AP_Krugman_Textbook

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

1. 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

2. 
   
   
   
   1. provide financial services to depository
      institutions—regional Federal Reserve banks
   
   
   
   

2. supervise and regulate banking institutions—regional
   Federal Reserve banks and the Board of Governors


3. maintain the stability of the financial system—the
   Board of Governors


4. conduct monetary policy—the Federal Open Market
   Committee

Module 28

Check Your Understanding

1. 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.


2. 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

1. d


2. d


3. b


4. d


5. e

S-16 SOLUTIONS TO AP REVIEW QUESTIONS