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( Unit 3 Answers to End of the Chapter Problems
Chapter 7
The Asset Market, Money, and Prices
Answers To Textbook Problems
Review Questions
1. Money is the economist’s term for assets that can be used in making payments, such as cash and checking accounts. In everyday speech, people often use the term “money” to refer to their income or wealth, but in economics money means only those assets that are widely used and accepted as payment.
2. The three functions of money are (1) the medium of exchange function, which contributes to a better-functioning economy by allowing people to make trades at a lower cost in time and effort than in a barter economy; (2) the unit of account function, which provides a single, uniform measure*…show more content…*

Velocity is a measure of how often money “turns over” in a period. It is equal to nominal GDP divided by the nominal money supply. The quantity theory of money assumes that velocity is constant, which implies that real money demand is proportional to real income and is unaffected by the real interest rate. 7. Equilibrium in the asset market is described by the condition that real money supply equals real money demand because when supply equals demand for money, demand must also equal supply for nonmonetary assets. The aggregation assumption that is needed for this is that we can lump all wealth into two categories: (1) money and (2) nonmonetary assets. 8. In equilibrium, the price level is proportional to the nominal money supply; in particular it equals the nominal money supply divided by real money demand. Similarly, the inflation rate is equal to the growth rate of the nominal money supply minus the growth rate of real money demand. 9. Factors that could increase the public’s expected rate of inflation include a rise in money growth or a decline in income growth. With no effect on the real interest rate, the increase in the expected inflation rate would increase the nominal interest rate. Numerical*…show more content…*

In Keynesian analysis, a supply shock may reduce output in two ways: (1) a reduction in output, because the supply shock reduces the marginal product of labor, shifting the FE line to the left; and (2) a further reduction in output if the supply shock is something like an oil price shock that is large enough to cause many firms to raise prices, shifting the LM curve up and to the left so much that it intersects the IS curve to the left of the FE line. Supply shocks create problems for stabilization policy because: (1) policy can do nothing to affect the location of the FE line; and (2) using expansionary policy risks worsening the already-high rate of

Velocity is a measure of how often money “turns over” in a period. It is equal to nominal GDP divided by the nominal money supply. The quantity theory of money assumes that velocity is constant, which implies that real money demand is proportional to real income and is unaffected by the real interest rate. 7. Equilibrium in the asset market is described by the condition that real money supply equals real money demand because when supply equals demand for money, demand must also equal supply for nonmonetary assets. The aggregation assumption that is needed for this is that we can lump all wealth into two categories: (1) money and (2) nonmonetary assets. 8. In equilibrium, the price level is proportional to the nominal money supply; in particular it equals the nominal money supply divided by real money demand. Similarly, the inflation rate is equal to the growth rate of the nominal money supply minus the growth rate of real money demand. 9. Factors that could increase the public’s expected rate of inflation include a rise in money growth or a decline in income growth. With no effect on the real interest rate, the increase in the expected inflation rate would increase the nominal interest rate. Numerical

In Keynesian analysis, a supply shock may reduce output in two ways: (1) a reduction in output, because the supply shock reduces the marginal product of labor, shifting the FE line to the left; and (2) a further reduction in output if the supply shock is something like an oil price shock that is large enough to cause many firms to raise prices, shifting the LM curve up and to the left so much that it intersects the IS curve to the left of the FE line. Supply shocks create problems for stabilization policy because: (1) policy can do nothing to affect the location of the FE line; and (2) using expansionary policy risks worsening the already-high rate of

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