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(econ216)[2007](s)Quiz%203-sol~PPSpider^_10242.pdf
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Econ216 C TAKE-HOM E QUI Z3 Ans wers are due onM rch 13ath, 2007
Problem 1 Suppose thatapersonsyearlynominal income is$50,000. Also supposethat herm oneydem and function is given by
M d = PY(0.25 C i)
(a) W hat isherdemand form oney whentheinterestrateis5%?
Md
= PY(0.25 C i) M d = 50000(0.25C 0.05) Md
= $10, 000
(b)Suppose thattheinterest rateis5%. Inpercentageterms, what happens toherdemand for money ifheryearly incom eisreduced by 50%?
If yearlyincome isreducedto$25,000,new moneydemand: M d = PY(0.25 C i) Md
= 25000 (0. 25 C 0. 05) M d = $5,000
Demand for m oneyfalls by 50%
Problem 2 A bondprom isesto pay100in oneyear
(a) W hatisthe interest rateon thebondifitsprice todayis75?85?95?
100
PB =
1+ i 100
i = .1
PB
i =33.33%, 17.6%, 5.26% whenPB =75,85,95 respectively.
(b) W hatistherelation betweentheprice ofthebondandtheinterestrate?Consideranexample of CBusingopenm arket purchase. Describehowthis purchaseaffects bothpricesof bonds and interest rate.
1
Whenthe price ofthe bondincreases,theinterestratefalls.
E.g. Consideranexpansionaryopenm arket operationwhere theCentralBankpurchasesbonds, and pays for them by creatingm oney.
(1)
Dem andfor bonds increases and price of bonds increases

(2)
Supply ofm ney intheeconoomy increases.

(3)
Asa result, weseea fallininterestrate;bondsbecome lessattractiveandm oney balances becomemore attractive. Demand form oneyincreasesandequilibrium in the m oney m arket is m aintained.


i i M d = PYL(i) M
SM

S
i
(c) Iftheinterest rateis8%,what is the price ofthebondtoday?
100

PB =
1+ i 100PB=
1+ 0.08 PB= 92.6
2