Tackle the Test:
Free-Response Question
2.
At an interest rate below equilibrium, the quantity of
money demanded exceeds the quantity of money supplied.
People want to shift more of their wealth out of interest-
bearing assets such as CDs and hold it as money instead.
Because the quantity of interest-bearing nonmoney assets
demanded is less than the quantity supplied, those trying
to sell these assets will have to offer a higher interest rate
to attract buyers. As the interest rate rises, the quantity of
money demanded decreases. This process continues until
the market returns to equilibrium.
Module 29
Check Your Understanding
- a.As capital flows into the economy, the supply of loanable
funds increases. This is illustrated by the shift of the sup-
ply curve from S 1 to S 2 in the accompanying diagram. As
the equilibrium moves from E 1 to E 2 , the equilibrium
interest rate falls from r 1 to r 2 , and the equilibrium quan-
tity of loanable funds increases from Q 1 to Q 2.
b.Savings fall due to the higher proportion of retired peo-
ple, and the supply of loanable funds decreases. This is
illustrated by the leftward shift of the supply curve from
S 1 to S 2 in the accompanying diagram. The equilibrium
moves from E 1 to E 2 , the equilibrium interest rate rises
from r 1 to r 2 , and the equilibrium quantity of loanable
funds falls from Q 1 to Q 2.
Quantity
of money
rE
rL
Interest
rate, r
E
MD
MS
M ML
Q 1 Q 2 Quantity of
loanable funds
r 1
r 2
Interest
rate, r
S 1
S 2
E 1
E 2
D
Tackle the Test:
Free-Response Question
- provide financial services to depository
institutions—regional Federal Reserve banks
- provide financial services to depository
- supervise and regulate banking institutions—regional
Federal Reserve banks and the Board of Governors - maintain the stability of the financial system—the
Board of Governors - conduct monetary policy—the Federal Open Market
Committee
Module 28
Check Your Understanding
- a.By increasing the opportunity cost of holding money, a
high interest rate reduces the quantity of money demand-
ed. This is a movement up and to the left along the
money demand curve.
b.A 10% fall in prices reduces the quantity of money
demanded at any given interest rate, shifting the money
demand curve leftward.
c.This technological change reduces the quantity of money
demanded at any given interest rate, so it shifts the
money demand curve leftward.
d.Payments in cash require employers to hold more
money, increasing the quantity of money demanded at
any given interest rate. So it shifts the money demand
curve rightward. - a.A 1% purchase fee on debit/credit card transactions
for purchases less than $50 increases the benefit of hold-
ing cash because consumers will save money by paying
with cash.
b.An increase in the interest paid on six-month CDs raises
the opportunity cost of holding cash because holding
cash requires forgoing the higher interest paid.
c.A fall in real estate prices has no effect on the opportuni-
ty cost or benefit of holding cash because real estate is an
illiquid asset and therefore isn’t relevant in the decision
of how much cash to hold. Also, real estate transactions
are generally not carried out using cash.
d.Because many purchases of food are made in cash, a sig-
nificant increase in the cost of food increases the benefit
of holding cash.
Tackle the Test:
Multiple-Choice Questions
- d
- d
- b
- d
- e
S-16 SOLUTIONS TO AP REVIEW QUESTIONS