158 ❯ Step 4. Review the Knowledge You Need to Score High
❯ Answers and Explanations
- B—The price in this case measures the relative
price (value) of the pop. - A—The reserve ratio = Required reserves/checking
deposits = 0.1 = 10%. Excess reserves = (Checking
deposits – Required reserves) = ($500 – $50) = $450. - E—The Fed has no control of tax rates, which are
an example of fiscal policy. All of the other choices
are tools of contractionary monetary policy. - B—If the demand for money is downward slop-
ing, the nominal interest rate falls because the
money supply curve has shifted rightward.
5. E—If the central bank has decided that moving
to full employment requires an increase in the
federal funds rate, it must sell bonds to decrease
the money supply. The resulting increase in
interest rates decreases AD and puts downward
pressure on the price level.
6. B—Expansionary monetary policies decrease the
interest rate, causing AD to increase, which
increases GDP at equilibrium and increases
employment.
❯ Rapid Review
Stock: A certificate that represents a claim to, or share of, the ownership of a firm.
Equity financing: The firm’s method of raising funds for investment by issuing shares of
stock to the public.
Bond: A certificate of indebtedness from the issuer to the bond holder.
Debt financing: A firm’s way of raising investment funds by issuing bonds to the public.
Fiat money: Paper and coin money used to make transactions because the government
declares it to be legal tender. Because it has no intrinsic value, it is backed by the public’s
trust that the government maintains its value.
Functions of money: Money serves three functions. It serves as a medium of exchange, a
unit of account, and a store of value.
Present value: If r is the current interest rate, the present value of $1 received one year
from now is $1/(1 + r).
Future value: If r is the current interest rate, the future value of $1 invested today for a period
of one year is $1 × (1 + r).
Money supply: The quantity of money in circulation as measured by the Federal Reserve
(the Fed) as M1 and M2. Assumed to be fixed at a given point in time.
M1: The most liquid of money definitions and the basis for all other more broadly defined
measures of money. M 1 = Cash + Coins + Checking deposits + Traveler’s checks.
Liquidity: A measure of how easily an asset can be converted to cash. The more easily it
can be converted to cash, the more liquid the asset.
Transaction demand: The amount of money held in order to make transactions. This is
not related to the interest rate, but it increases as nominal GDP increases.
Asset demand: The amount of money demanded as an asset. As nominal interest rates rise,
the opportunity cost of holding money begins to rise and you are more likely to lessen your
asset demand for money.
Money demand: The demand for money is the sum of money demanded for transactions
and money demanded as an asset. It is inversely related to the nominal interest rate.