Econ 110A Ch 4 Homework Questions

Please, do not use a calculator or any devices such as cell phones or computers.
1. You bought a bond at the price of $1000 in 2014. The bond offers to pay you $1100 in
2015. The interest rate on the bond is ___ %.
A. 5.

B. 6.

C. 10.

D. 11.

E. 20.

F. 200.

2. Money is
A. income.

B. investment.

C. a medium of exchange.

B. stocks.

C. bonds.

D. GDP

3. Which is money?
A. cash.

D. real estate.

4. The reason for the demand for money is to

A. earn interest.

B. make transactions.

C. make profits.

5. If income decreases, the demand for money

A. increases.

B. decreases.

C. doubles.

6. As a result of the decrease in income in question 5, the ___ shifts to the ___.
A. demand for money, right.
C. supply of money, right.

B. demand for money, left.

D. supply of money, left.

7. As a result of the shift in the relevant curve in question 6, the equilibrium interest rate
A. increases.

B. decreases.

C. doubles.

D. does not change.

8. If the Fed sells bonds, it ___ the bond price and ___ the equilibrium interest rate.
A. increases, increases.
C. decreases, increases.

B. increases, decreases.
D. decreases, decreases.

9. You paid $1000 to buy the bond in question 1, but the price of the bond changes according to
market situations. Assume that more investors are now interested in the bond, increasing its price.
The interest rate on the bond to those investors who buy the bond at the higher price is now __ %
(choose the best one, given the information available).
A. 5.
B. 10.
C. 15.
D. 20.
E. 25.
F. 40.

10. Individuals like you in question 1 and investors in question 9 purchase bonds to earn interest.
The Fed purchases bonds to
A.earn interest.
C. decrease the money supply

B. decrease the equilibrium interest rate

D. decrease the equilibrium GDP.

11. You are a prospective home buyer, and are looking for a low-interest mortgage. When would you
buy a house? (think about questions 11 and 12 together)
A. in a recession.

B. in a boom.

C. either in a recession or in a boom.

12. A plausible reason for the answer to question 11 is that in a recession

A.the demand for money increases.
C. the government does not change G.

B. the Fed is likely to increase the money supply

D. the Fed is likely to sell bonds.

13. Assume that you have private information that the Fed will buy bonds next week. To
maximize capital gains or to minimize capital losses, you should
A. sell bonds now.

B. buy bonds now.

C. borrow money now.

14. Which policy will increase the money supply?

A. a sale of bonds by the Fed.
C. a purchases of bonds by the Fed.
E. an increase in government spending.

B. an increase in taxes by Congress.

D. an increase in the interest rate.
F. a decrease in the budget deficit.

15. In a growing economy where GDP and incomes grow every year, the equilibrium
interest rate will ___ every year if the Fed takes no action.
A. increase.

B. decrease.

C. not change.

16. To counteract the change in the equilibrium interest rate, mentioned in question 15, and
hence to maintain the interest rate at the same level every year, the Fed should ___ every
year.
A. buy bonds.

B. sell bonds.

C. cut taxes.

D. increase taxes.

17. If the interest rate on a bond is z and the price of the bond is $x, the bond must offer
to pay you how much one year later?
18. Discuss the effect of an open market purchase of bonds by the Fed on the equilibrium
interest rate. In your discussion, draw a graph with clearly-labeled curves and axes, and
explain why and how a curve or curves shift in your graph.

Optional question: #5 from the textbook: A persons wealth is $50,000 and her income is
$60,000, and her demand for money is Md = Y (.35 i).
a. Derive the demand for bonds. Suppose the interest rate increases by 10% points.
What is the effect on the demand for bonds?
b. What are the effects of an increase in wealth on money demand and on bond
demand? Explain in words.
c. What are the effects of an increase in income on money demand and on bond
demand? Explain in words.
d. When people earn more money, they will obviously hold more bonds. What is
wrong with this sentence?

Answer keys
1. C
2. C
3. A
4. B
5. B
6. B
7. B
8. C
9.A
10.B
11.A
12.B
13.B
14.C
15.A
16.A
17. x(1+z)
18. The money supply curve shifts to the right, and the money demand curve stays the same.
The equilibrium interest rate falls.
#5 from the textbook:
a. BD = 50,000 - 60,000*(.35-i)
An increase in the interest rate of 10% P increases bond demand by $6,000.
b. An increase in wealth increases bond demand, but has no effect on money demand,
which depends on income (a proxy for transactions demand).
c. An increase in income increases money demand, but decreases bond demand, since we
implicitly hold wealth constant.
d. When people earn more income, this does not change their wealth right away. Thus,
they increase their demand for money and decrease their demand for bonds.