1. What is the opportunity cost of
a. holding $10,000 in your checking account (that doesn't pay interest) when the interest
rate on interest bearing assets is 5%.
b. holding $10,000 in your checking account (that doesn't pay interest) when the interest
rate on interest bearing assets is 10%.
c. Do you think people are more or less likely to hold balances in their checking account
in part b, compared to part a? Why?
2. Suppose the Federal Reserve wants to shift to more restrictive monetary policy.
a. What economic problem is the Federal Reserve worried about here?
b. How would the Federal Reserve shift to restrictive monetary policy using open market
operations? How this open market operation decrease the money supply?
c. What would be the effect of restrictive monetary policy on:
i. The reserves available to banks
ii. The real interest rate
iii. Household spending on consumer durables
iv. The dollar price of foreign currency.
v. Net exports
vi. The prices of stocks and real assets like apartments or office buildings
vii. Real GDP
3. Suppose the economy is in a recession with high unemployment and low output.
a. Draw an aggregate demand and aggregate supply diagram to illustrate the current
situation. Be sure to include the AD, SRAS, and LRAS curves.
b. Identify the open market operation that would bring the economy out of recession and
into long-run equilibrium.
c. Draw a graph of the loanable funds market to show the effect of this open market
operation on the real interest rate. Why does the open market operation affect the real
interest rate?
d. Draw an aggregate demand and aggregate supply diagram to illustrate the effect of the
open market operation on output and the price level. Explain in works why the policy has
the effect that you have shown in the graph.
