Free Response 2009

Scoring Guidelines 2009

Question 1 (d)

  • Money Supply in the graph of the money market is vertical

    NOMINAL INTEREST RATE

Question 1 (e)

  • Higher interest rate decreases investment and interest-sensitive consumption spending, and that both consumption and investment are components of aggregate demand.

Question 1 (f)

Disinflationary Monetary Policy in the Short Run and the Long Run Inflation Rate Long-tun Phillips curve c Natural rate of unemployment I. Contractionary policy moves the economy down along the short-lun Phillips curve .. Short-run Phillips curve with high expected inflation Sh01t-run Phillips curve with low expected inflation Unemployment Rate . but in the long run, expected 2... inflation falls, and the short-run Phillips curve shifts to the left.

Question 2 (b)

26-3a Supply and Demand for Loanable Funds The economy's market for loanable funds, like other markets in the economy, is governed by supply and demand. To understand how the market for loanable funds operates, therefore, we first look at the sources of supply and demand in that market. The supply of loanable funds comes from people who have some extra income they want to save and lend out. This lending can occur directly, such as when a household buys a bond from a firm, or it can occur indirectly, such as when a household makes a deposit in a bank, which in turn uses the funds to make loans. In both cases, saving is the source of the supply of loanablefunds. The demand for loanable funds comes from households and firms who wish to borrow to make investments. This demand includes families taking out mortgages to buy new homes. It also includes firms borrowing to buy new equipment or build factories. In both cases, investment is the source of the demand for loanable funds.

Question 3 (a)

Assume that the reserve requirement is 20 percent and banks hold no excess reserves. (a) Assume that Kim deposits $100 of cash from her pocket into her checking account. Calculate each of the following. (i) The maximum dollar amount the commercial bank can initially lend (ii) The maximum total change in demand deposits in the banking system (iii) The maximum change in the money supply

maximum dollar amount the bank can initially lend is $80. maximum change in demand deposits is $500. maximum change in the money supply is $400.

  • Maximum change in money supply = Initial deposit / RRR - Initial deposit

Question 3 (c)

  • Inflation will decrease the value of real wages.

    Inflation Effects of Inflation — Decrease purchasing Power of a Dollar — Decrease Value of Real Wages — Increased Interest Rates — Decreased Saving and Investing — Increased Production Costs

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