Economics 470/570
Winter 2006
Review Questions - Midterm 1
[pdf
file]
Definitions
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Financial intermediary
Direct and indirect finance
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Federal Funds rate
Essay
1. How is money measured? Why is there more than one definition of the money supply?
2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?
3. Describe the evolution of money from barter to fiat money.
4. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.
5. How do financial intermediaries, through their ability to pool resources promote more efficient use of financial resources? Be sure to cover risk pooling, the pooling of small investors, and pooling over time in your answer.
6. How do financial intermediaries reduce default risk, transactions costs, and matching costs?
7. Briefly describe the major functions of Federal Reserve district banks.
8. Who is on the FOMC? What does the FOMC do?
9. Describe the structure of Federal Reserve districts and Federal Reserve banks.
10. Describe the structure and function of the Board of Governors of the Federal Reserve System.
11. How has the power structure of the Federal Reserve System shifted over time?
12. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed (we will discuss this question next class).
Economics 470/570
Winter 2006
Review Questions - Midterm 2
[pdf
file.]
Definitions
Monetary Base
Borrowed and Non-borrowed reserves
Operating and intermediate targets
Monetary Policy Goals
Defensive and Dynamic Open Market Operations
Primary, Secondary, and Seasonal Credit
Monetary aggregate
Velocity of money
Output gap
Potential output
Natural rate of output
Explain Poole's rules.
Liquidity preference
Essay
1. Derive the deposit and money multipliers when people hold currency and when banks hold excess reserves. Are the multipliers larger or smaller than the simple multiplier, i.e. when currency held and excess reserves are both zero? Explain.
2. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 200. Use the money multiplier to find the new value of the money supply.
3. Using t-accounts, show that the Fed can increase the monetary base by (a) making discount loans to banks, (b) an open market purchase of government bonds from banks, or (c) an open market purchase of government bonds from an individual.
4. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.
5. Show that the Fed cannot simultaneously control bank reserves and the federal funds rate and therefore cannot adopt both as operating targets.
6. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?
7. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this limits the amount the federal funds rate can rise.
8. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages and disadvantages of each tool?
9. What are the tools, operating targets, intermediate targets, and goals of Federal Reserve Policy? How are they related?
10. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.
11. Can the Fed control bank reserves exactly? Explain. Why is this important?
12. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.
13. Explain Poole's rules.
14. What is the Taylor rule? How is it used? How well does it predict Fed policy?
15. What is the role of money in the classical model?
16. Represent the classical model using an AD-AS diagram and show that changes in money, government spending, and taxes do not affect real output. What is the AD curve in the classical model?
17. State Say’s law. What is the significance of this in terms of government stabilization policy? Explain why Malthus does not believe in Say’s law. How does classical interest theory answer address Malthus’ criticism of Say’s law?
18. Explain classical interest theory. Be sure to explain why the investment function slopes downward and the saving function slopes upward.
19. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?
20. What is the money demand function in the classical model?
21. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand emerges?
22. According to Baumol, 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?
Economics 470/570
Winter 2006
Review Questions Through Week 9
[pdf
file.]
Definitions
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out
Essay
1. Show graphically using a money demand – money supply diagram and explain intuitively how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) autonomous money demand increases.
2. Derive the LM curve graphically and explain intuitively why the LM curve slopes upward.
3. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|Li|) increases.
4. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.
5. Explain why setting income equal to expenditures is equivalent to setting saving equal to investment.
6. What does the 45 degree line diagram show? Show the equilibrium on the 45 degree line diagram and explain how the economy moves to equilibrium if output differs from its equilibrium value. How will the equilibrium level of output change if there is a change in autonomous consumption, investment, government spending, or taxes? Explain. How will income change if the interest rate falls?
7. What is the expenditure multiplier? Why is it useful?
8. Explain why investment is negatively related to the interest rate.
9. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.
10. Show graphically and explain intuitively how the slope of the IS curve changes when the responsiveness of investment to the interest rate (|Ii|) increases. When is investment more sensitive to changes in the interest rate, at full employment or in a recession? Explain.
11. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.
12. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.
13. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively.
14. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as money demand becomes less sensitive to the interest rate. Explain the result intuitively.
Economics 470/570
Winter 2006
Review Questions for Week 10
[pdf
file.]
Definitions
Liquidity trap
Monetary shock
SRAS
Full employment
Wealth effect
Real shock
LRAS
Taylor rule
MP curve
Essay
1. Use the IS-LM model to show and explain how price adjustments return the economy to full employment when output differs from its full employment level.
2. Use the AD-AS model to show the SR and LR adjustment to AD shocks in the presence of frictions such as rigid wages.
3. What is a liquidity trap and how does it arise? Explain your answer intuitively and graphically. Is the economy more likely to be in a liquidity trap near full employment or in a recession? Explain.
4. Explain and show graphically using the IS-LM model how the economy can become stuck in a liquidity trap with output less than its full employment level. How can wealth effects overcome this problem?
5. Explain and show graphically using the IS-LM model that when investment is highly insensitive to changes in interest rates, the automatic adjustment mechanism that returns the economy to full employment can break down.
6. In the Keynesian liquidity trap version of the IS-LM model, show that, when the economy is in the liquidity trap, (a) monetary policy is ineffective, and (b) fiscal policy is fully effective.
7. What is the Taylor rule? What are the issues involved in its implementation?
8. Explain why the MP curve slopes upward.
9. Use the IS-MP model to examine the effects of an increase in government spending on output, the real interest rate, consumption, and investment.
10. Use the IS-MP model to examine the effects of tighter monetary policy on output, the real interest rate, consumption, and investment.
11. Use the IS-MP model to examine the effects of a fall in consumer confidence on output, the real interest rate, consumption, and investment.
12. Explain why the SRAS curve shifts upward when output exceeds the natural rate and downward when output is below the natural rate.
13. Derive the AD curve from the IS-MP diagram and explain why it slopes downward.
14. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of an increase in government spending or a decrease in taxes on output, inflation, the real interest rate, consumption, and investment.
15. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of tighter monetary policy on output, inflation, the real interest rate, consumption, and investment.
