Free Response

1
Free Response

• Macro Unit 5

2
1) The Bank of Redwood has 1,000,000 in total
reserves and the reserve ratio is 20.
Draw a correctly labeled T-account which
illustrates the current financial position at the
Bank of Redwood assuming they have no excess
reserves. Bob deposits 10,000 of currency into
Bank of Redwood High School Show calculations
for the change in money supply in the entire
banking system caused from this deposit.
(assume no excess reserves are kept in the
banking system) The Federal Reserve purchases
20,000 worth of Government Securities
(bonds) Show calculations for the change in money
supply created by this purchase (assume no
excess reserves are kept in the banking
system) State how much money supply changes if
the Fed purchases 10,000 in bonds with a 100
reserve requirement? Briefly explain your
answer
2) The U.S.
economy is operating above full potential
output Draw a correctly labeled AD/AS model
to illustrate the economic situation described
above show the current equilibrium price level
real GDP Draw a correctly labeled Money Market
graph to illustrate a current equilibrium State
the type of monetary policy the Federal Reserve
should use in the described situation. State how
the Fed would adjust each tool of monetary policy
listed below to solve our current economic
problem Reserve requirement Discount rate- Open
Market Operations Modify both the AD/AS graph
and the Money Market graph for the effect of this
monetary policy Briefly Explain the reasons for
any short run effect of this monetary policy on
Aggregate Demand (AD) Briefly Explain the short
run effect of this monetary policy on
unemployment inflation Clearly Explain how open
market operations effects money supply and
interest rates Hint Be sure to discuss the type
of interest rate in the money market its role
in our economy
3
) Monetarism Write the Equation of
Exchange and state what each variable stands
for Clearly Explain what a monetarist economist
believes when they say money is neutral
Hint describe what monetarism believes
in. Holding everything else constant, if the
Velocity of Money suddenly fell by 50, briefly
explain how the Federal Reserve would most
likely respond to this event.


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Free Response Problem 1 25 pts
4
Free Response Problem 2 30PTS

• Must show an inflationary Gap
• F) AD shifts left

B) Must have nominal i-rate E) MS must shift
left
Nominal
MS
2
MS
2
MS1
Interest
Rate
------------
P1
---------
A
i2
---------
B
-----------
----------
AD2
4
MD
Y1
Qty of
C) Contractionary D) i) R.R.
increases ii) Disc. Rate increases iii) Sell
Bonds
F) When MS ? nominal interest rates ? gt more
expensive for business to borrow gt business net
investment (I) declines gt decreases AD
G) AD shifts left which lowers the price level
and therefore inflation. Based on the short run
Phillips Curve unemployment inflation have an
inverse relationship, so unemployment must ?
H) Open Market Operations is when the Fed
purchases or sell bonds in the open market. When
they buy bonds money flows into the banking
system from Feds vault bonds flow into Fed.
This new money causes MS to rise in the money
market nominal interest rates fall. Lower
interest rates will make it less expensive to
borrow money and therefore directly impact
investment spending AD. In this way, the Fed
has an impact on the growth rate of an economy in
the short run.
5
Free Response Problem 3 20 pts
a) MV PY Money Supply Velocity
Price Level Real GDP (must say real or -2)

• b) Monetarist economists believe that Money is
  Neutral. This means that money supply has no
  effect on real GDP. That is, printing money will
  notby itselfincrease a countries ability to
  produce goods and services (shift our PPF curve)
• Monetarist believe in the Quantity Theory of
  Money where Velocity is constant. Therefore an
  increase in money supply (M) of 20 in the above
  equation will increase price level by the same
  amount. (one ? 20, the other must ? 20)
  (Money is neutral meaning it has no affect on
  real variables)
• This increase will have no affect on real
  GDP as money is neutral!

c) If the Velocity of money fell 50, then the
real money supply also declined by 50 So the
Fed would double the money supply which would
keep nominal output the same Example M 10 V
2 MV 20 then V falls 50 so
M20 V 1 MV 20