Question

t t Question 1 (5 marks) I. Suppose money demand (on the horizontal axis) is plotted against the nominal interest rate on the vertical axis). This money demand curve will shift to the right when which of the following occurs? a. an increase in income. b. a reduction in the interest rate. c. an increase in the money supply. d. a decrease in the money supply. II. At the current interest rate, suppose the supply of money is less than the demand for money. Given this information, we know that: a. the price of bonds will tend to increase. b. the price of bonds will tend to fall. c. the goods market is in equilibrium. d. the supply of bonds equals the demand for bonds. III. Consider an IS/LM model in which money demand depends positively on income and negatively on interest rates, suppose that investment spending depends only on the interest rate (an increase in the interest rate lowers investment demand). Given this information, an increase in taxes: a. will cause investment to decrease. b. will cause investment to increase.' c. may cause investment to increase or to decrease. d. will have no effect on output. IV. In the IS/LM model presented in lectures, suppose the government simultaneously reduces the money supply and cuts taxes. We know with certainty that this combination of policies must cause: a. an increase in the interest rate b. a reduction in the interest rate c. an increase in output- d. a reduction in output- V. In the IS/LM model presented in lectures, suppose that the aggregate demand for goods does not depend on the interest rate. A reduction in the money supply will cause which of the following for this economy? a. no change in the interest rate b. no change in output- c. a reduction in investment- d. an increase in investment- t t

Answer 1

Ans 1: (A) An increase in income will shift the money demand curve to right. As the income rises, individuals will demand more money.

Ans 2: Since, the money supply is less than money demand, so interest rate will rise. This means the price of bonds will fall. Because there is an inverse relation between price of bond and interest rate. So, the correct option is (B) The price of bonds will fall. People will buy bonds and money demand reduces and become equal to money supply.

Ans 3: (A) this will cause the investment to decrease.

Ans 4: (A) An increase in the interest rate. A tax cut would shift the IS curve to the right and a reduction in money supply shifts the LM curve to left, which definitely cause the interest rate to rise. Output can rise, fall or stays same depending upon the magnitude of shift in both curves.

Ans 5: (B) No change in output. This is because when Aggregate demand is unaffected due to change in interest rate then money supply would not affect it.