Economic Equations and Monetary Theory Questions

Extra review questions for Final exam

1. Y = C + I + G + (N-X), Explain what each component in this equation stands for. Now show long run equilibrium on a graph using Aggregate Demand and Aggregate Supply curves. Make sure to label everything.

2. Explain what is meant by the quantity theory of money. Write down the equation and explain each component.

3. What is the relationship between the velocity of money and money demand?

4. What is the relationship between the price level (P) and the purchasing power of money (PPM)?

5. Using two separate money demand and supply graphs, show how deflation (fall in P) can occur in two ways.

6. Using two separate money demand and supply graphs, show how inflation (rise in P) can occur in two ways.

7. What is the monetary base? Assume the Fed increases the monetary base by increasing reserves at Bank A by $200 million and the required reserve ratio is 5%. Show how the money supply would increase using balance sheets of 3 different banks.

8. Draw two separate graphs that show the “do nothing” or classical approach and the active monetary policy or Keynesian approach in the case of an aggregate demand shock in the AS-AD framework. Briefly explain the steps involved in the Fed’s monetary response.

9. Draw two separate graphs that show the Fed’s response in the case of a short-run aggregate supply shock, one in the case of prioritizing inflation and the other in the case of prioritizing output stabilization, in the AS-AD framework. Briefly explain the steps involved in the Fed’s monetary response.

10. What is meant by stagflation? Draw a graph that depicts stagflation using the AS-AD framework. Is an active monetary policy likely to be effective under stagflation? Why or why not?