ECON 214 HW21 Monetary and Fiscal Policy Assignment Liberty University updated
answers
1. The opportunity cost of holding money
Suppose you've just inherited $5,000 from a relative. You're trying to decide
whether to put the $5,000 in a non-interest-bearing account so that you can use
it whenever you want (that is, hold it as money) or to use it to buy a U.S.
Treasury bond.
The opportunity cost of holding the inheritance as money depends on the
interest rate on the bond.
For each of the interest rates in the following table, compute the opportunity cost
of holding the $5,000 as money.
Interest Rate on Government Bond
Opportunity Cost
(Percent)
(Dollars per year)
5
7
What does the previous analysis suggest about the market for money?
The quantity of money demanded increases as the interest rate rises.
The quantity of money demanded decreases as the interest rate rises.
The supply of money is independent of the interest rate.
Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the
$5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it
as money) or to use it to buy a U.S. Treasury bond.
The opportunity cost of holding the inheritance as money depends on the interest rate on the bond.
For each of the interest rates in the following table, compute the opportunity cost of holding the
$5,000 as money.
Interest Rate on Government Bond Opportunity Cost
(Percent) (Dollars per year)
8
6
What does the previous analysis suggest about the market for money?
The quantity of money demanded decreases as the interest rate falls.
The supply of money is independent of the interest rate.
The quantity of money demanded increases as the interest rate falls.
Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the
$5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it
as money) or to use it to buy a U.S. Treasury bond.
The opportunity cost of holding the inheritance as money depends on the interest rate on the bond.
For each of the interest rates in the following table, compute the opportunity cost of holding the
$5,000 as money.
Interest Rate on Government Bond Opportunity Cost
(Percent) (Dollars per year)
6
3
What does the previous analysis suggest about the market for money?
The supply of money is independent of the interest rate.
The quantity of money demanded decreases as the interest rate falls.
The quantity of money demanded increases as the interest rate falls.
2. The theory of liquidity preference and the downward-sloping aggregate demand
curve
Suppose the money market for some hypothetical economy is given by the following graph, which
plots the money demand and money supply curves. Assume the central bank in this economy (the
Fed) fixes the quantity of money supplied.
Suppose the price level decreases from 90 to 75.
Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level
on the market for money.
Following the price level decrease, the quantity of money demanded at the initial interest rate of
6% will be than the quantity of money supplied by the Fed at this interest rate. As a result,
individuals will attempt to their money holdings. In order to do so, they will bonds
and other interest-bearing assets, and bond issuers will realize that they interest rates until
equilibrium is restored in the money market at an interest rate of
.
The following graph plots the aggregate demand curve for this economy.
Show the impact of the decrease in the price level by moving the point along the curve or shifting
the curve.
The change in the interest rate found in the previous task will lead to a in residential and
business spending, which will cause in the quantity of output demanded in the economy.
Suppose the money market for some hypothetical economy is given by the following graph, which
plots the money demand and money supply curves. Assume the central bank in this economy (the
Fed) fixes the quantity of money supplied.
Suppose the price level increases from 150 to 175.
Shift the appropriate curve on the graph to show the impact of an increase in the overall price level
on the market for money.
Following the price level increase, the quantity of money demanded at the initial interest rate of
9% will be than the quantity of money supplied by the Fed at this interest rate. As a result,
individuals will attempt to their money holdings. In order to do so, they will bonds
and other interest-bearing assets, and bond issuers will realize that they interest rates until
equilibrium is restored in the money market at an interest rate of
.
The following graph plots the aggregate demand curve for this economy.
Show the impact of the increase in the price level by moving the point along the curve or shifting
the curve.
The change in the interest rate found in the previous task will lead to a in residential and
business spending, which will cause in the quantity of output demanded in the economy.
3. Changes in the money supply
The following graph represents the money market for some hypothetical economy. This economy is
similar to the United States in the sense that it has a central bank called the Fed, but a major
difference is that this economy is closed (and therefore does not have any interaction with other
world economies). The money market is currently in equilibrium at an interest rate of 6% and a
quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.
Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75
percentage points. To do this, the Fed will use open-market operations to the money
by the public.
Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by
placing the new money supply curve (MS) in the correct location. Place the black point (plus
symbol) at the new equilibrium interest rate and quantity of money.
Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy
of targeting a higher interest rate will the cost of borrowing, causing residential and
business investment spending to and the quantity of output demanded to at each
price level.
Shift the curve on the graph to show the general impact of the Fed's new interest rate target on
aggregate demand.
The following graph represents the money market for some hypothetical economy. This economy is
similar to the United States in the sense that it has a central bank called the Fed, but a major
difference is that this economy is closed (and therefore does not have any interaction with other
world economies). The money market is currently in equilibrium at an interest rate of 5% and a
quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.
3. Changes in the money supply
The following graph represents the money market for some hypothetical economy. This economy is
similar to the United States in the sense that it has a central bank called the Fed, but a major
difference is that this economy is closed (and therefore does not have any interaction with other
world economies). The money market is currently in equilibrium at an interest rate of 5% and a
quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.
New MS CurveNew Equilibrium00.10.20.30.40.50.60.70.87.06.56.05.55.04.54.03.53.0INTEREST
RATE (Percent)MONEY (Trillions of dollars)Money SupplyMoney Demand
Suppose the Fed announces that it is lowering its target interest rate by 25 basis points, or 0.25
percentage points. To do this, the Fed will use open-market operations to the money
by the public.
Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by
placing the new money supply curve (MS) in the correct location. Place the black point (plus
symbol) at the new equilibrium interest rate and quantity of money.
Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy
of targeting a lower interest rate will the cost of borrowing, causing residential and business
investment spending to and the quantity of output demanded to at each price level.
Shift the curve on the graph to show the general impact of the Fed's new interest rate target on
aggregate demand.
The following graph represents the money market for some hypothetical economy. This economy is
similar to the United States in the sense that it has a central bank called the Fed, but a major
difference is that this economy is closed (and therefore does not have any interaction with other
world economies). The money market is currently in equilibrium at an interest rate of 3.5% and a
quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.
Suppose the Fed announces that it is raising its target interest rate by 50 basis points, or 0.5
percentage points. To do this, the Fed will use open-market operations to the money
by the public.
Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by
placing the new money supply curve (MS) in the correct location. Place the black point (plus
symbol) at the new equilibrium interest rate and quantity of money.
Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy
of targeting a higher interest rate will the cost of borrowing, causing residential and
business investment spending to and the quantity of output demanded to at each
price level.
Shift the curve on the graph to show the general impact of the Fed's new interest rate target on
aggregate demand.
4. The multiplier effect of a change in government purchases
Suppose there is some hypothetical closed economy in which households spend $0.80 of each
additional dollar they earn and save the remaining $0.20.
The marginal propensity to consume (MPC) for this economy is , and the spending multiplier
for this economy is .
Suppose the government in this economy decides to increase government purchases by $400
billion. The increase in government spending will lead to an increase in income, creating an initial
change in consumption equal to . This increases income yet again, leading to a second
change in consumption equal to . The total change in demand resulting from the initial
change in government spending is .
The following graph shows the aggregate demand curve (AD1AD1) for this economy before the
change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2AD2) after the
multiplier effect takes place. For simplicity, assume that there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2AD2) is parallel to the initial aggregate
demand curve (AD1AD1). You can see the slope of AD1AD1 by selecting it on the graph.
Suppose there is some hypothetical closed economy in which households spend $0.85 of each
additional dollar they earn and save the remaining $0.15.
The marginal propensity to consume (MPC) for this economy is , and the spending multiplier
for this economy is .
Suppose the government in this economy decides to increase government purchases by $300
billion. The increase in government spending will lead to an increase in income, creating an initial
change in consumption equal to . This increases income yet again, leading to a second
change in consumption equal to . The total change in demand resulting from the initial
change in government spending is .
The following graph shows the aggregate demand curve (AD1AD1) for this economy before the
change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2AD2) after the
multiplier effect takes place. For simplicity, assume that there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2AD2) is parallel to the initial aggregate
demand curve (AD1AD1). You can see the slope of AD1AD1 by selecting it on the graph.
Suppose there is some hypothetical closed economy in which households spend $0.80 of each
additional dollar they earn and save the remaining $0.20.
The marginal propensity to consume (MPC) for this economy is , and the spending multiplier
for this economy is .
Suppose the government in this economy decides to decrease government purchases by $300
billion. The decrease in government spending will lead to a decrease in income, creating an initial
change in consumption equal to . This decreases income yet again, leading to a second
change in consumption equal to . The total change in demand resulting from the initial
change in government spending is .
The following graph shows the aggregate demand curve (AD1AD1) for this economy before the
change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2AD2) after the
multiplier effect takes place. For simplicity, assume that there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2AD2) is parallel to the initial aggregate
demand curve (AD1AD1). You can see the slope of AD1AD1 by selecting it on the graph.
5. Fiscal policy, the money market, and aggregate demand
Suppose there is some hypothetical economy in which households spend $0.50 of each additional
dollar they earn and save the $0.50 they have left over. The following graph plots the economy's
initial aggregate demand curve (AD1AD1).
Suppose now that the government increases its purchases by $2 billion.
Use the green line (triangle symbol) on the following graph to show the aggregate demand curve
(AD2AD2) after the multiplier effect takes place.
Hint: Be sure the new aggregate demand curve (AD2AD2) is parallel to AD1AD1. You can see the
slope of AD1AD1 by selecting it on the following graph.
The following graph plots equilibrium in the money market at an interest rate of 1.5% and a
quantity of money equal to $45 billion.
Show the impact of the increase in government purchases on the interest rate by shifting one or
both of the curves on the following graph.
Suppose that for every increase in the interest rate of one percentage point, the level of
investment spending declines by $1 billion. Based on the changes made to the money market in
the previous scenario, the new interest rate causes the level of investment spending to by
.
Taking the multiplier effect into account, the change in investment spending will cause the quantity
of output demanded to by at every price level. The impact of an increase in
government purchases on the interest rate and the level of investment spending is known as the
effect.
Use the purple line (diamond symbol) on the graph at the beginning of this problem to show the
aggregate demand curve (AD3AD3) after accounting for the impact of the increase in government
purchases on the interest rate and the level of investment spending.
Hint: Be sure your final aggregate demand curve (AD3AD3) is parallel to AD1AD1 and AD2AD2.
You can see the slopes of AD1AD1 and AD2AD2 by selecting them on the graph.
Suppose there is some hypothetical economy in which households spend $0.50 of each additional
dollar they earn and save the $0.50 they have left over. The following graph plots the economy's
initial aggregate demand curve (AD1AD1).
Suppose now that the government increases its purchases by $2.5 billion.
Use the green line (triangle symbol) on the following graph to show the aggregate demand curve
(AD2AD2) after the multiplier effect takes place.
Hint: Be sure the new aggregate demand curve (AD2AD2) is parallel to AD1AD1. You can see the
slope of AD1AD1 by selecting it on the following graph.
The following graph plots equilibrium in the money market at an interest rate of 1.5% and a
quantity of money equal to $15 billion.
Show the impact of the increase in government purchases on the interest rate by shifting one or
both of the curves on the following graph
Suppose that for every increase in the interest rate of one percentage point, the level of
investment spending declines by $1 billion. Based on the changes made to the money market in
the previous scenario, the new interest rate causes the level of investment spending to by
.
Taking the multiplier effect into account, the change in investment spending will cause the quantity
of output demanded to by at every price level. The impact of an increase in
government purchases on the interest rate and the level of investment spending is known as the
effect.
Use the purple line (diamond symbol) on the graph at the beginning of this problem to show the
aggregate demand curve (AD3AD3) after accounting for the impact of the increase in government
purchases on the interest rate and the level of investment spending.
Hint: Be sure your final aggregate demand curve (AD3AD3) is parallel to AD1AD1 and AD2AD2.
You can see the slopes of AD1AD1 and AD2AD2 by selecting them on the graph.
Suppose there is some hypothetical economy in which households spend $0.50 of each additional
dollar they earn and save the $0.50 they have left over. The following graph plots the economy's
initial aggregate demand curve (AD1AD1).
Suppose now that the government increases its purchases by $3 billion.
Use the green line (triangle symbol) on the following graph to show the aggregate demand curve
(AD2AD2) after the multiplier effect takes place.
Hint: Be sure the new aggregate demand curve (AD2AD2) is parallel to AD1AD1. You can see the
slope of AD1AD1 by selecting it on the following graph.
6. Changes in taxes
The following graph plots an aggregate demand curve.
Using the graph, shift the aggregate demand curve to depict the impact that a tax hike has on the
economy.
Suppose the governments of two very similar economies, economy N and economy M, implement a
permanent tax cut of equal size. The marginal propensity to consume (MPC) in economy N is 0.85
and the MPC in economy M is 0.8. The economies are otherwise completely identical.
The tax cut will have a larger impact on aggregate demand in the economy with the .
The following graph plots an aggregate demand curve.
Using the graph, shift the aggregate demand curve to depict the impact that a tax cut has on the
economy.
Suppose the governments of two very similar economies, economy B and economy A, implement a
permanent tax cut of equal size. Investment spending in economy B is more sensitive to changes in
the interest rate than investment spending in economy A. The economies are otherwise completely
identical.
The tax cut will have a smaller impact on aggregate demand in the economy with the
The following graph plots an aggregate demand curve.
Using the graph, shift the aggregate demand curve to depict the impact that a tax hike has on the
economy.
Suppose the governments of two very similar economies, economy Y and economy Z, implement a
tax cut of equal size. The tax cut in economy Y is permanent, while the tax cut in economy Z is
temporary. The economies are otherwise completely identical.
The tax cut will have a larger impact on aggregate demand in the economy with the .
7. Use of discretionary policy to stabilize the economy
Should the government use monetary and fiscal policy in an effort to stabilize the economy? The
following questions address the issue of how monetary and fiscal policies affect the economy, as
well as the pros and cons of using these tools to combat economic fluctuations.
The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply (AS),
and long-run aggregate supply (LRAS) curves for the U.S. economy in February 2026.
Suppose the government chooses to intervene in order to return the economy to the natural level
of output by using policy.
Depending on which curve is affected by the government policy, shift either the AS curve or the AD
curve to reflect the change that would successfully restore the natural level of output.
Suppose that in February 2026 the government successfully carries out the type of policy
necessary to restore the natural level of output described in the previous question. In July 2026,
U.S. imports decrease because the United States has implemented trade restrictions on Mexican
goods. Due to the associated with implementing monetary and fiscal policy, the impact of
the government's new policy will likely once the effects of the policy are fully realized.
Should the government use monetary and fiscal policy in an effort to stabilize the economy? The
following questions address the issue of how monetary and fiscal policies affect the economy, as
well as the pros and cons of using these tools to combat economic fluctuations.
The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply (AS),
and long-run aggregate supply (LRAS) curves for the U.S. economy in May 2026.
Suppose the government chooses to intervene in order to return the economy to the natural level
of output by using policy.
Depending on which curve is affected by the government policy, shift either the AS curve or the AD
curve to reflect the change that would successfully restore the natural level of output.
Suppose that in May 2026 the government successfully carries out the type of policy necessary to
restore the natural level of output described in the previous question. In November 2026, U.S.
exports decrease because India implements trade restrictions on U.S. goods. Due to the
associated with implementing monetary and fiscal policy, the impact of the government's new
policy will likely once the effects of the policy are fully realized.
Should the government use monetary and fiscal policy in an effort to stabilize the economy?
The following questions address the issue of how monetary and fiscal policies affect the
economy, as well as the pros and cons of using these tools to combat economic fluctuations.
The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply
(AS), and long-run aggregate supply (LRAS) curves for the U.S. economy in January 2026.
Suppose the government chooses to intervene in order to return the economy to the natural
level of output by using policy.
Depending on which curve is affected by the government policy, shift either the AS curve or the AD
curve to reflect the change that would successfully restore the natural level of output.
Suppose that in January 2026 the government successfully carries out the type of policy necessary
to restore the natural level of output described in the previous question. In March 2026, consumer
confidence increases, leading to an increase in consumer spending. Due to the associated
with implementing monetary and fiscal policy, the impact of the government's new policy will likely
once the effects of the policy are fully realized.
8. Using policy to stabilize the economy
The government possesses the tools necessary to influence the output level in the short run
through use of monetary and fiscal policy. However, there is some debate regarding whether the
government should attempt to stabilize the economy.
Which of the following are arguments in favor of active stabilization policy by the
government? Check all that apply.
Businesses make investment plans many months in advance.
Shifts in aggregate demand are often the result of waves of pessimism or optimism among
consumers and businesses.
Changes in government purchases and taxation must be passed by both houses of Congress
and signed by the president.
The current tax system acts as an automatic stabilizer.
Which of the following policies are examples of automatic stabilizers? Check all that apply.
Corporate income taxes
Personal income taxes
The discount rate
The government possesses the tools necessary to influence the output level in the short run
through use of monetary and fiscal policy. However, there is some debate regarding whether the
government should attempt to stabilize the economy.
Which of the following statements regarding the debate over stabilization policy are correct? Check
all that apply.
Opponents of active stabilization policy believe that significant time lags in both fiscal and
monetary policy often exacerbate economic fluctuations.
Advocates of active stabilization policy believe that the government can adjust monetary and
fiscal policy to counteract waves of excessive optimism and pessimism among consumers and
businesses.
Opponents of active stabilization believe that active fiscal and monetary policies have no
effect on aggregate demand.
Advocates of active stabilization believe that implementation lags for fiscal and monetary
policy do not exist.
Which of the following policies are examples of automatic stabilizers? Check all that apply.
Unemployment insurance benefits
Corporate income taxes
The federal funds rate
The government possesses the tools necessary to influence the output level in the short run
through use of monetary and fiscal policy. However, there is some debate regarding whether the
government should attempt to stabilize the economy.
Which of the following are arguments in favor of active stabilization policy by the
government? Check all that apply.
The Fed can effectively respond to excessive pessimism by expanding the money supply and
lowering interest rates.
The current tax system acts as an automatic stabilizer.
Changes in government purchases and taxation must be passed by both houses of Congress
and signed by the president.
Shifts in aggregate demand are often the result of waves of pessimism or optimism among
consumers and businesses.
Which of the following policies are examples of automatic stabilizers? Check all that apply.
Corporate income taxes
Unemployment insurance benefits
Personal income taxes
