Test Bank For Macroeconomics 10th Edition Abel

Test Bank for Macroeconomics 10th Edition Abel
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Macroeconomics, 10e (Abel/Bernanke/Croushore)
Chapter 7 The Asset Market, Money, and Prices
7.1 What Is Money?
1) A system in which people trade goods they don't want to consume for goods they do want to
consume is called
A) an indirect exchange economy.
B) a commodity money system.
C) a barter system.
D) a fiat money system.
Answer: C
Diff: 1
Topic: Section: 7.1
Question Status: New
2) A disadvantage of the barter system is that

A) no trade occurs.
B) people must produce all their own food, clothing, and shelter.
C) the opportunity to specialize is greatly reduced.
D) gold is the only unit of account.
Answer: C
Diff: 1
Topic: Section: 7.1
Question Status: Previous Edition
3) The use of money is more efficient than barter because the introduction of money
A) reduces the need for economic specialization.
B) reduces the need to exchange goods.
C) reduces the need for other stores of value.
D) reduces transaction costs.
Answer: D
Diff: 1
Topic: Section: 7.1
4) In economics, money refers to

A) income.
B) wealth.
C) assets used and accepted as payment.
D) currency.
Answer: C
Diff: 1
Topic: Section: 7.1
1
Copyright © 2020 Pearson Education, Inc.
5) The following are all functions of money except
A) medium of exchange.
B) store of value.
C) unit of account.
D) source of anxiety.
Answer: D
Diff: 1
Topic: Section: 7.1
6) Money's primary role in the economy comes from the benefits of lowering transactions costs
and allowing specialization. This function of money is called
A) store of value.
B) medium of exchange.
C) standard of deferred payment.
D) unit of account.
Answer: B
Diff: 1
Topic: Section: 7.1
7) For something to satisfy the medium-of-exchange function of money, it must be

A) backed by gold.
B) readily exchangeable for other goods.
C) issued by a central bank.
D) an inherently valuable commodity.
Answer: B
Diff: 1
Topic: Section: 7.1
8) Which of the following best illustrates the medium of exchange function of money?
A) The price of a new car is $25,000.
B) A penny saved is a penny earned.
C) A person owes $10,000 on his or her credit card.
D) You pay $3 to purchase a bag of apples.
Answer: D
Diff: 1
Topic: Section: 7.1
2
9) In some countries, prices in stores are listed in terms of U.S. dollars, rather than in units of the
local currency. That's most likely because
A) the country's political system is unstable.
B) interest rates are higher using U.S. dollars than using the local currency.
C) there is no other store of value.
D) the country has experienced high rates of inflation.
Answer: D
Diff: 1
Topic: Section: 7.1
10) In some countries the U.S. dollar is used as a unit of account rather than the local currency.
The primary reason for this is that
A) the nation has been running a trade surplus.
B) the nation has been running a trade deficit.
C) the U.S. inflation rate is higher than the local inflation rate.
D) U.S. dollars reduce the need to change prices frequently.
Answer: D
Diff: 1
Topic: Section: 7.1
11) The number of units of one good that trade for one unit of alternative goods can be
determined most easily when
A) there is one unit of account.
B) the goods all weigh about the same.
C) the goods are all new.
D) the goods are actively traded through barter.
Answer: A
Diff: 1
Topic: Section: 7.1
12) A good that is used as a medium of exchange as well as being a consumption good is called
A) a barter money.
B) a commodity money.
C) a legal tender.
D) a debased money.
Answer: B
Diff: 1
Topic: Section: 7.1
3
13) Why do people keep currency in their pockets when bank deposits pay interest?
A) Because banks might steal your money.
B) Because currency is more liquid.
C) Because bank deposits lose value due to inflation.
D) Because bank deposits lose value due to changes in interest rates.
Answer: B
Diff: 1
Topic: Section: 7.1
14) One of moneys primary roles in the economy comes from the use of money to transfer
purchasing power to the future. This role of money is called
A) store of value.
B) unit of account.
C) medium of exchange.
D) standard of deferred payment.
Answer: A
Diff: 1
Topic: Section: 7.1
15) Which of the following measures is the best measure of money as a medium of exchange?
A) M1
B) M2
C) M3
D) None of the above
Answer: A
Diff: 1
Topic: Section: 7.1
16) Suppose your bank raises its minimum-balance requirement for free checking on checking
accounts by $500. You take $500 out of your passbook savings account and put it in your
checking account. What is the overall effect on M1 and M2?
A) M1 rises by $500; M2 falls by $500.
B) M1 is unchanged; M2 is unchanged.
C) M1 rises by $500; M2 is unchanged.
D) M1 is unchanged; M2 falls by $500.
Answer: C
Diff: 3
Topic: Section: 7.1
4
17) Suppose you decide to move $2000 from your checking account and move it to your savings
account. What is the overall effect on M1 and M2?
A) M1 declines by $2000, M2 rises by $2000.
B) M1 declines by $2000, M2 is unchanged.
C) M1 is unchanged, M2 is unchanged.
D) M1 is unchanged, M2 falls by $2000.
Answer: B
Diff: 3
Topic: Section: 7.1
18) M1 does not include

A) MMMFs.
B) travelers' checks.
C) currency.
D) transaction accounts.
Answer: A
Diff: 1
Topic: Section: 7.1
19) Which of the following is not part of M1?

A) Transaction accounts
B) Checking accounts
C) Time deposits
D) Travelers' checks
Answer: C
Diff: 1
Topic: Section: 7.1
20) Which of the following statements about M1 and M2 is true?

A) Demand deposits are not part of M1.
B) M2 is more liquid than M1.
C) M1 is larger than M2.
D) Savings deposits are part of M2.
Answer: D
Diff: 1
Topic: Section: 7.1
5
21) Which of the following statements about M1 and M2 is not true?
A) Transaction accounts are part of M1.
B) M2 is more liquid than M1.
C) M2 is larger than M1.
D) Transaction accounts are part of M2.
Answer: B
Diff: 2
Topic: Section: 7.1
22) M2 includes
A) large-denomination time deposits.
B) institutional MMMFs.
C) commercial paper.
D) M1.
Answer: D
Diff: 1
Topic: Section: 7.1
23) M2 does not include

A) Treasury bonds.
B) passbook savings accounts.
C) small-denomination time deposits.
D) M1.
Answer: A
Diff: 1
Topic: Section: 7.1
24) Which of the following is not included in M2?

A) Money market mutual funds held by individuals
B) Money market deposit accounts
C) Money market mutual funds held by institutions
D) Small-denomination time deposits
Answer: C
Diff: 1
Topic: Section: 7.1
6
25) Over half of U.S. currency is
A) held abroad.
B) used in the underground economy.
C) held by banks as reserves.
D) held by businesses, especially retailers, for making transactions.
Answer: A
Diff: 1
Topic: Section: 7.1
26) People in other countries want to hold U.S. dollars as a

A) medium of exchange.
B) store of value.
C) unit of account.
D) standard of deferred payment.
Answer: B
Diff: 1
Topic: Section: 7.1
27) We shouldn't be concerned about U.S. currency held abroad because

A) the currency will never return to the United States.
B) foreigners use it to buy U.S. bonds.
C) it represents an interest-free loan to the United States.
D) foreigners can't spend it in their own countries.
Answer: C
Diff: 1
Topic: Section: 7.1
28) What's the most common way for a central bank to reduce the money supply?
A) Collect higher taxes
B) Sell bonds to the public
C) Buy bonds from the government
D) Buy bonds from the public
Answer: B
Diff: 1
Topic: Section: 7.1
7
29) What's the most common way for a central bank to increase the money supply?
A) Collect higher taxes
B) Sell bonds to the public
C) Buy bonds from the government
D) Buy bonds from the public
Answer: D
Diff: 1
Topic: Section: 7.1
30) What's the most common way for a central bank to change the money supply?
A) Changing tax collections
B) Buying bonds from or selling bonds to the public
C) Buying bonds from or selling bonds to the government
D) Using open-market operations
Answer: D
Diff: 1
Topic: Section: 7.1
31) Suppose you read in the paper that the Federal Reserve plans to expand the money supply.
The Fed is most likely to do this by
A) printing more currency and distributing it.
B) purchasing government bonds from the public.
C) selling government bonds to the public.
D) buying newly issued government bonds directly from the government itself.
Answer: B
Diff: 1
Topic: Section: 7.1
32) A developing country does not have enough taxes to cover its expenditures and is unable to
borrow. This government would be most likely to cover its deficit by
A) purchasing government bonds from the public.
B) selling government bonds to the public.
C) selling newly issued government bonds directly to the central bank.
D) buying newly issued government bonds directly from the central bank.
Answer: C
Diff: 2
Topic: Section: 7.1
8
33) What are the major components of M1? What are the major components of M2? Describe
each component.
Answer: The principal components of M1 are currency, transaction accounts, and travelers'
checks. Currency includes coins and Federal Reserve notes (i.e., paper money). Transaction
accounts are those against which checks may be drawn. Travelers' checks are a substitute for
currency that can be replaced if lost or stolen. The principal components of M2 are M1, savings
account deposits including money market deposit accounts (MMDAs), small time deposits, and
money market mutual funds (MMMFs). Small time deposits are certificates of deposit (CDs) of
less than $100,000 denomination. MMMFs invest their shareholders' funds in short-term
securities, pay market-based interest rates, and allow holders to write a limited number of
checks. MMDAs are like MMMFs, except they are offered by banks or thrift institutions such as
savings and loan associations.
Diff: 2
Topic: Section: 7.1
34) What function is money playing in each of these situations:

a. You walk into a store in Germany and see that all the prices are in euros.
b. You buy a candy bar for $1.25.
c. Your Aunt Jane keeps $100 bills tucked into many books in her house.
Answer: a. unit of account; b. medium of exchange; c. store of value.
Diff: 2
Topic: Section: 7.1
35) What happens to M1 and M2 due to each of the following changes?

(a) You take $500 out of your checking account and put it into a passbook savings account.
(b) You take $1000 out of your checking account and buy travelers' checks.
(c) You take $1500 out of your money market mutual fund and deposit into your checking
account.
(d) You cash in $2000 in savings bonds and invest the money in a certificate of deposit.
Answer:
(a) M1 falls $500, M2 is unchanged (remember that M1 is part of M2).
(b) M1 and M2 are both unchanged.
(c) M1 rises $1500, M2 is unchanged.
(d) M1 is unchanged, M2 rises $2000.
Diff: 2
Topic: Section: 7.1
9
36) Why is per-capita U.S. currency demand so large? Who is holding large amounts of U.S.
currency and why are they doing so? Should U.S. policymakers be concerned about this? Why?
Answer: Currency demand is large mostly because foreigners hold many dollars. They do so
because of inflation or political instability in their countries. Policymakers shouldn't be very
concerned, since foreigners' dollar holdings represent an interest-free loan to the United States.
However, a cause for concern may be that fluctuations in our money supply may reflect
conditions abroad that are unrelated to the U.S. economy.
Diff: 1
Topic: Section: 7.1
7.2 Portfolio Allocation and the Demand for Assets
1) You are putting together a portfolio of assets. The four most important characteristics of the
assets you will choose are expected return, time to maturity,
A) risk, and liquidity.
B) risk, and collateral
C) risk, and reward.
D) liquidity, and standard issue size.
Answer: A
Diff: 1
Topic: Section: 7.2
2) People's best guesses about returns on assets are called

A) expected returns.
B) liquidity.
C) risk.
D) the term structure of returns.
Answer: A
Diff: 1
Topic: Section: 7.2
3) The set of assets that a holder of wealth chooses to own is called

A) an asset assortment.
B) a wealth strategy.
C) a portfolio.
D) an investment envelope.
Answer: C
Diff: 1
Topic: Section: 7.2
10
4) Which of the following portfolio allocation decisions represents the best individual response
to an increase in the interest rate on nonmonetary assets?
A) Sell some stocks and use the money to buy bonds.
B) Sell some bonds and use the money to buy stocks.
C) Buy some nonmonetary assets with cash.
D) Sell some nonmonetary assets to get cash.
Answer: C
Diff: 2
Topic: Section: 7.2
5) The uncertainty about the return an asset will earn is

A) liquidity.
B) risk.
C) time to maturity.
D) stochastic dominance.
Answer: B
Diff: 1
Topic: Section: 7.2
6) The risk premium is

A) the amount by which the expected return on a risky asset exceeds the return on an otherwise
comparable safe asset.
B) a measure of the riskiness of the overall economy in a domestic country compared with a
foreign country.
C) the amount an investor must pay to insure his or her stock portfolio to protect against a fall in
value.
D) the amount an investment bank charges to guarantee an annuity that pays a fixed rate of
return in the future.
Answer: A
Diff: 1
Topic: Section: 7.2
7) The amount by which the expected return on a risky asset exceeds the return on an otherwise
comparable safe asset is known as the
A) CDS spread.
B) risk premium.
C) VIX.
D) term spread.
Answer: B
Diff: 1
Topic: Section: 7.2
11
8) The existence of a ________ means that the interest rate on a two-year bond will exceed the
average interest rate on two successive one-year bonds.
A) risky asset.
B) securitization premium.
C) term structure.
D) risk premium.
Answer: D
Diff: 1
Topic: Section: 7.2
9) The ease and quickness with which an asset can be exchanged for goods, services, or other
assets is its
A) risk.
B) time to maturity.
C) velocity.
D) liquidity.
Answer: D
Diff: 1
Topic: Section: 7.2
10) Time to maturity refers to the amount of time until

A) an asset repays the principal to an investor.
B) an asset pays interest for the first time.
C) a bond can be sold on the secondary market.
D) the yield curve shows an upward slope.
Answer: A
Diff: 1
Topic: Section: 7.2
11) Compared with money, bonds have

A) less risk and less liquidity.
B) less risk and more liquidity.
C) more risk and less liquidity.
D) more risk and more liquidity.
Answer: C
Diff: 1
Topic: Section: 7.2
12
12) AAA Company stock has a higher expected rate of return than ZZZ Company stock. All else
being equal, you would expect that relative to ZZZ, AAA company stock provides
A) less risk and less liquidity.
B) less risk and more liquidity.
C) more risk and less liquidity.
D) more risk and more liquidity.
Answer: C
Diff: 1
Topic: Section: 7.2
13) The least liquid asset on this list is

A) money.
B) bonds.
C) houses.
D) stocks.
Answer: C
Diff: 1
Topic: Section: 7.2
14) In the early 2000s, lenders began issuing mortgage loans to people who would normally not
be qualified to take out loans because they did not meet lending standards. Those borrowers are
known as
A) alternative borrowers.
B) weak borrowers.
C) subprime borrowers.
D) credit risks.
Answer: C
Diff: 1
Topic: Section: 7.2
15) The financial crisis occurred in 2008 in large part because of losses on securities consisting
of bundles of mortgage loans known as
A) home loan loss reserves.
B) credit default swaps.
C) mortgage-backed securities.
D) naked put options.
Answer: C
Diff: 1
Topic: Section: 7.2
13
16) A one-year bond has an interest rate of 5% today. Investors expect that in one year, a one-
year bond will have an interest rate equal to 7%. According to the expectations theory of the term
structure of interest rates, in equilibrium, a two-year bond today will have an interest rate equal
to
A) 3.0%.
B) 5.0%.
C) 5.5%.
D) 6.0%.
Answer: D
Diff: 2
Topic: Section: 7.2
17) A one-year bond has an interest rate of 5% today. Investors expect that in one year, a one-
year bond will have an interest rate equal to 7%. Investors expect that in two years, a one-year
bond will have an interest rate equal to 9%. According to the expectations theory of the term
structure of interest rates, in equilibrium, a three-year bond today will have an interest rate equal
to
A) 4.0%.
B) 5.0%.
C) 6.0%.
D) 7.0%.
Answer: D
Diff: 2
Topic: Section: 7.2
18) The idea that investors today compare the returns on bonds with differing times to maturity
to see which is expected to give them the highest return is the underlying principle behind the
________ of the term structure of interest rates.
A) expectations theory
B) investors' viewpoint analysis
C) segmented-markets theory
D) yield comparison theory
Answer: A
Diff: 1
Topic: Section: 7.2
14
19) The interest rate on long-term bonds is somewhat higher than suggested by the expectations
theory because
A) the expectations theory doesn't account for taxes.
B) a risk premium exists.
C) an inflation premium must be added to long-term bonds.
D) the Fed can only control short-term interest rates.
Answer: B
Diff: 1
Topic: Section: 7.2
20) By spreading her investments out over many different assets, an investor achieves
A) a higher expected return.
B) increased risk.
C) diversification.
D) greater liquidity.
Answer: C
Diff: 1
Topic: Section: 7.2
21) Suppose that you could buy a one-year bond today, which has an interest rate of 3%. If you
wait a year and buy a one-year bond then, the interest rate will be 4%. Two years from now, a
one-year bond is expected to offer an interest rate of 5%. According to the expectations theory of
the term structure of interest rates, what is the interest rate on a two-year bond today? What is the
interest rate on a three-year bond today?
Answer: Two-year bond: (3% + 4%)/2 = 3.5%; Three-year bond: (3% + 4% + 5%)/3 = 4%.
Diff: 2
Topic: Section: 7.2
15
22) Suppose that:
1) The interest on a one-year bond today is 3%;
2) The interest on a one-year bond starting one year from now is expected to be 4% per year;
3) The interest on a one-year bond starting two years from now is expected to be 5% per year;
4) The risk premium on a two-year bond is 0.5%; and
5) The risk premium on a three-year bond is 1.0%.
Use that information to answer the following questions.

a) According to the expectations theory, what is the interest rate today on a two-year bond?
Show your work.
b) According to the expectations theory, what is the interest rate today on a three-year bond?
Show your work.
c) Plot the yield curve.
Answer:
a) (3% + 4%)/2 + 0.5% = 4.0%
b) (3% + 4% + 5%)/3 + 1.0% = 5.0%
c) plot 3 points with 1, 2, and 3 years to maturity vs. yields of 3%, 4%, and 5%.
Diff: 2
Topic: Section: 7.2
7.3 The Demand for Money
1) A 10% decrease in real income usually leads to ________ in money demand.

A) an increase
B) no change
C) a decrease of less than 10%
D) a decrease of 10%
Answer: C
Diff: 1
Topic: Section: 7.3
2) A 5% increase in real income usually leads to ________ in money demand.

A) a decrease
B) no change
C) an increase of less than 5%
D) a decrease of 5%
Answer: C
Diff: 1
Topic: Section: 7.3
16
3) Which of the following is most likely to lead to a decrease of 10% in the nominal demand for
money?
A) An increase in real income of 5%
B) A decrease in real income of 5%
C) A decline of 10% in the price level
D) An increase of 10% in the price level
Answer: C
Diff: 2
Topic: Section: 7.3
4) Which of the following is most likely to lead to an increase of 1% in the nominal demand for
money?
A) An increase in real income of 0.5%
B) A decrease in real income of 0.5%
C) A decline of 1% in the price level
D) An increase of 1% in the price level
Answer: D
Diff: 2
Topic: Section: 7.3
5) The opportunity cost of holding currency decreases when

A) income decreases.
B) the interest rate on bonds decreases.
C) the interest rate on money decreases.
D) wealth decreases.
Answer: B
Diff: 1
Topic: Section: 7.3
6) An increase in the real interest rate would cause an increase in the real demand for money
A) no matter what the change in expected inflation.
B) if expected inflation fell by less than the rise in the real interest rate.
C) if expected inflation fell by the same amount as the rise in the real interest rate.
D) if expected inflation fell by more than the rise in the real interest rate.
Answer: D
Diff: 2
Topic: Section: 7.3
17
7) An increase in expected inflation is likely to cause
A) a decline in the demand for real balances.
B) an increase in the demand for real balances.
C) no change in the demand for real balances.
D) no change in the demand for real balances only if the income elasticity of real money demand
is zero.
Answer: A
Diff: 1
Topic: Section: 7.3
8) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times,
and will shift $10,000 into bonds from his checking account for each percentage point that the
interest rate on bonds exceeds the interest rate on his checking account. If the interest rate on
checking accounts is 4% and the interest rate on bonds is 9%, how much does Mr. Pierpont keep
in his checking account?
A) $50,000
B) $70,000
C) $130,000
D) $150,000
Answer: B
Diff: 1
Topic: Section: 7.3
9) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times,
and will shift $10,000 into bonds from his checking account for each percentage point that the
interest rate on bonds exceeds the interest rate on his checking account. Currently, he keeps
$100,000 in bonds, which pay him 7%. What is the current interest rate on checking accounts?
A) 5%
B) 7%
C) 9%
D) 10%
Answer: A
Diff: 1
Topic: Section: 7.3
18
10) Money demand is given by
Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, real money demand is equal to
A) 1300.
B) 1500.
C) 260,000.
D) 300,000.
Answer: A
Diff: 2
Topic: Section: 7.3
11) Over time, the wealth of society increases and payments technologies get more efficient.
What is the effect on money demand of these two changes?
A) Money demand rises proportionately to the rise in wealth.
B) Money demand rises, but less than proportionately to the rise in wealth.
C) The overall effect is ambiguous.
D) Money demand declines.
Answer: C
Diff: 2
Topic: Section: 7.3
12) If there is a financial panic and increased uncertainty about the returns in the stock market
and bond market, what is the likely effect on money demand?
A) Money demand declines first, then rises when inflation increases.
B) Money demand rises.
Answer: B
Diff: 2
Topic: Section: 7.3
13) Suppose a new law imposes a tax on all trades of bonds and stock. What is the likely effect
on money demand?
A) Money demand declines first, then rises when inflation increases.
B) Money demand rises.
Answer: B
Diff: 2
Topic: Section: 7.3
19
14) If real income rises 4%, prices rise 1%, and nominal money demand rises 4%, what is the
income elasticity of real money demand?
A) 3/4
B) 4/5
C) 5/6
D) 1
Answer: A
Diff: 3
Topic: Section: 7.3
15) If real income rises 5%, prices rise 3%, and nominal money demand rises 7%, what is the
income elasticity of real money demand?
A) 3/4
B) 4/5
C) 5/6
D) 6/7
Answer: B
Diff: 3
Topic: Section: 7.3
16) If the interest elasticity of money demand is -0.1, by what percent does money demand
change if the nominal interest rate rises from 2% to 3%?
A) -0.1%
B) 5%
C) 0%
D) -5%
Answer: D
Diff: 2
Topic: Section: 7.3
17) If the income elasticity of money demand is 3/4 and the interest elasticity of money demand
is -1/4, by what percent does money demand rise if income rises 10% and the nominal interest
rate rises from 4% to 5%?
A) 7.50%
B) 6.25%
C) 5.00%
D) 1.25%
Answer: D
Diff: 3
Topic: Section: 7.3
20
18) Velocity is defined as
A) nominal money stock/nominal GDP.
B) nominal GDP/nominal money stock.
C) real money stock/real GDP.
D) mc2.
Answer: B
Diff: 1
Topic: Section: 7.3
19) If real GDP is $4 billion, the price level is 1.25, and the nominal money stock is $500
million, then velocity is
A) 0.1.
B) 1.
C) 10.
D) 100.
Answer: C
Diff: 2
Topic: Section: 7.3
20) Money demand is given by

Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, velocity is equal to
A) 0.65.
B) 0.75.
C) 1.33.
D) 1.54.
Answer: D
Diff: 2
Topic: Section: 7.3
21) Suppose velocity is 3, real output is 9000, and the price level is 1.5. What is the level of real
money demand in this economy?
A) 2000
B) 3000
C) 6000
D) 30,000
Answer: B
Diff: 2
Topic: Section: 7.3
21
22) Suppose real money demand is 1000, real output is 6000, and the price level is 200. What is
the level of velocity in this economy?
A) 2
B) 3
C) 6
D) 12
Answer: C
Diff: 2
Topic: Section: 7.3
23) Suppose real money demand is 400, real output is 16,000, and the price level is 150. What is
the level of velocity in this economy?
A) 40
B) 400
C) 4,000
D) 6,000
Answer: A
Diff: 2
Topic: Section: 7.3
24) Suppose velocity is constant at 4, real output is 10, and the price level is 2. From this initial
situation, the government increases the nominal money supply to 6. If velocity and output remain
unchanged, by how much will the price level increase?
A) 2.4%
B) 20%
C) 24%
D) 50%
Answer: B
Diff: 3
Topic: Section: 7.3
25) A claim to resources that is recorded in a computer system is called a(n)

A) autoimmune claim.
B) cryptocurrency.
C) digital image.
D) stakeholder claim.
Answer: B
Diff: 1
Topic: Section: 7.3
22
26) According to the quantity theory of money, velocity
A) increases with nominal income.
B) is constant.
C) is positively related to the real interest rate.
D) is proportional to the price level.
Answer: B
Diff: 1
Topic: Section: 7.3
27) What happens to real money demand (rise, fall, no change) due to a change in each of the
following factors?
(a) A tax on stock market transactions is introduced.
(b) Computerized bond trading reduces transactions costs.
(c) People's average level of wealth rises.
(d) The threat of a recession increases the riskiness of stocks and bonds.
(e) The interest rate paid on checking account balances declines.
(f) The price level falls in a one-time jump.
Answer:
(a) Rises
(b) Falls
(c) Rises
(d) Rises
(e) Falls
(f) Is unchanged
Diff: 1
Topic: Section: 7.3
28) Give five examples of factors that could reduce the demand for money.
Answer: Lower price level, lower real income, higher real interest rate, higher expected
inflation, lower nominal interest rate on money, lower wealth, lower risk on alternative assets,
higher risk on money, increased liquidity of alternative assets, or increased efficiency of
payments technologies.
Diff: 2
Topic: Section: 7.3
23
29) Suppose the money demand function is
Md/P = 1000 + 0.2Y - 1000 (r + πe).
(a) Calculate velocity if Y = 2000, r = .06, and πe = .04.
(b) If the money supply (Ms) is 2600, what is the price level?
(c) Now suppose the real interest rate rises to 0.11, but Y and Ms are unchanged. What happens
to velocity and the price level? So if the nominal interest rate were to rise from 0.10 to 0.15 over
the course of a year, with Y remaining at 2000, what would the inflation rate be?
Answer:
(a) V = PY/M = Y/(M/P). From the money demand function, M/P = 1300. So V = 2000/1300 =
1.54.
(b) P = Ms/(Md/P) = 2600/1300 = 2.
(c) Now Md/P = 1250. So V = 2000/1250 = 1.6. P = Ms/(Md/P) = 2600/1250 = 2.08. The
inflation rate would be 4%.
Diff: 3
Topic: Section: 7.3
7.4 Asset Market Equilibrium
1) Under a situation of asset market equilibrium,

A) the quantity of money supplied equals the quantity of money demanded.
B) the quantity of money supplied equals the quantity of nonmonetary assets demanded.
C) the quantity of nonmonetary assets supplied equals the quantity of monetary assets demanded.
D) the quantity of money supplied equals the quantity of nonmonetary assets supplied.
Answer: A
Diff: 1
Topic: Section: 7.4
2) When the real quantity of money supplied equals the real quantity of money demanded, there
is said to be
A) goods market equilibrium.
B) asset market equilibrium.
C) monetary neutrality.
D) money illusion.
Answer: B
Diff: 1
Topic: Section: 7.4
24
3) When the quantity of money supplied equals the quantity of money demanded, then
A) the goods market is in equilibrium.
B) the asset market is in equilibrium.
C) the money market is in equilibrium.
D) the money market is not in equilibrium.
Answer: B
Diff: 1
Topic: Section: 7.4
4) Which of these variables is not a variable in the equation for the asset market equilibrium
condition?
A) Nominal money supply
B) Price level
C) Real income
D) Investment
Answer: D
Diff: 1
Topic: Section: 7.4
5) Which of these variables is not a variable in the equation for the asset market equilibrium
condition?
A) Saving
B) Expected rate of inflation
C) Real interest rate
D) Real income
Answer: A
Diff: 1
Topic: Section: 7.4
6) If the quantity of money demanded exceeds the quantity of money supplied, then
A) the quantity of nonmonetary assets demanded exceeds the quantity supplied.
B) the quantity of nonmonetary assets supplied exceeds the quantity demanded.
C) the quantity of nonmonetary assets demanded will still equal the quantity supplied, all else
being equal.
D) you can make no conclusions about the relative supply and demand of nonmonetary assets.
Answer: B
Diff: 2
Topic: Section: 7.4
25
7) If the asset market is to remain in equilibrium, then if the money supply increases, output is
unchanged, the price level is unchanged, and the expected inflation rate is unchanged, then
A) the real interest rate must rise.
B) the real interest rate must decline.
C) the nominal interest rate must rise.
D) the inflation rate must rise.
Answer: B
Diff: 2
Topic: Section: 7.4
8) Suppose the real money demand function is

Md/P = 2400 + 0.2Y - 10,000 (r + πe).
Assume M = 4000, P = 2.0, πe = .03, and Y = 5000. The real interest rate that clears the asset
market is
A) 3%.
B) 6%.
C) 11%.
D) 14%.
Answer: C
Diff: 3
Topic: Section: 7.4

Md/P = 2400 + 0.2Y - 10,000 (r + πe).
Assume M = 5000, πe = .03, and Y = 5000. If the price level were to decrease from 2.5 to 2.0,
then the real interest rate would decrease by how many percentage points (assuming Md, πe, and
Y are unchanged)?
A) 4
B) 5
C) 9
D) 14
Answer: B
Diff: 3
Topic: Section: 7.4
26
Md/P = 2400 + 0.2Y - 10,000 (r + πe).
Assume M = 5000, P = 2.0, and πe = .03. If Y were to increase from 4000 to 5000, then the real
interest rate would increase by how many percentage points?
A) 2
B) 4
C) 5
D) 7
Answer: A
Diff: 3
Topic: Section: 7.4
11) Suppose real money demand is

L = 0.8 Y - 100,000 (r + πe).
If the nominal money supply is 12,000, real output is 15,000, the real interest rate is .02, and the
expected inflation rate is .01, then the price level is
A) 3/4.
B) 1.
C) 4/3.
D) 3.
Answer: C
Diff: 3
Topic: Section: 7.4
12) Suppose the real interest rate is 4% and the expected inflation rate is 3%. If the money
supply increases by 10% and output, the real interest rate, and the expected inflation rate are
unchanged, then the price level increases by
A) 3%.
B) 4%.
C) 7%.
D) 10%.
Answer: D
Diff: 3
Topic: Section: 7.4
13) Define asset market equilibrium and state the asset market equilibrium condition.
Answer: Asset market equilibrium exists when the quantity of assets supplied equals the
quantity of assets demanded in a national economy in some time period. The asset market
equilibrium equation is M/P = L(Y, r + πe).
Diff: 1
Topic: Section: 7.4
27
14) Suppose the money demand function is given by
Md/P = 640 + 0.1Y - 5000 (r + πe).
Suppose the central bank changes the nominal money supply depending on income and inflation:
Ms = 1000 + 0.1Y - 4000π.
(a) If expected inflation equals actual inflation = 0.03, Y = 1000, and r = 0.02, calculate the price
level.
(b) If inflation rises to 0.04 while the other variables remain as in part a, calculate the price level.
(c) If expected inflation rises to 0.04 while the other variables remain as in part a, calculate the
price level.
(d) If the real interest rate rises to 0.03 while the other variables remain as in part a, calculate the
price level.
Answer:
Plug in the value of Y and use text Eq. (7.10) to get P = [1100 - 4000π]/[740 - 5000(r + πe)].
When r = 0.02, this becomes P = [1100 - 4000π]/[640 - 5000π].
(a) P = 980/490 = 2.
(b) P = 940/490 = 1.92.
(c) P = 980/440 = 2.23.
(d) P = 980/440 = 2.23.
Diff: 2
Topic: Section: 7.4
15) Assume that prices and wages adjust rapidly so that the markets for labor, goods, and assets
are always in equilibrium. What are the effects of each of the following on output, the expected
real interest rate, and the current price level?
(a) a temporary increase in taxes
(b) a reduction in the effective tax rate on capital
(c) an increase in expected inflation
Answer:
(a) Under Ricardian equivalence, no effect on output, real interest rate, or price level. Without
Ricardian equivalence, higher national saving means a lower expected real interest rate. Output
is unchanged because of no change in labor supply or demand. The lower expected real interest
rate increases real money demand, thus reducing the price level.
(b) The lower tax rate on capital increases desired investment, thus raising the expected real
interest rate. No effect on the labor market, so output is not changed. The higher expected real
interest rate reduces real money demand, thus increasing the price level.
(c) The increase in the expected inflation rate has no effect on the labor market or goods market,
so output and the expected real interest rate do not change. The higher expected inflation rate
reduces real money demand, thus increasing the price level.
Diff: 2
Topic: Section: 7.4
28
7.5 Money Growth and Inflation
1) If the nominal money supply doubles while real money demand is unchanged, what happens
to the price level?
A) The price level increases by a factor of four.
B) The price level doubles.
C) The price level is unchanged.
D) The price level falls by one-half.
Answer: B
Diff: 1
Topic: Section: 7.5
2) If real money demand doubles while the nominal money supply is unchanged, what happens
to the price level?
A) The price level increases by a factor of four.
B) The price level doubles.
C) The price level is unchanged.
D) The price level falls by one-half.
Answer: D
Diff: 1
Topic: Section: 7.5
3) If the asset market is in equilibrium, the growth rate of the nominal money supply minus the
growth rate of real money demand equals
A) the real interest rate.
B) the inflation rate.
C) the price level.
D) the growth rate of real output.
Answer: B
Diff: 2
Topic: Section: 7.5
4) If nominal money supply grows 3% and real money demand grows 8%, the inflation rate is
A) -5%.
B) 8/3%.
C) 5%.
D) 11%.
Answer: A
Diff: 2
Topic: Section: 7.5
29
5) If real money demand increases 5% and real money supply increases 10%, by about how
much does the price level change?
A) Falls by 5%
B) Unchanged
C) Rises by 2%
D) Rises by 5%
Answer: D
Diff: 1
Topic: Section: 7.5
6) If the income elasticity of money demand is 3/4 and income increases 8%, by about how much
does the price level change?
A) Falls by 6%
B) Unchanged
C) Rises by 6%
D) Rises by 8%
Answer: A
Diff: 1
Topic: Section: 7.5
7) If the nominal money supply grows 5%, real income falls 2%, and the income elasticity of
money demand is 0.8, then the inflation rate is
A) 3.0%.
B) 3.4%.
C) 6.6%.
D) 7.0%.
Answer: C
Diff: 2
Topic: Section: 7.5
8) If the nominal money supply grows 6%, real income rises 2%, and the inflation rate is 5%,
then the income elasticity of money demand is
A) 0.5.
B) 0.75.
C) 1.0.
D) 1.5.
Answer: A
Diff: 2
Topic: Section: 7.5
30
9) If the nominal money supply grows 10%, the inflation rate is 6%, and the income elasticity of
money demand is 1.0, then real income growth equals
A) 1%.
B) 2%.
C) 3%.
D) 4%.
Answer: D
Diff: 2
Topic: Section: 7.5
10) Large differences in inflation rates among countries are almost always the result of large
differences in
A) productivity.
B) real income growth.
C) the growth rates of real money demand.
D) the growth rates of nominal money supplies.
Answer: D
Diff: 1
Topic: Section: 7.5
11) When a government prints money to finance its expenditures, it is likely to cause
A) unemployment.
B) inflation.
C) deflation.
D) reductions in the use of barter.
Answer: B
Diff: 1
Topic: Section: 7.5
12) The most likely explanation for the high inflation rates that countries like Russia and the
Ukraine have suffered is that
A) large inflows of foreign funds increase the money supply, causing inflation.
B) without inflation, these countries would be unable to achieve high rates of growth.
C) borrowing from the central bank is the most expedient method of funding the government's
expenditures.
D) the flood of financial innovations has increased liquidity in these nations' economies.
Answer: C
Diff: 2
Topic: Section: 7.5
31
13) Bonds sold by the U.S. government that offer a certain real interest rate are known as
A) zero-coupon bonds.
B) Treasury Inflation-Protected Securities.
C) denominalized securities.
D) savings bonds.
Answer: B
Diff: 2
Topic: Section: 7.5
14) The excess of the nominal interest rate over the TIPS interest rate is known as the
A) interest-rate differential.
B) break-even inflation rate.
C) yield spread.
D) term structure.
Answer: B
Diff: 1
Topic: Section: 7.5
15) The break-even inflation rate is the

A) excess of the nominal interest rate over the TIPS interest rate.
B) inflation rate that makes the nominal interest rate equal the real interest rate.
C) negative of the real interest rate.
D) inflation rate that is optimal according to the Friedman rule.
Answer: A
Diff: 1
Topic: Section: 7.5
16) How does the break-even inflation rate differ from the expected inflation rate as measured in
surveys?
A) They are very close to each other.
B) The break-even inflation rate varies less than the expected inflation rate from surveys.
C) The break-even inflation rate varies more than the expected inflation rate from surveys.
D) The break-even inflation rate is always several percentage points higher than the expected
inflation rate from surveys.
Answer: C
Diff: 2
Topic: Section: 7.5
32
17) Calculate the change in the price level for each of the following events, taken one at a time,
with other variables unchanged.
(a) Money supply increases 10%.
(b) Money demand increases 5%.
(c) Money supply decreases 5% while money demand increases 5%.
(d) Money supply increases 15% while money demand increases 5%.
Answer:
(a) 10%
(b) -5%
(c) -10%
(d) 10%
Diff: 1
Topic: Section: 7.5
18) Why did some of the formerly Communist countries of Eastern Europe have inflation rates
over 100%, while others didn't? Which factor was more important in explaining the differing
inflation rates, real money demand or nominal money supply? Why did the countries with high
inflation rates allow inflation to get so high?
Answer: Some countries had high inflation while others didn't because of differences in rates of
money growth. Real money demand didn't vary enough to explain the differences in inflation
rates; instead, nominal money supply growth was strongly correlated with inflation. The
countries allowed inflation to get so high because they were trying to finance government
expenditures by printing money.
Diff: 1
Topic: Section: 7.5
33
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7.1 What Is Money?

2) A disadvantage of the barter system is that

4) In economics, money refers to

7) For something to satisfy the medium-of-exchange function of money, it must be

18) M1 does not include

19) Which of the following is not part of M1?

20) Which of the following statements about M1 and M2 is true?

23) M2 does not include

24) Which of the following is not included in M2?

26) People in other countries want to hold U.S. dollars as a

27) We shouldn't be concerned about U.S. currency held abroad because

34) What function is money playing in each of these situations:

35) What happens to M1 and M2 due to each of the following changes?

7.2 Portfolio Allocation and the Demand for Assets

2) People's best guesses about returns on assets are called

3) The set of assets that a holder of wealth chooses to own is called

5) The uncertainty about the return an asset will earn is

6) The risk premium is

10) Time to maturity refers to the amount of time until

11) Compared with money, bonds have

13) The least liquid asset on this list is

Use that information to answer the following questions.

7.3 The Demand for Money

1) A 10% decrease in real income usually leads to ________ in money demand.

2) A 5% increase in real income usually leads to ________ in money demand.

5) The opportunity cost of holding currency decreases when

20) Money demand is given by

25) A claim to resources that is recorded in a computer system is called a(n)

7.4 Asset Market Equilibrium

1) Under a situation of asset market equilibrium,

8) Suppose the real money demand function is

9) Suppose the real money demand function is

11) Suppose real money demand is

15) The break-even inflation rate is the

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