Question

1. If the Federal Reserve decreases the money supply to raise the federal funds rate, ceteris paribus, then

a. The value of the U.S. dollar will increase in foreign exchange markets

b. Economic output will increase

c. The economy will experience inflation

d. The unemployment rate will fall

e. The value of the U.S. dollar will decrease in foreign exchange markets

2. When the short-run aggregate supply (SRAS) curve is steeper, expansionary monetary policy ________ in the short run, and when the short-run aggregate supply (SRAS) curve is flatter, expansionary monetary policy __________ in the short run.

a. has no effect on output; has no effect on prices.

b. has an effect on output that is equal to the effect on prices; has an effect on prices that is equal to the effect on output

c. has a larger effect on prices than on output; has a larger effect on output than on prices.
d. has no effect on prices or output

e. has a larger effect on output than prices; has a larger effect on prices than output

Answer 1

1).

Here as the money supply decreases that decrease the US price level. Now, according to monetary approach to exchange rate the exchange rate is the ratio of US price to foreign price. As the US price decreases implied the exchange rate also decreases, => the value of US currency increases compare to the foreign currency.

So, the correct answer is “A”.

2).

When the SRAS is steeper, expansionary monetary policy “has a larger effect on price than on output” in the SR, and when the SRAS is flatter, expansionary monetary policy “has a larger effect on output than on price” in SR. So, the correct answer is “C”.

Consider the following fig.

Here the initial equilibrium is E0, where equilibrium price is P0 and the output is Y0. Now, as the money supply increases, that will increase the AD to AD2. So, for steeper SRAS1 the new equilibrium is E1, the equilibrium price and output are P1 and Y1 respectively. Now, for flatter SRAS2 the new equilibrium is E2, the equilibrium price and output are P2 and Y2 respectively.

Now, “P1 > P2” and “Y1 < Y2”, => expansionary monetary policy “has a larger effect on price than on output” in the SR, and when the SRAS is flatter, expansionary monetary policy “has a larger effect on output than on price” in SR.