Lesson 4

Question 1

Define Demand Deposits

Answer 1

Deposits which can be converted into currency on demand and transferred by cheque or debit card

Question 2

What is Money Stock

Answer 2

Ms = Currency in Circulation + Demand Deposits

Money stock is determined by the central bank. Determined by “Monetary Policy”

Question 3

What are the three functions of Money?

Answer 3

1. Medium of Exchange: a generally-accepted means of making payments; this is the key, or defining, function of money.
2. Unit of Account: the generally-accepted measure of value: the unit in which prices of goods and services, and values of assets, and liabilities are quoted and recorded.
3. Store of Value: a means of holding wealth and of transferring purchasing power from the present to the future.

Question 4

Money Demand depends on…

Answer 4

1. Expected rate of return - low for money
2. Risk - N/A
3. Liquidity - Very liquid

Question 5

Effects..

Answer 5

a) ⇧ P (Y, R constant) → ⇧ value of transactions → ⇧ PxL(R, Y) → ⇧ Md
b) ⇧ R (P, Y constant) → ⇧ opportunity cost of holding money→ ⇩ L (R, Y) →⇩ Md
c) ⇧ Y (P, R constant) → ⇧ volume and value of transactions → ⇧ L (R, Y) →⇧ Md

Question 6

Consider the determination of the dollar/euro exchange rate, defined as the dollar price of one euro. Suppose that the European Central Bank adopts contractionary monetary policy by reducing Europe’s money supply, while the U.S. Federal Reserve keeps the U.S. money supply constant. Assuming no changes in (domestic and foreign) price levels and levels of real income, we can predict that on the FX market:

Answer 6

demand for euros will rise, supply of dollars will rise, and the exchange rate will rise

Question 7

In our model money is neutral in the long run in because a one-time, permanent change in money supply has no effect on the long-run equilibrium values of real variables such as the real money supply, the interest rate, and real exchange rate.

Answer 7

true

Question 8

Which of the following is true of our general model of long-run exchange rates?

Answer 8

other things equal, the adoption of more expansionary domestic monetary policy will affect the long-run equilibrium value of the nominal exchange rate but leave the long-run equilibrium value of the real exchange rate unchanged

Question 9

Along the AA curve the exchange rate falls as real income rises because

Answer 9

the increase in income raises real money demand and increases the equilibrium interest rate which then requires a fall in the equilibrium exchange rate

Question 10

The aggregate demand curve, showing how D varies with Y, slopes up because the marginal propensity to consume is positive and larger than the marginal propensity to import.

Answer 10

The aggregate demand curve, showing how D varies with Y, slopes up because the marginal propensity to consume is positive and larger than the marginal propensity to import.

Question 11

Other things equal, a decrease in the level of national income (Y) causes a decrease in the equilibrium interest rate (R) and an increase in the equilibrium exchange rate (E).

Answer 11

True