Review Material for Midterm 2
Economics 470/570
Fall 2011
These are review questions for the midterm exam which will be on Tuesday, November 15.
Definitions
Quantity equation
Velocity of money
Equation of exchange
Aggregate demand or expenditures
Expenditure multiplier
AE curve
MP curve
Inflation target
Interest rate target
Output target
Policy effectiveness
Crowding out
Debt monetization
Inflation
Government budget constraint
Questions
1. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.
2. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.
3. Describe the three traditional tools available to the Fed for controlling the money supply.
4. 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.
5. Explain the quantity theory of money. What assumptions are imposed to arrive at a theoretical statement? Explain the Cambridge approach and illustrate that it leads to the same result as the quantity theory.
6. What is the money demand function in the classical model?
7. 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?
8. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.
9. 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?
10. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?
11. Explain Friedman's Modern Quantity Theory of the Demand for Money.
12. Can budget deficits lead to inflation? Explain using the government budget constraint.
13. Derive the AE curve.
14. What makes the AE curve flatter or steeper?
15. What causes the AE curve to shift?
16. What is the MP curve?
17. Explain the difference between the MP curve used in the book and the MP curve used in class.
18. Show and explain how the MP curve shifts when there is a change in the inflation rate.
19. Using the MP curve from class, derive the dynamic AD curve.
20. Show graphically how the AD curve shifts when there is a change in government spending or taxes. In general, what causes the AD curve to shift?
