Question

l. Following an increase in money supply, if the interest rates fall immediately and then eventually rise higher than the original level, then :

a. The liquidity effect is weaker than the income and price level effect and there is fast adjustrnent

b. The liquidity effect is stronger than the income and price level effect

c. The liquidity effect is weaker than the income and price level effect and there is slow adjustment

d. The liquidity effect is stronger than the income and price level effect and there is slow adjustment

2. From historical evidence, we know that in an economic expansion :

a. Supply shifts right and demand shifts left causing equilibrium bond price to rise

b. Supply shifts left and demand shifts right causing equilibrium bond price to rise

c. Supply shifts right by more than the amount that the demand shifts right, causing equilibrium bond price to fall

d. Supply shifts left by more than the demand curve shifts right, causing equilibrium bond price to fall e. Supply shifts right by less than the demand shifts right, causing equilibrium bond price to rise

3. In Keynes framework, if the bond price is below the equilibrium level this means that there is an excess_______ for/of money, which leads interest rates to_______

a. Demand, rise

b. Demand, fall

c. Supply, rise

d. Supply, fall

4.In Keynes framework, if the interest rate is below the equilibrium level, this means there is an excess______ for bonds, which means more people will________leads bond prices to________.

a. Demand, sell, rise

b. Demand, sell, fall

c. Supply, buy, rise

d. Supply, sell, fall

5. An increase in brokerage fees on stocks would lead bond prices

a. To fall and interest to rise

b. To fall and interest to fall

c. To rise and interest to rise

d. To rise and interest to fall

6. If the yield to maturity is greater than the coupon rate:

a. the current price of the bond will be greater than the face value

b. the current price of the bond will be the same as the face value

c. the current price of the bond will be less than the face value

d. the current price could be higher or lower than the face value

7. A rise in inflation rate will:

a. benefit people who will receive payments in the future

b. increase the demand for bonds

c. decrease the supply of bonds

d. benefit people who will make payments in the future

e. C and D are correct

Answer 1

1. The liquidity effect is when the central bank increases money supply and this increases economic activity in the economy. More money means more loans, lesser interest rate, more investment, more consumption and further more income. As income rises eventually as the economy adjusts to new amount of aggregate demand the price level rises. While IS curve will also shift rightwards and so nterest rate rises.

As in the given question, interest rate immediately changes back and even rises! This indicates a strong income and a price effect. A strong income and price effect means that increased income has increased aggregate demand and hence prices and that has a negative effect which is why the interest rate jumps higher than the original level. Also since things with the interest rate change so fast, there indicates fast adjustment process.

Hence option a is correct.

option b cannot be correct because had liquidity effect been stronger, the interest rate would be lower for a longer tiime period

option c is incorrect as there is very fast adjustment.

option d is incorrect because liquidity effect is not stronger than income and price effect.