ASSIGNMENT

A4

QUESTIONS Q1 First, explain why the money demand curve is downward sloping. Second, graphically illustrate and explain what factor(s) will cause shifts in the money demand curve. Explain what effect changes in interest rate and nominal GDP have on the demand for central bank money.

Q2 Explain what types of policies a central bank can implement to reduce and increase he interest rate. Graphically illustrate and explain what effect a purchase and sale of bonds by the Federal Reserve will have on the money market.

Q3 The demand for money is given by MD = $Y (0.15 – i), where $Y = $20,000 (million), the money supply (MS) is $2000 (million), and i is the policy interest rate determined by the central bank.

a.What is the equilibrium interest rate? Show the equilibrium interest rate on a diagram with money demand and supply curves.

b. Suppose that the following year the nominal GDP ($Y) increases from $20,000 to $25,000 (million) and the amount of money in circulation remains unchanged. What would be the new equilibrium interest rate? Show the equilibrium interest rate on a diagram with money demand and supply curves.

c.Now suppose that the central bank responds to the change in GDP by $500 (million) increase in money supply. What is the impact on the interest rate if central bank money is increased to $2500 (million)? Show the equilibrium interest rate on a diagram with money demand and supply curves.