Macroeconomic Theory Econ 202 Section 003 Bonus assignment 1 Mykhaylo Oystrakh

Name Student Number

Answer each of the short answer questions in the space provided. Show all your work. Label all the diagrams.

0.1

2 points

Let money demand be M d = Y (0.3 i). Let the monetary base (central bank money) be equal to H . Let the currency ratio be equal to 0 < c < 1, let the reserve ratio be equal to 0 < < 1. Derive the demand for central bank money. Show your work.

0.2

2 points

Based on the information in the previous question, solve for the equilibrium money supply. Identify the money multiplier.

0.3

1 point

Now assume households decided to distrust the banking system and decided to hold all their money in the form of currency (c = 1). What will be the effect on the money supply. Will it increase or decrease in comparison to the money supply in the previous question? (You do not have to re-solve, just explain in few lines).

0.4

10 points

Show the effect of people switching from holding both deposits and currency to holding only the currency on the IS-LM model. Draw the diagram, shift the curve(s), explain. (Hint: think of the exogenous variable that was affected by households switching to currency in the previous question. How does this variable affect the IS curve? How does it affect the LM curve?)