ANSWERS, SOLUTIONS, AND EXERCISES
PROBLEM SET
1. a. The money supply curve shifts to the right, the money supply increases by $100
b. The money supply curve shifts to the left, and the money supply decreases by $50
2. a. The money supply curve shifts to the right, the money supply increases by $196
b. The money supply curve shifts to the left, the money supply decreases by $119
3.
Pric
e
Amt. Paid in 1
Year
Interest
Payment
Interest Rate
As the price of the bond rises, the interest rate falls.
4. a.
Price Amount Paid
in 1 Year
Interest
Payment
Interest Rate Quantity of Money
Demanded
0
276
277 Instructor’s Manual for Economics: Principles and Applications, 6e
0
b.
c. If the money supply increases to $3,200 billion, there will be a shortage of bonds,
bond prices will rise, and the interest rate will fall until the quantity of money
5.
The student’s reasoning is incorrect. He is confusing a shift of the money demand
Money
($ billions)
Interest
Rate
Md1
Ms1
Md2
A
6%
8% B
Chapter 26 The Money Market and Monetary Policy 278
shift the money demand curve to the right, from Md1 to Md2. At the original interest
6. a. The money demand curve will shift to the left; the Fed should decrease the money
b. The money demand curve will shift to the right; the Fed should increase the money
c. The money demand curve will shift to the left; the Fed should decrease the money
7. a. The current price is $1,000/1.06 = $943.40.
c. You will want to sell your bond now. By doing so, you can avoid a loss of
d. Selling a bond is equivalent to demanding money. So, if most other people share
Interest
Rate
Money
r
′
r
E
E′
Ms2
2 Ms1
Md
Real
Aggregate
Expenditure
Real
GDP
E
E′
AEr′
4
5
°
AEr
Y2
Y1
Z
Z
279 Instructor’s Manual for Economics: Principles and Applications, 6e
8.
Initially, the economy is at point E in the top diagram. To raise the interest rate, the
Fed conducts an open-market sale of bonds. The money supply decreases to M2s and
9. a. When we take account of the effect on net exports, a given change in the money
Interest
Rate
Q and I
Real GDP
Multiplier
Effect
Chapter 26 The Money Market and Monetary Policy 280
. . . and a net export effect:
b. Since monetary policy is stronger in an open economy (when a net export effect
10. The long-run/classical theory relies on flow variables (the flow of loanable funds),
11. a. If a financial crisis develops, people start to consider corporate bonds as more
b. When a financial crisis ends, people start to consider corporate bonds as less risky
c. The spread would decrease. In fact, if the Fed or the Treasury guarantees all
payments due to holders of moderately risky corporate bonds, then these bonds
d. Higher chance of bankruptcy implies higher risk, and therefore higher interest
e. Huge amounts of additional new 10 year treasury securities would drive down
281 Instructor’s Manual for Economics: Principles and Applications, 6e
MORE CHALLENGING
12.
Initially, the economy is at point E in the top diagram and point J in the bottom
diagram. The Fed sets a target interest rate of rT and conducts an open market sale of
bonds to raise the interest rate. The money supply decreases from Ms1 to Ms2. The
higher interest rate leads to reduced aggregate spending shifting the aggregate
Chapter 26 The Money Market and Monetary Policy 282
EXPERIENTIAL EXERCISE
A favorite activity of many macroeconomists is “Fed watching.” Go to the Federal Reserve
System’s Web site and look for the most recent Congressional testimony of the board