. If Danielle were to sell her (old) bond, its price would be approximately

Accepted Answer

The yield of the new bond is 3.25% ($325/$10,000). To make Danielle's old bond attractive at the same yield, its price should adjust so that $350 represents a 3.25% yield. Therefore, $350 / 0.0325 = $10,769 approximately.

Question 8

The economy is in a recessionary gap and there is complete crowding out. Furthermore, there is no evidence that the economy is in a liquidity trap or that investment is interest-insensitive. This makes the case for the use of __________ policy stronger than it might be otherwise.

Accepted Answer

In a recessionary gap with complete crowding out, expansionary fiscal policy might not be effective because increased government spending could lead to higher interest rates, which in turn could reduce investment. Since there's no evidence of a liquidity trap or interest-insensitive investment, expansionary monetary policy, which involves lowering interest rates to stimulate borrowing and investment, could be more effective in boosting economic activity.

Question 9

The money supply decreased and the AD curve shifted to the left. This is consistent with the

Accepted Answer

The decrease in the money supply and the leftward shift of the AD curve can be explained by both the Keynesian transmission mechanism (when there is neither a liquidity trap nor interest-insensitive investment) and the monetarist transmission mechanism. Both perspectives acknowledge that changes in the money supply can affect aggregate demand, though they explain the process differently.

Question 10

The economy is in a recessionary gap, wages are inflexible downward, and investment spending is insensitive to changes in the interest rate. In this situation, a Keynesian is likely to advocate the use of __________ policy.

Accepted Answer

In this situation, Keynesians would advocate for expansionary fiscal policy. Since wages are inflexible downward and investment spending is not sensitive to changes in interest rates, traditional monetary policy would likely have little effect on the economic conditions. Expanding government spending or cutting taxes would increase aggregate demand directly and help close the recessionary gap.

Question 11

The economy is in the horizontal portion of the AS curve, there is a liquidity trap, and investment spending is sensitive to changes in the interest rate. According to the Keynesian transmission mechanism, if the money supply increases the interest rate __________, investment spending __________, the AD curve __________ and the price level __________.

Accepted Answer

In a liquidity trap, increasing the money supply does not change the interest rate because people prefer to hold cash. Consequently, investment spending, the AD curve, and the price level remain unchanged.

Question 12

The rules-based monetary policy reads: The money supply will increase 3 percent each year. If the average annual growth rate in Real GDP is 2 percent and velocity increases by 1 percent each year, it follows that

Accepted Answer

The Fisher Equation, MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the real GDP, can be used to understand this scenario. If the money supply increases by 3% per year, real GDP grows by 2% per year, and velocity increases by 1% per year, the total nominal GDP (PQ) will grow by 3% + 1% = 4% per year. Since real GDP (Q) grows by 2%, the difference (4% - 2% = 2%) must be attributed to the growth in the price level (P), indicating inflation. However, these are average rates, and actual yearly changes can vary due to fluctuations in growth rates, velocity, or other factors, leading to years with more or less inflation or even stable price levels.

Question 13

According to Keynesian economists, monetary policy is __________ effective at changing the price level and Real GDP.

Accepted Answer

According to Keynesian economists, monetary policy can be effective in changing the price level and Real GDP under certain circumstances, such as when the economy is experiencing a recession or low levels of demand. However, it may not always be effective in combating inflationary pressures or when interest rates are already low. Therefore, the answer is sometimes.

Question 14

The economy is in a recessionary gap and there is evidence that the economy is in a liquidity trap. In this situation, a Keynesian is likely to advocate the use of __________ policy.

Accepted Answer

In a recessionary gap, there is a shortfall in aggregate demand leading to low economic growth and high unemployment. In a liquidity trap, monetary policy becomes ineffective as interest rates are already very low and households and firms are not motivated to spend or invest further. In this situation, Keynesians suggest using expansionary fiscal policy, i.e., increasing government spending and reducing taxes to stimulate aggregate demand and raise economic growth. This would involve the government increasing its spending on infrastructure projects, providing subsidies to businesses, and increasing transfer payments to individuals to boost their spending. The expansionary fiscal policy would increase the aggregate demand and lower unemployment.

Question 15

According to Keynesians, __________ monetary policy will not remove the economy from a(an) __________ gap if __________.

Accepted Answer

Keynesians believe that during a recessionary gap, the economy is not spending enough, and so monetary policy should be expansionary, increasing the money supply to encourage spending. However, if the economy is stuck in the liquidity trap, where interest rates are already very low, this expansionary monetary policy will not have much effect on increasing spending. In other words, trying to use monetary policy to stimulate the economy in a liquidity trap is like pushing on a string - it will have little effect.

Question 16

Last year, Leah bought a bond for $1,000 that promises to pay $40 a year. This year, a person who buys a bond for $1,000 receives $45 a year. If Leah were to sell her (old) bond, its price would be approximately

Accepted Answer

Leah's bond has a fixed interest rate of $40 per year, regardless of changes in the market interest rates. Since the current market interest rate has increased (as evidenced by the $45 per year being offered), the price of Leah's bond would decrease in order to make it attractive to buyers.

To calculate the approximate price of Leah's bond, we can use the formula:

Bond Price = Annual Coupon Payment / Market Interest Rate

Leah's bond has an annual coupon payment of $40 and we can assume that the market interest rate is around 4.5% (since a bond with a $1,000 face value is currently offering $45 per year).

Bond Price = $40 / 0.045 = $888.89

Therefore, the best choice for the approximate price of Leah's bond is A) $889, since this is the closest option to our calculated price.

Question 17

Assuming that the SRAS curve is upward sloping, which of the following statements represents a correct and sequentially accurate economic explanation?

Accepted Answer

DA) When the demand for bonds falls, their price decreases, leading to higher interest rates. Higher interest rates make borrowing more expensive, which can reduce investment spending. This reduction in investment spending can cause the aggregate demand (AD) curve to shift to the left, leading to a lower price level and a decrease in real GDP, assuming the short-run aggregate supply (SRAS) curve is upward sloping.D) If the supply of bonds decreases, the price of bonds increases because there are fewer bonds available for the same level of demand. This leads to lower interest rates, as bond prices and interest rates move inversely. Lower interest rates make borrowing cheaper, potentially increasing investment spending. This can cause the AD curve to shift to the right, which, in an upward sloping SRAS scenario, could initially increase the price level and real GDP. However, the statement ends with "the price level declines and Real GDP increases," which seems contradictory in the context of an AD shift to the right. The correct sequence up to the shift of the AD curve is valid, but the final outcomes seem inconsistent with standard economic theory. Therefore, while the initial sequence in D is logically correct, the final outcomes provided do not align with the expected effects of an AD shift to the right.

Question 18

The rules-based monetary policy reads: The annual growth rate in the money supply will be equal to the average annual growth rate in Real GDP minus the growth rate in velocity. If the average growth rate in Real GDP this year is 3 percent and the growth rate in velocity is 2 percent, then the money supply will increase by ______________ percent this year.

Accepted Answer

According to the rules-based monetary policy, the growth rate in the money supply will be equal to the difference between the average annual growth rate in Real GDP (3 percent) and the growth rate in velocity (2 percent), which is 1 percent. Therefore, the money supply will increase by 1 percent this year.

Question 19

The money supply increased and the AD curve did not shift to the right. This is consistent with the

Accepted Answer

The answer of The money supply increased and the AD...

Question 20

The supply of bonds rises, ceteris paribus, and the price of bonds __________. This __________ the interest rate and __________ the quantity demanded of money.

Accepted Answer

When the supply of bonds rises, their price falls due to the increased availability and decreased scarcity. A fall in bond prices raises the interest rate because the yield (interest payment divided by the price) on the bond increases when the price of the bond decreases. A higher interest rate lowers the quantity demanded of money, as the opportunity cost of holding money (which earns little to no interest) increases.

Quiz 15: Monetary Policy

Interest rates and the price of old or existing bonds are

Suppose that a rules-based monetary policy proposal specifies that the money supply will grow 5 percent each year. If velocity grows 2 percent this year and Real GDP grows 2 percent, the price level will by percent.

The SRAS curve is upward sloping, there is a liquidity trap, and investment spending is sensitive to changes in the interest rate. According to the monetarist transmission mechanism, if the money supply increases the AD curve and the price level .

If you believe the economy is self-regulating, you are more likely to be a(an) than a(an) .

Investment spending is insensitive to changes in the interest rate and the SRAS curve is upward sloping. According to a monetarist, an increase in the money supply will Real GDP. According to a Keynesian, an increase in the money supply will Real GDP.

The Keynesian link between the money market and the goods and services market is . Changes in the money market must affect the market before the goods and services market is affected.