Economics 470/570
Summer 1997
Midterm
I. Short Answer. Answer five of the following seven questions. Each question is worth 8 points.
1. How do bonds and equities differ? Which is more risky?
2. Explain intuitively why the IS curve is negatively sloped.
3. What defines a capital market instrument? Describe two capital market instruments.
4. What is the expenditure multiplier? Why is it useful?
5. Explain the difference between direct and indirect finance.
6. How is the monetary base defined? What are excess reserves?
7. Suppose that the required reserve ratio is 25%, the currency to deposit ratio is .10, the excess reserve to deposit ratio is .20, and the monetary base is 5,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 500. Use the money multiplier to find the new value of the money supply.
II. Essay Questions. Answer four of the following five questions. Each question is worth 15 points.
1. Describe the structure of federal reserve districts and federal reserve banks. How has the power structure of the federal reserve system shifted over time?
2. According to Baumol and Tobin, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?
3. Derive the LM curve. Show graphically and explain intuitively how an increase in the money supply affects income and the interest rate in the IS-LM model.
4. How do financial intermediaries, through their ability to pool resources and economize on transactions costs, promote more efficient use of financial resources?
5. Show that the Fed can control the monetary base better than it can control reserves. How does the Fed use the monetary base to control the money supply?
