Check Your Understanding

AP Macroeconomics MODULE 31 REVIEW

1. Assume that there is an increase in the demand for money at every interest rate. Using a diagram, show what effect this will have on the equilibrium interest rate for a given money supply.

2. Now assume that the Fed is following a policy of targeting the federal funds rate. What will the Fed do in the situation described in question 1 to keep the federal funds rate unchanged? Illustrate with a diagram.

3. Suppose the economy is currently suffering from a recessionary gap and the Federal Reserve uses an expansionary monetary policy to close that gap. Describe the short-run effect of this policy on the following. a. the money supply curve

b. the equilibrium interest rate

c. investment spending

d. consumer spending

e. aggregate output

Tackle the Test: Multiple-Choice Questions

1. At each meeting of the Federal Open Market Committee, the Federal Reserve sets a target for which of the following? I. the federal funds rate II. the prime interest rate III. the market interest rate a. I only b. II only c. III only d. I and III only e. I, II and III 2. Which of the following actions can the Fed take to decrease the equilibrium interest rate? a. increase the money supply b. increase money demand c. decrease the money supply d. decrease money demand e. both (a) and (d)

3. Contractionary monetary policy attempts to ______aggregate demand by ______interest rates. a. Decrease Increasing b. Increase Decreasing c. Decrease Decreasing d. Increase Increasing e. Increase Maintaining

4. Which of the following is a goal of monetary policy? a. zero inflation b. deflation c. price stability d. increased potential output e. decreased actual real GDP

5. When implementing monetary policy, the Federal Reserve attempts to achieve a. an explicit target inflation rate. b. zero inflation. c. a low rate of deflation. d. a low, but positive inflation rate. e. 4–5% inflation.

Tackle the Test: Free-Response Questions (answer on loose leaf)

1. a. What can the Fed do with each of its tools to implement expansionary monetary policy during a recession?

b. Use a correctly labeled graph of the money market to explain how the Fed’s use of expansionary monetary policy affects interest rates in the short run.

c. Explain how the interest rate changes you graphed in part b affect aggregate supply and demand in the short run.

d. Use a correctly labeled aggregate demand and supply graph to illustrate how expansionary monetary policy affects aggregate output in the short run.