9) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times,
and will shift $10,000 into bonds from his checking account for each percentage point that the
interest rate on bonds exceeds the interest rate on his checking account. Currently, he keeps
$100,000 in bonds, which pay him 7%. What is the current interest rate on checking accounts?
A) 5%
B) 7%
C) 9%
D) 10%
10) Money demand is given by
Md/P = 1000 + .2Y – 1000i.
Given that P = 200, Y = 2000, and i = .10, real money demand is equal to
A) 1300.
B) 1500.
C) 260,000.
D) 300,000.
11) Over time, the wealth of society increases and payments technologies get more efficient.
What is the effect on money demand of these two changes?
A) Money demand rises proportionately to the rise in wealth.
B) Money demand rises, but less than proportionately to the rise in wealth.
C) The overall effect is ambiguous.
D) Money demand declines.
12) If there is a financial panic and increased uncertainty about the returns in the stock market
and bond market, what is the likely effect on money demand?
A) Money demand declines first, then rises when inflation increases.
B) Money demand rises.
C) The overall effect is ambiguous.
D) Money demand declines.
13) Suppose a new law imposes a tax on all trades of bonds and stock. What is the likely effect
on money demand?
A) Money demand declines first, then rises when inflation increases.
B) Money demand rises.
C) The overall effect is ambiguous.
D) Money demand declines.
14) If real income rises 4%, prices rise 1%, and nominal money demand rises 4%, what is the
income elasticity of real money demand?
A) 3/4
B) 4/5
C) 5/6
D) 1
15) If real income rises 5%, prices rise 3%, and nominal money demand rises 7%, what is the
income elasticity of real money demand?
A) 3/4
B) 4/5
C) 5/6
D) 6/7
16) If the interest elasticity of money demand is -0.1, by what percent does money demand
change if the nominal interest rate rises from 2% to 3%?
A) -0.1%
B) 5%
C) 0%
D) -5%
17) If the income elasticity of money demand is 3/4 and the interest elasticity of money demand
is -1/4, by what percent does money demand rise if income rises 10% and the nominal interest
rate rises from 4% to 5%?
A) 7.50%
B) 6.25%
C) 5.00%
D) 1.25%
18) Velocity is defined as
A) nominal money stock/nominal GDP.
B) nominal GDP/nominal money stock.
C) real money stock/real GDP.
D) mc2.
19) If real GDP is $4 billion, the price level is 1.25, and the nominal money stock is $500
million, then velocity is
A) 0.1.
B) 1.
C) 10.
D) 100.
20) Money demand is given by
Md/P = 1000 + .2Y – 1000i.
Given that P = 200, Y = 2000, and i = .10, velocity is equal to
A) 0.65.
B) 0.75.
C) 1.33.
D) 1.54.
21) Suppose velocity is 3, real output is 9000, and the price level is 1.5. What is the level of real
money demand in this economy?
A) 2000
B) 3000
C) 6000
D) 30,000
22) Suppose real money demand is 1000, real output is 6000, and the price level is 200. What is
the level of velocity in this economy?
A) 2
B) 3
C) 6
D) 12
23) Suppose velocity is constant at 4, real output is 10, and the price level is 2. From this initial
situation, the government increases the nominal money supply to 6. If velocity and output remain
unchanged, by how much will the price level increase?
A) 2.4%
B) 20%
C) 24%
D) 50%
24) What happens to real money demand (rise, fall, no change) due to a change in each of the
following factors?
(a) A tax on stock market transactions is introduced.
(b) Computerized bond trading reduces transactions costs.
(c) People’s average level of wealth rises.
(d) The threat of a recession increases the riskiness of stocks and bonds.
(e) The interest rate paid on checking account balances declines.
(f) The price level falls in a one-time jump.
25) Give five examples of factors that could reduce the demand for money.
26) Suppose the money demand function is
Md/P = 1000 + 0.2Y – 1000 (r + πe).
(a) Calculate velocity if Y = 2000, r = .06, and πe = .04.
(b) If the money supply (Ms) is 2600, what is the price level?
(c) Now suppose the real interest rate rises to 0.11, but Y and Ms are unchanged. What happens
to velocity and the price level? So if the nominal interest rate were to rise from 0.10 to 0.15 over
the course of a year, with Y remaining at 2000, what would the inflation rate be?
7.4 Asset Market Equilibrium
1) Under a situation of asset market equilibrium,
A) the quantity of money supplied equals the quantity of money demanded.
B) the quantity of money supplied equals the quantity of nonmonetary assets demanded.
C) the quantity of nonmonetary assets supplied equals the quantity of monetary assets demanded.
D) the quantity of money supplied equals the quantity of nonmonetary assets supplied.
2) When the real quantity of money supplied equals the real quantity of money demanded, there
is said to be
A) goods market equilibrium.
B) asset market equilibrium.
C) monetary neutrality.
D) money illusion.
3) When the quantity of money supplied equals the quantity of money demanded, then
A) the goods market is in equilibrium.
B) the asset market is in equilibrium.
C) the money market is in equilibrium.
D) the money market is not in equilibrium.
4) Which of these variables is not a variable in the equation for the asset market equilibrium
condition?
A) Nominal money supply
B) Price level
C) Real income
D) Investment
5) Which of these variables is not a variable in the equation for the asset market equilibrium
condition?
A) Saving
B) Expected rate of inflation
C) Real interest rate
D) Real income
6) If the quantity of money demanded exceeds the quantity of money supplied, then
A) the quantity of nonmonetary assets demanded exceeds the quantity supplied.
B) the quantity of nonmonetary assets supplied exceeds the quantity demanded.
C) the quantity of nonmonetary assets demanded will still equal the quantity supplied, all else
being equal.
D) you can make no conclusions about the relative supply and demand of nonmonetary assets.
7) If the asset market is to remain in equilibrium, then if the money supply increases, output is
unchanged, the price level is unchanged, and the expected inflation rate is unchanged, then
A) the real interest rate must rise.
B) the real interest rate must decline.
C) the nominal interest rate must rise.
D) the inflation rate must rise.
8) Suppose the real money demand function is
Md/P = 2400 + 0.2Y – 10,000 (r + πe).
Assume M = 4000, P = 2.0, πe = .03, and Y = 5000. The real interest rate that clears the asset
market is
A) 3%.
B) 6%.
C) 11%.
D) 14%.
9) Suppose the real money demand function is
Md/P = 2400 + 0.2Y – 10,000 (r + πe).
Assume M = 5000, πe = .03, and Y = 5000. If the price level were to decrease from 2.5 to 2.0,
then the real interest rate would decrease by how many percentage points (assuming Md, πe, and
Y are unchanged)?
A) 4
B) 5
C) 9
D) 14
10) Suppose the real money demand function is
Md/P = 2400 + 0.2Y – 10,000 (r + πe).
Assume M = 5000, P = 2.0, and πe = .03. If Y were to increase from 4000 to 5000, then the real
interest rate would increase by how many percentage points?
A) 2
B) 4
C) 5
D) 7
11) Suppose real money demand is
L = 0.8 Y – 100,000 (r + πe).
If the nominal money supply is 12,000, real output is 15,000, the real interest rate is .02, and the
expected inflation rate is .01, then the price level is
A) 3/4.
B) 1.
C) 4/3.
D) 3.
12) Suppose the real interest rate is 4% and the expected inflation rate is 3%. If the money
supply increases by 10% and output, the real interest rate, and the expected inflation rate are
unchanged, then the price level increases by
A) 3%.
B) 4%.
C) 7%.
D) 10%.
13) Define asset market equilibrium and state the asset market equilibrium condition.
14) Suppose the money demand function is given by
Md/P = 640 + 0.1Y – 5000 (r + πe).
Suppose the central bank changes the nominal money supply depending on income and inflation:
Ms = 1000 + 0.1Y – 4000π.
(a) If expected inflation equals actual inflation = 0.03, Y = 1000, and r = 0.02, calculate the price
level.
(b) If inflation rises to 0.04 while the other variables remain as in part a, calculate the price
level.
(c) If expected inflation rises to 0.04 while the other variables remain as in part a, calculate the
price level.
(d) If the real interest rate rises to 0.03 while the other variables remain as in part a, calculate the
price level.
15) Assume that prices and wages adjust rapidly so that the markets for labor, goods, and assets
are always in equilibrium. What are the effects of each of the following on output, the expected
real interest rate, and the current price level?
(a) a temporary increase in taxes
(b) a reduction in the effective tax rate on capital
(c) an increase in expected inflation
7.5 Money Growth and Inflation
1) If the nominal money supply doubles while real money demand is unchanged, what happens
to the price level?
A) The price level increases by a factor of four.
B) The price level doubles.
C) The price level is unchanged.
D) The price level falls by one-half.
2) If real money demand doubles while the nominal money supply is unchanged, what happens
to the price level?
A) The price level increases by a factor of four.
B) The price level doubles.
C) The price level is unchanged.
D) The price level falls by one-half.
3) If the asset market is in equilibrium, the growth rate of the nominal money supply minus the
growth rate of real money demand equals
A) the real interest rate.
B) the inflation rate.
C) the price level.
D) the growth rate of real output.
4) If nominal money supply grows 3% and real money demand grows 8%, the inflation rate is
A) -5%.
B) 8/3%.
C) 5%.
D) 11%.
5) If real money demand increases 5% and real money supply increases 10%, by about how
much does the price level change?
A) Falls by 5%
B) Unchanged
C) Rises by 2%
D) Rises by 5%
6) If the income elasticity of money demand is 3/4 and income increases 8%, by about how much
does the price level change?
A) Falls by 6%
B) Unchanged
C) Rises by 6%
D) Rises by 8%
7) If the nominal money supply grows 5%, real income falls 2%, and the income elasticity of
money demand is 0.8, then the inflation rate is
A) 3.0%.
B) 3.4%.
C) 6.6%.
D) 7.0%.
8) If the nominal money supply grows 6%, real income rises 2%, and the inflation rate is 5%,
then the income elasticity of money demand is
A) 0.5.
B) 0.75.
C) 1.0.
D) 1.5.
9) If the nominal money supply grows 10%, the inflation rate is 6%, and the income elasticity of
money demand is 1.0, then real income growth equals
A) 1%.
B) 2%.
C) 3%.
D) 4%.
10) Large differences in inflation rates among countries are almost always the result of large
differences in
A) productivity.
B) real income growth.
C) the growth rates of real money demand.
D) the growth rates of nominal money supplies.
11) When a government prints money to finance its expenditures, it is likely to cause
A) unemployment.
B) inflation.
C) deflation.
D) reductions in the use of barter.
12) The most likely explanation for the high inflation rates that countries like Russia and the
Ukraine have suffered is that
A) large inflows of foreign funds increase the money supply, causing inflation.
B) without inflation, these countries would be unable to achieve high rates of growth.
C) borrowing from the central bank is the most expedient method of funding the government’s
expenditures.
D) the flood of financial innovations has increased liquidity in these nations’ economies.
13) Bonds sold by the U.S. government that offer a certain real interest rate are known as
A) zero-coupon bonds.
B) Treasury Inflation-Protected Securities.
C) denominalized securities.
D) savings bonds.
14) The excess of the nominal interest rate over the TIPS interest rate is known as the
A) interest-rate differential.
B) break-even inflation rate.
C) yield spread.
D) term structure.
15) The break-even inflation rate is the
A) excess of the nominal interest rate over the TIPS interest rate.
B) inflation rate that makes the nominal interest rate equal the real interest rate.
C) negative of the real interest rate.
D) inflation rate that is optimal according to the Friedman rule.
16) How does the break-even inflation rate differ from the expected inflation rate as measured in
surveys?
A) They are very close to each other.
B) The break-even inflation rate varies less than the expected inflation rate from surveys.
C) The break-even inflation rate varies more than the expected inflation rate from surveys.
D) The break-even inflation rate is always several percentage points higher than the expected
inflation rate from surveys.
17) Calculate the change in the price level for each of the following events, taken one at a time,
with other variables unchanged.
(a) Money supply increases 10%.
(b) Money demand increases 5%.
(c) Money supply decreases 5% while money demand increases 5%.
(d) Money supply increases 15% while money demand increases 5%.
18) Why did some of the formerly Communist countries of Eastern Europe have inflation rates
over 100%, while others didn’t? Which factor was more important in explaining the differing
inflation rates, real money demand or nominal money supply? Why did the countries with high
inflation rates allow inflation to get so high?