Economics s350k

Summer 2014

Practice Problem Set 4

1. Explain the quantity theory of money. What assumptions are imposed to arrive at a theoretical statement?

2. What is the money demand function in the classical model?

3. How well does the quantity theory explain inflation in the short-run and long-run?

4. 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?

5. Show how velocity and money demadn change when people make more visits to the bank each month. How can the optimal number of visits be determined? How does the optimal number change when there is a change in the cost of a visit to the bank, or a change in the interest rate?

6. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

7. Explain the portfolio theory of money demand and how it relates to the Keynesian model.

8. Can budget deficits lead to inflation? Explain using the government budget constraint.

9. Derive the IS curve graphically and mathematically.

10. What makes the IS curve flatter or steeper?

11. What causes the IS curve to shift?

12. What is the MP curve?

13. Explain the difference between the MP curve used in the book and the MP curve sometimes used in class.

14. Show and explain how the MP curve shifts when there is a change in the inflation rate.

15. Derive the AD curve.

16. Show graphically how the AD curve shifts when there is a change in government spending or taxes. Show how the AD curve shifts when monetary policy becomes tighter. In general, what causes the AD curve to shift?

17. Do monetary and fiscal policy become more or less effective when investment or net exports become more responsive to changes in the interest rate? Explain.