Deck 7: The Asset Market, Money, and Prices

Question 1

The following are all functions of money except

A) medium of exchange.
B) store of value.
C) source of anxiety.
D) unit of account.

Answer 1

C

Question 2

Personal fixed-term savings deposits are included in M2+ rather than M1 because

A) they are available only to institutions, not to individuals.
B) they can be used as a medium of exchange, but are not as useful as the components of M1 as a store of value.
C) they can be used as a medium of exchange, but are less useful because of restrictions on their use for transactions.
D) they can easily be turned into cash for transaction purposes, but cannot be used directly as a medium of exchange.

Answer 2

C

Question 3

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 3

B

Question 4

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

Question 5

Which of the following is not included in M2+?

A) money market mutual funds
B) deposits at trust and mortgage companies
C) non-personal fixed-term deposits
D) small-denomination personal fixed-term deposits

Question 6

One of money's 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.

Question 7

Money Market Mutual Funds (MMMFs) are similar to money because

A) they pay a high rate of interest.
B) they are as liquid as all other components of money.
C) holders can write cheques on them.
D) they cannot be liquidated except at great cost.

Question 8

Suppose your bank lowers its minimum-balance requirement on personal chequing accounts by $500. You take $500 out of your personal chequing account and put it in the money market mutual fund account. What is the overall effect on M1 and M2?

A) M1 falls by $500, M2 rises by $500
B) M1 is unchanged, M2 is unchanged
C) M1 falls by $500, M2 is unchanged
D) M1 is unchanged, M2 rises by $500

Question 9

Which of the following is not part of M1?

A) currency
B) personal chequing accounts
C) personal savings deposits
D) current accounts

Question 10

Which of the following measures is the best measure of money as a medium of exchange?

A) M1
B) M2
C) M3
D) L

Question 11

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.

Question 12

M2 includes

A) large-denomination time deposits.
B) institutional MMMFs.
C) commercial paper.
D) M1.

Question 13

Money's primary role in the economy comes from the benefits of lowering transaction 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.

Question 14

M2 does not include

A) Treasury bonds.
B) passbook savings accounts.
C) small-denomination time deposits.
D) M1.

Question 15

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.

Question 16

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 flat money system.

Question 17

Debit card

A) is money since it can be used for purchasing goods and services.
B) is money since it shows how much money one has in her/his banking account.
C) is not money because it does not look like money.
D) is not money because it cannot be used a medium of exchange, store of value, and unit of account.

Question 18

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.

Question 19

Cigarettes were used as money among the prisoners of war in the German camps at the end of World War II, because

A) cigarettes could be used as a medium of exchange.
B) cigarettes could be used as store of value.
C) cigarettes could be used as unit of accounts.
D) all of the above.

Question 20

Which of the following statements about M1 and M2 is not true?

A) Current accounts are part of M1.
B) M2 is more liquid than M1.
C) M2 is larger than M1.
D) Savings accounts are part of M2.

Question 21

If the income elasticity of money demand is 3/4, by what percent does money demand rise if income rises 10%?

A) 10.00%
B) 7.50%
C) 2.50%
D) 0.75%

Question 22

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.

Question 23

Between 1992 and 2002 Mr. Junius Morgan's real income increased from $100,000 to $200,000. All else being equal, his real demand for money probably

A) decreased.
B) increased, but by less than the increase in real income.
C) increased proportionately to the increase in real income.
D) increased by more than the increase in real income.

Question 24

Money demand is given by M^d/P = 1000 + .2Y - 1000i. Given that P = 200, Y = 2000, and i = .10, nominal money demand is equal to

A) 1,300.
B) 1,500.
C) 260,000.
D) 300,000.

Question 25

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.
C) The overall effect is ambiguous.
D) Money demand declines.

Question 26

If the income elasticity of money demand is 3/4 and the interest elasticity of money demands 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%

Question 27

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.

Question 28

During the past year, Lotusland saw an increase in the price level and increase in interest rates on financial assets, but a fall in personal incomes. The overall demand for money fell. Which of the following factors was most likely to have contributed to this fall in the demand for money?

A) changes in the price level and in interest rates
B) changes in interest rates and personal incomes
C) changes in the price level and personal incomes
D) changes in personal incomes only

Question 29

Which of the following types of money is more liquid?

A) M1
B) M2+
C) M3
D) Currency

Question 30

If the interest elasticity of money demand is -1/4, by what percent does money demand rise if the nominal interest rate rises from 4% to 5%?

A) 6.25%
B) 0.25%
C) -0.25%
D) -6.25%

Question 31

Which of the following is the most likely explanation for the causes behind the fall in the demand for M1 in the 1970s?

A) Higher prices in the 1970s reduced the demand for money.
B) Government deficits increased the demand for money, draining it out of the private sector.
C) Financial innovations, such as money market mutual funds, changed the demand for narrow definitions of money such as M1.
D) Increases in Eurodollar deposits drew money out of the banking system.

Question 32

You are putting together a portfolio of assets. The three most important characteristics of the assets you will choose are

A) expected return, risk, and liquidity.
B) expected return, risk, and collateral.
C) expected return, risk, and maturity.
D) expected return, liquidity, and maturity.

Question 33

Suppose you read in the paper that the Central Bank of Canada plans to expand the money supply. The Central Bank 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.

Question 34

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 chequing account for each percentage point that the interest rate on bonds exceeds the interest rate on his chequing account. If the interest rate on chequing accounts is 4% and the interest rate on bonds is 9%, how much does Mr. Pierpont keep in his chequing account?

A) $50,000
B) $70,000
C) $130,000
D) $150,000

Question 35

Higher interest rates lower the real quantity of money demanded

A) by making alternative nonmonetary assets look relatively more attractive to wealth holders.
B) by causing an increase in the issuance of corporate debt.
C) by changing the distribution of wealth toward the poor who have a lower demand for money.
D) by increasing government interest payments, which in turn increase taxes, lowering disposable income.

Question 36

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.

Question 37

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.

Question 38

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.
C) The overall effect is ambiguous.
D) Money demand declines.

Question 39

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.

Question 40

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 chequing account for each percentage point that the interest rate on bonds exceeds the interest rate on his chequing account. Currently he keeps $100,000 in bonds, which pay him 7%. What is the current interest rate on chequing accounts?

A) 5%
B) 7%
C) 9%
D) 10%

Question 41

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.

Question 42

Which of the following is true about velocity?

A) Velocity is constant.
B) M1 Velocity is more stable than M2 velocity.
C) M2 velocity is more stable than M1 velocity.
D) All else equal, velocity increases as demand for money rises.

Question 43

Suppose velocity is constant at 3, real output is 6000, and the price level is 20. From this initial situation, the government increases the nominal money supply to $50,000. If velocity and output remain unchanged, by how much will the price level increase?

A) 10%
B) 20%
C) 25%
D) 50%

Question 44

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.

Question 45

Suppose velocity is 3, real output is 6000, and the price level is 20. What is the level of real money demand in this economy?

A) 100
B) 2,000
C) 40,000
D) 120,000

Question 46

If nominal GDP is $500 billion, real GDP is $250 billion, and the nominal money stock is $100 billion, then velocity is

A) 2.
B) 2.5.
C) 5.
D) 10.

Question 47

The quantity theory of money assumes that

A) real income is constant.
B) price level is constant.
C) velocity is constant.
D) Money demand is constant.

Question 48

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.

Question 49

An introduction of ATM (automatic teller machines), other things being constant,

A) reduces interest rates since it shifts money demand leftward.
B) reduces interest rates since it shifts money demand rightward.
C) increases interest rates since it shifts money demand leftward.
D) increases interest rates since it shifts money demand rightward.

Question 50

Suppose the real money demand function is M^d/P = 2000 + 0.2Y - 10,000 ^{(i - im)}. Assume M = 5000, P = 2.0, i^m = .04, and π^e = .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

Question 51

Which of the following is true about the asset market equilibrium?

A) The asset market is in equilibrium only if the labour market is in equilibrium.
B) The asset market is in equilibrium when the money market is in equilibrium.
C) The money market is in equilibrium only if the non-monetary asset market is in equilibrium.
D) The asset market is in equilibrium, even if the money market is not.

Question 52

Money demand is given by M^d/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.

Question 53

The asset market equilibrium condition indicates that

A) the price level in an economy is determined by the ratio of money supply to the real demand for money.
B) the price level in an economy is determined by the ratio of the real demand for money to money supply.
C) the price level in an economy is determined by the ratio real demand for money to interest rates.
D) the price level in an economy is determined by the ratio of money supply to real GDP.

Question 54

Suppose the real money demand function is M^d/P = 2000 + 0.2Y - 10,000 ^{(i - im).} Assume M = 5000, i^m = .04, π^e = .03, and Y = 5000. If the price level were to increase from 2.0 to 2.5, then the real interest rate would increase by how many percentage points?

A) 4
B) 5
C) 9
D) 14

Question 55

Suppose the nominal money supply is 5000 and real money demand is 2500. What is the price level?

A) 200
B) 20
C) 2
D) 1/2

Question 56

Velocity is defined as

A) nominal money stock/nominal GDP.
B) nominal GDP/nominal money stock.
C) real money stock/real GDP.
D) E = mc².

Question 57

If real money demand increases 5%, and real money supply remain unchanged, by about how much does the price level change?

A) falls 5%
B) falls 50%
C) rises 50%
D) rises 5%

Question 58

Velocity of money is

A) the ratio of nominal money stock to nominal GDP.
B) the ratio of nominal GDP to nominal money stock.
C) the nominal money stock multiplied by the nominal GDP.
D) the ratio of nominal money stock to real GDP.

Question 59

Suppose the real money demand function is M^d/P = 2000 + 0.2Y - 10,000 (i - i^m). Assume M = 4000, P = 2.0, i^m = .04, π^e = .03, and Y = 5000. The real interest rate that clears the asset market is

A) 3%.
B) 6%.
C) 11%.
D) 14%.

Question 60

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.

Question 61

Suppose the money demand function is given by M^d/P = 640 + 0.1 Y - 5000i. Suppose the Central Bank changes the nominal money supply depending on income and inflation: M^s = 1000 + 0.1 Y - 4000p.
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.

Question 62

Suppose that the money supply and real GDP in 2006 were $80 billion and $220 billion, respectively. In 2007, the central bank increased money supply to $88 billion and real GDP rose to $231 billion. Assume the income elasticity of money is 0.5.
a. What are the rates of growth in money supply and real GDP?
b. What is the inflation rate?
c. If, in 2008, the money supply level remains the same level as 2007, but real GDP grows at another 5 percent, what will be the inflation rate in 2008?

Question 63

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%

Question 64

Why did some of the 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?

Question 65

If real money demand increases 5% and real money supply increases 10%, by about how much does the price level change?

A) falls 5%
B) unchanged
C) rises 2%
D) rises 5%

Question 66

Bank of Canada measures inflation expectations by

A) gathering data by means of a survey of private firms.
B) comparing two long run bonds with the nominal and the real yields to maturity.
C) looking at the past inflation rates in Canada.
D) Both A and B are correct.

Question 67

Describe the Bank of Canada's policy of gradualism in the 1970s. What money aggregate did they attempt to target. What led to great difficulties in their targeting? How long was this policy followed?

Question 68

Suppose the income elasticity of money demand is 0.75 and the interest elasticity of money demand is -0.2. By what percentage does real money demand change in each of the following circumstances?
a. Income rises 2%.
b. The interest rate rises from 4% to 5%.
c. Income falls 4%.
d. The interest rate falls from 6% to 4%.
e. Income rises 3% at the same time that the interest rate rises from 2% to 3%.

Question 69

Although rapid money growth causes inflation, some countries keep increasing their money growth. We can explain this by noting that

A) inflation in those countries is low enough to be ignored by the policy makers.
B) printing money is the only and easy way to finance the government expenditures in those countries.
C) in rich countries inflation does not hurt the economy.
D) policy makers do not know the relationship between inflation and money growth.

Question 70

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 6%
B) unchanged
C) rises 6%
D) rises 8%

Question 71

If the income elasticity of money demand is 3/4, income increases 8%, and real money supply increases 10%, by about how much does the price level change?

A) falls 4%
B) unchanged
C) rises 4%
D) rises 6%

Question 72

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.

Question 73

In each of the following cases, one factor affecting money demand changes. You must tell how the second factor would have to change if real money demand were to remain unchanged overall.
a. Expected inflation rises; real income ________.
b. Nominal interest rate on money rises; wealth ________.
c. Risk on stocks and bonds rises; efficiency of payments technology ________.
d. Risk on money rises; real interest rate ________.
e. Liquidity of nonmonetary assets rises; expected inflation ________.
f. Wealth rises; risk on nonmonetary assets ________.

Question 74

What happens to real money demand (rises, falls, 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 transaction 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 chequing account balances declines.
f. The price level falls in a one-time jump.

Question 75

Which of the following statements about the historical relationship between nominal interest rates and inflation in Canada is true?

A) The nominal interest rate has always been smaller than the inflation rate.
B) The nominal interest rate has always moved with the inflation rate.
C) The nominal interest rate and the inflation rate have tended to move together, but the movements are not perfectly matched because the real interest rate has not been constant.
D) The observed relationship is not consistent with the theory.

Question 76

Suppose the money demand function is M^d/P = 1000 + 0.2Y - 1000i.
a. Calculate velocity if Y: 2000 and i = 0.10.
b. If the money supply (M^s) is 2600, what is the price level?
c. Now suppose the nominal interest rate rises to 0.15, but Y and M^s 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?

Question 77

What happens to M1 and M2+ due to each of the following changes?
a. You take $500 out of your chequing account and put it into a passbook savings account.
b. You take $1000 out of your chequing account and put it into a current account.
c. You take $1500 out of your money-market mutual fund and deposit into your chequing account.
d. You cash in $2000 in savings bonds and invest the money in a certificate of deposit.

Question 78

Calculate the appropriate (income or interest) elasticity of money demand for each of the following cases:
a. Income rises 2% while real money demand rises 1%
b. Interest rate rises from 4% to 5% while real money demand falls 1%
c. Income rises 3% and the interest rate rises from 5% to 6%, while real money demand rises 1% during one year; in another year, income falls 3.5%, the interest rate falls from 4% to 3%, while real money demand falls 1%

Question 79

The most likely explanation for the high inflation rates that countries like Belarus have suffered is

A) that large inflows of foreign funds increase the money supply, causing inflation.
B) that without inflation, these countries would be unable to achieve high rates of growth.
C) that borrowing from the Central Bank is the most expedient method of funding the government's expenditures.
D) that the flood of financial innovations has increased liquidity in these nations' economies.